The Pepsi Bottling Group, Inc. Q4 2009 Earnings Call Transcript

Feb. 2.10 | About: Pepsi Bottling (PBG)

The Pepsi Bottling Group, Inc. (PBG) Q4 2009 Earnings Call Transcript February 2, 2010 11:00 AM ET

Executives

Jeff Dahncke – Director of Public Relations

Eric Foss – Chairman and CEO

Al Drewes – SVP and CFO

Rob King – President, PBG North America

Analysts

Bill Picarello – Consumer Edge Research

Judy Hong – Goldman Sachs & Company

Caroline Levy – CLSA

Mark Swartzberg – Stifel Nicolaus

John Faucher – J.P. Morgan

Ann Gurkin – Davenport & Company

Operator

Welcome to the Pepsi Bottling Group’s fourth quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions) As a reminder, today’s conference is being recorded, Tuesday, February 2nd, 2010.

Please note the company’s cautionary statement. Statements made in this conference call that relate to future performance of financial results of this company are forward-looking statements, which involve uncertainties that could cause actual performance or results to materially differ. PBG undertakes no obligations to update any of these statements. Listeners are cautioned not to place undue reliance on these forward-looking statements, which should be taken in conjunction with the additional information about risks and uncertainties set forth in the company’s annual report on Form 10-K for the year ended December 27th, 2008. I would now like to turn the conference over to Jeff Dahncke, Director, Public Relations of the Pepsi Bottling Group. Please go ahead.

Jeff Dahncke

Thank you, Mandy, and thanks everyone for joining us. PBG Chairman and CEO, Eric Foss; CFO, Al Drewes; and, North America President, Rob King are on the call this morning. Our call is being recorded and will be available for playback on our Web site at pbg.com. We are also broadcasting the call live on our Web site.

Please keep in mind that all numbers referenced, unless specifically stated otherwise, are on a comparable basis. The items that impact our comparability are laid out in our non-GAAP reconciliation, which is available on the Investor Relations section of our Web site.

When it comes to Q&A, please try to limit yourselves to one theme of questioning at a time so that everyone has a chance to ask what is on their mind. If you would like to ask a second question, please get back into the queue. I would also ask that you take note of the cautionary statement that the operator just read.

And with that, let me turn the call over to Eric.

Eric Foss

Thank you, Jeff, and good morning. We’re pleased that you’ve joined us to discuss our 2009 performance. As you saw in this morning’s press release, PBG delivered a strong steady result in 2009, particularly when you reflect back on where we began the year. As you'll recall, the start of 2009 was a very uncertain time, instability in the financial markets, volatility in foreign currencies, and deteriorating macroeconomic trends created a challenging operating environment. In the face of these challenges, we remained optimistic. We focused on controlling what we could control while remaining flexible and nimble enough to adapt to the changes the marketplaces needed.

Our success in 2009 is reflected by our comparable diluted earnings per share of $2.55. As you recall, we previously raised our EPS guidance three times during the course of the year. And at $2.55, we were ahead of our most recent guidance range and delivered a double digit increase versus the prior year.

One of our key focal points was to grow the top line. And we delivered currency neutral top line growth of 1%, in line with our expectations. The success of our revenue management strategy enabled us to effectively manage revenue and margin with worldwide net revenue per case growing 4% and our gross profit per case up 2%, both on a currency neutral basis.

We generated operating pre-tax flow of $578 million, excluding advisory fees related to the pending PepsiCo transaction. This is an increase of over $125 million from our guidance at the start of the year, and a 10% increase versus prior year driven by disciplined approach to capital spending, strong working capital management, and lower cash (inaudible).

We also achieved approximately $350 million in costs and productivity savings, more than double the prior year. This was driven by our efforts to optimize our manufacturing costs, transform our warehouse operations, and maximize our go-to-market effectiveness.

We also generated solid results in each of our geographic segments. In the US and Canada, we achieved strong cost performance with full year savings of more than $250 million. And while category trends remained challenging, we outgrew and posted positive share performance versus our primary competitor.

We also drove 1% top line growth in the US and Canada driven by 3% net revenue per case growth and a 2% gross profit per case growth, again on a currency neutral basis. In Mexico, we had a very strong year. We delivered double digit operating profit growth, 2% top line growth, 6% net revenue per case growth, and 4% gross profit per case growth, again all on comparable currency neutral basis.

In Europe, our currency neutral top line results were down 1%, due to a particularly challenging macroeconomic environment in which we saw mid to high single digit GDP declines in all of our European countries. Despite the macro challenges, however, we were still able to deliver 6% – 7% net revenue per case growth and 2% operating profit growth on a comparable currency neutral basis, and we continue to see sequential improvement in our European volume and top line versus the first half of the year.

I’m extremely proud of our organization for these results as well as our ability to stay focused on our three strategic priorities for future growth, strengthening and repositioning our brand portfolio, transforming our performance through operational excellence, and capitalizing on geographic growth opportunities.

Let me take a moment to say a few things about the progress we made in Nigeria. First, our brand portfolio, we reengaged consumer’s interest in colas with the Pepsi Cola Refresh Everything campaign. We strengthened our position greatly in fruit-flavored CSDs in the energy category, where we went from having the number four share position in each segment to having the number one or strong number two position in most of our US markets. We made significant inroads in the enhanced water category with SoBe Life Water, which was the growth leader in the segment, up over 40% for the year.

When it comes to transforming our performance through operational excellence, we took a number of steps to achieve cost and productivity savings as well as to enhance our consumer value proposition in 2009. And while we make great progress, we still have opportunities ahead of us. Ensuring we have effective and efficient go-to-market system and the right price-packed channel architecture has always been among our top priorities and it will remain so in 2010.

Lastly, we capitalized on geographic growth opportunities, both domestically and abroad. In 2009, we continued to benefit from the accelerated pace of bottler consolidation. We expect to complete our (inaudible) acquisition during the first quarter of 2010. And last week we announced plans to acquire an independent Pepsi franchise bottlers in Northern California.

We also continue to make progress with our Lebedyansky Juice business in Russia. And although the category declined in 2009, we grew our share position as we benefited from the strength and diversity of the Lebedyansky portfolio as well as benefited from the integration work we did in conjunction with PepsiCo. We continue to remain optimistic about the long term growth potential of the Russia juice market, and Lebedyansky is well positioned to take advantage of opportunities as the category rebounds.

So to summarize, 2009 was a year in which PBG did much more than simply manage through a challenging set of marketplace conditions. We strengthened our brand portfolio, advanced operational excellence, and capitalized on the geographic growth opportunities, all of which will help fuel the success of the Blue system into the future.

Looking ahead to 2010, our outlook for the global economy in the LRB category remains cautious. We expect low single digit GDP growth in the US, Mexico, and Russia. We also expect the LRB category to continue to be under some pressure with low single digit category declines in the US and Russia and low single digit category growth in Mexico. As always, our expectations would be to grow at or above the category growth rates.

We believe we’ll be successful in 2010 for many of the same reasons we were in 2009, that’s our ability to adapt to changing marketplace dynamics, while simultaneously executing a long term strategy for growth. In fact, this has been a quality that has really defined PBG as a company for the past 10 years. And while it has been a decade of great change within our industry and in the global economy, our strong track record of results has been constant.

Now let me provide a brief update on where the PepsiCo transaction currently stands. As I’ve said before, we believe there are tremendous strategic benefits to this deal. The combined company will transform the Blue system in ways that give us a competitive advantage to drive growth for our customers and enable our success for many years to come.

As you know, we are in the process of obtaining necessary regulatory and shareholder approvals. We received SEC approval of our proxy statement on January 13th. And we've scheduled a PBG shareholder meeting for February 17th, at which shareholders would be asked to vote on the transaction. The SEC approval process continues to move forward, and PepsiCo has said publicly that it does not anticipate a second request for information. Everything remains on track for the transaction to be completed by the end of the first quarter of 2010.

I’d also like to provide an update on some of the integration planning work. While the three companies remain separate operations, teams comprised of experienced leaders from PBG, Pepsi Americas, and PepsiCo have been diligently preparing for the integration. We’ve been bringing together the incredible talent that exists with all three companies to ensure we’re ready for day one. As part of this work, we’re assembling the most talented team in beverages from my vantage point, establishing the strategic priorities for the new organization, and creating the performance metrics that will define success going forward.

In addition, we’ve been focused on developing strategies to capture the synergies in the area of SG&A back office, supply chain, and selling. And our plan is to begin capturing these synergies on day one. And I look forward to sharing additional details following the completion of the merger.

With that, let me turn the call over to Al for greater insight into our 2009 and Q4 financial results.

Al Drewes

Thanks, Eric, and good morning. As Eric alluded to, 2009 was a remarkable year in which we faced a very high level of macroeconomic uncertainty, foreign exchange volatility, and LRB category pressure. Given everything that took place during the past 12 months, our leaders did an excellent job navigating through a difficult period.

Our teams in Europe and Mexico had a strong year delivering currency neutral offering profit growth in the face of commodity inflation, significant currency devaluations, and consumer spending pressure. They did this by being nimble, and in several of our international markets, our teams quite quickly downshifted from a growth and investment strategy to a more aggressive productivity and cash management focus.

In the US and Canada, which have always been a foundation of PBG, our teams once again delivered a solid year. They leveraged price and margin management capabilities to deliver balanced top line growth. They also delivered record productivity savings to buffer the top line challenges.

Our overall (inaudible) results for the year demonstrate the success our teams had in achieving our objectives. We had currency neutral top line growth of 1%, in line with our guidance, our final productivity number of $350 million, with $100 million ahead of our original goal. And our operating free cash flow of $578 million was more than $125 million above our initial target. Both our operating profit and volume results were in line with the internal financial plan we established at the beginning of the year. Making plan was a significant accomplishment in light of the economic turbulence that everyone felt during the year.

So from an operational stand point, our results were right as expected. In addition, at $2.55, our comparable diluted EPS was up 12% versus last year and came in far ahead of our guidance.

Let me now walk you through the global line items that added to our EPS. First, below-the-line ForEx was stable was stable by approximately $30 million versus prior year as we cycled the devaluation impact of Q4 of 2008.

Our comparable effective tax rate of 18% for the year was lower than we expected. During the course of the year we benefited from lower interest charges on tax reserves, favorable country mix, and successful tax planning issues. In addition, during the last few weeks of the year, we benefited from the reversal evaluation allowances, the majority of which were not contemplated in our previous guidance. These reversals, which added $0.13 of EPS to our results, recognized deferred tax assets that will generate future benefits.

Our COGS per case was up 6% in 2009 on a comparable currency neutral basis, and that was consistent with our expectations. This COGS number includes one-and-a-half points of transactional ForEx impact.

As Eric mentioned, we expect the global economy in LRB category to remain challenging in 2010. This will once again place a premium on financial flexibility, robust cost productivity, disciplined working capital management and proven capital budgeting. These are all core areas of expertise at PBG, something we demonstrated in 2009 and throughout our 10 years as a public company. And they will continue to help fuel the success of PepsiCo’s bottling operations following the completion of the merger.

Normally, I’d now transition to a discussion of our guidance for the upcoming year, but due to the pending PepsiCo transaction, we’ll not be providing 2010 guidance in this morning’s call.

Since this is likely to be our final earnings call as a publicly traded company, I’d like to close by thanking all of you who followed PBG and invested with us over the past 10 years. We’ve always tried to maintain an open dialog with the investment community. And the feedback you’ve provided us has been instrumental in the development of the metrics we’ve used to manage our business in the way we tried to communicate our results. Your feedback has also been invaluable as we developed our investment priorities, capital structure, and approach to share buybacks and dividends.

This successful partnership between PBG and its investors has produced some terrific results. I’m very proud of our organization for the year delivered in 2009 as well as the track record we’ve achieved over the past decade. And I thank you for all your advice and support along the way.

And with that, let me turn the call back over to Eric.

Eric Foss

Thanks, Al. Before we take questions, I just want to echo Al’s thanks and also I’ll just say a few more words about PBGs track record of success that Al just talk about. During our time as a publicly traded company, we've nearly doubles our revenue, more than doubled our operating profit, and we’ve seen PBG share price more than triple. By comparison, the S&P 500 index declined 11% over that same timeframe.

Over that time, we also enabled our customers to grow their businesses, something we planned to even get better at in the future. And we built a diverse and inclusive culture that has enabled PBG employees to grow their careers.

At the end of the day, the people of PBG have really fueled our success as a company. And I have no doubt that the people of PBG, Pepsi Americas, and PepsiCo will continue to fuel the success of the Blue system for the next decade and beyond.

And with that, we’ll open the floor any questions.

Question-and-Answer Session

Operator

Thank you, ladies and gentlemen. The floor is now open for questions. (Operator Instructions) Please hold while we pool for questions.

Our first question is from Bill Picarello with Consumer Edge Research. Please pose your question.

Bill Picarello – Consumer Edge Research

Good morning, Eric, Al, and Rob.

Eric Foss

Hi, Bill.

Bill Picarello – Consumer Edge Research

What I was just hoping you can give us an update on the pricing environment you see out there. I know you took pricing post-Labor Day, and the coke system's supposed to go up post-Super Bowl. So it’s 2% or so pricing what you see for 2010. And then just, Eric, one other thing I was hoping – as you’ve work through the integration and planning, if you could talk about it all, and the strategic benefits that you see for this combination beyond of the obvious cost energy benefits, which are clear when as you’ve done more planning on the strategy front. Thanks.

Rob King

So Bill, this is Rob. I’ll answer the pricing question. So I think you should know consistent with our post-Labor Day action, it's probably for that part of the last decade. We executed a price increase coming out of Labor Day. And as you can see from our results, we delivered those three points of revenue for case growth in the quarter.

I would suggest that the pricing environment in the marketplace right now is rational. And we would foresee that continuing at least based on what we see in the marketplace.

Eric Foss

Yes, Bill, my point on the pricing would be that, obviously, we took our pricing post-Labor Day, and so some of this is from a competitive standpoint is catch up. But we’ll look post-Super Bowl to make sure that we’re competitively priced. And again I have go Rob’s point on the rationality that exists.

On your question on the integration, my immediate focus has continued to be to fulfill my role as PBG chairman and CEO. I would tell you from an integration standpoint, we’ve been very focused as we continue to head towards day one and day one readiness. Second, we’re focused on making sure we get it – the year one synergies. Third, a lot of work is going into just thinking about making sure we had the best team through the structuring staffing exercise. And then, I think the final one is just making sure we get the right culture established.

There is a lot of thinking that’s going into what I call the strategic repositioning of the business going forward. But I think I’d rather saved that for a post-merger completion and a discussion after that.

Operator

Thank you. Out next question is with Judy Hong with Goldman Sachs & Company. Please post your question.

Judy Hong – Goldman Sachs & Company

Thanks. Good morning, everyone.

Eric Foss

Good morning, Judy.

Judy Hong – Goldman Sachs & Company

Eric, you’ve talked about the LRD category you think will be down another low single digits in 2010, of you can help us – give us your perspective on CSD versus non-carbs in that context. And secondly, if you think that the category will continue to decline for another 6 or 12 months. Is there a need for Pepsi to get more aggressive in terms of share performance? And do you think that that will require more spending behind the brands and the likes going forward?

Eric Foss

Well I would say first of all that relative to the category dynamic, if you look at last year, I’m assuming your question is largely based on the US or North America, the CSD category performance was – we were down slightly. But I think, the big issues were non-carbs and the water, both now high single digit or double digit. I think you’re going to continue to see the CSD category be more resilient than the non-carb category. I think going forward, the reality is from a share standpoint, we were very pleased with our share performance. We outgrew our competitor share-wise. And I think our volume results all in will fare very well.

I think the reality is as the category – to get the category back to the right spot, there’re a variety of things that need to be done, one of which is more marketing, more innovation. I think getting the value price tag right, which we actually feel pretty good about and just getting more in-store excitement is something else that’ll be needed. So certainly, there’s an opportunity for everybody in the industry to spend their marketing money wisely to try to stimulate more consumer demand.

Operator

Thank you. Our next question is from Caroline Levy with CLSA. Please post your question.

Caroline Levy – CLSA

Good morning. And I’m sad this is the last call you’ll do.

Eric Foss

Good morning, Caroline. How are you doing?

Caroline Levy – CLSA

I’m good. Eric, great to hear your voice again. I was just wondering, you had just a minute ago talked about share being good. But as we look at the market share data, it actually looks like Pepsi overall – we obviously don't have your breakups specifically, but would you available any market share data for the fourth quarter on CSDs and non-carbs, and how ever you want to break that out?

Rob King

So Caroline, this is Rob. So if you look at our four-year resolves where our volume was down about 2%. We think that that’s roughly in line with how the category performed, and our CSD business was a little bit better than the categories that we had a positive share swings versus our primary competitor in CSD, and then overall in LRB. Our share was roughly flat, but favorable to our competitor.

In the fourth quarter, our volume we believe was a little bit softer than the category, and so we probably gave up a little bit of share. But overall, on a full year basis, we feel very, very good about our share performance.

Eric Foss

And again, Caroline, overall beyond the US, I think if you look in our countries we compete in, I think in five of the seven, we actually had a positive share swing versus our primary competitor. So all-in in 2009, our approach was really to try to balance the top line. We didn’t want to pursue value over volume. As we try to do that both with our pricing actions, our execution, and we were successfully able to do that relative to the share results.

Operator

(Operator instructions) Our next question is of Mark Swartzberg with Stifel Nicolaus. Please place your question.

Mark Swartzberg – Stifel Nicolaus

Thanks. Good morning, guys.

Eric Foss

Good morning, Mark.

Mark Swartzberg – Stifel Nicolaus

Question on the fourth quarter, am I right in reading that North America comparable operating income was down 21% year-on-year in the fourth quarter?

Eric Foss

Let me get you the right number here. I’m sure that's the right number. It’s that right, yes. So let we comment on what was going on in that business. Our volume performance was a little bit softer than the trend for the full year or for the first three quarters. But the other things that was affecting the comps was we had some really tough cost lapse versus prior year, so there were a number of items in Q4 last year that related to what was going on from the macro standpoint that affected our cost structure, and so there was a tough cost lap there a swell. But the overall productivity numbers for the year were excellent, both for the US and around the world. But that is a factor in the Q4 results.

Mark Swartzberg – Stifel Nicolaus

So productivity came in where you expected at the time of the third quarter comments?

Eric Foss

The productivity for the year was way ahead of what we now wind up in both in the US and worldwide. I think we said it was $100 million higher than – that's the worldwide number. It’s $100 million higher than our regional focus. And so the productivity numbers were very good. But as I said there were some lapses versus some things than in Q4 last year in the operating expenses that makes for challenge comp in the US and Canada

Operator

Thank you. Our next question is with John Faucher with J.P. Morgan. Please place your question.

John Faucher – J.P. Morgan

Yes, thanks. And guys, I agree, it’s been great working with you guys over the past couple of years. And Al, hopefully, we will meet again. And quick question on pricing within the category, and I guess as I look at CSDs, volumes can be back to levels from a total category standpoint similar to the late 1990s. And we hear about it being a tough environment for pricing. So, Eric, walk me through the rationale for, given the volume struggles that the categories had, why CSDs deserved to take pricing here to give us more confidence that, "Look, even if the volumes continue to be down, you’ll be able to hold on to the pricing?"

Rob King

This is Rob. First off, from a pricing perspective, we think that there is room for more pricing in the marketplace. And we believe we’ve demonstrated over the years that having the right balance between price, value, and investing in brands in the marketplace is actually the right combination for driving a profitable business.

As I mentioned before, we executed our price increase post-Labor Day. That price increase has stopped. And we still think that we deliver solid consumer value to help our customers resell our products to our consumers. We’re able to work and continue to defend our margins I the marketplace and create room to continue to invest in the brand. So that combination, while certainly pricing is a factor, pricing isn’t the only factor in how we’re addressing the CSD business in the marketplace.

Eric Foss

And John, I would just say that if you think about value in the CSD category, I think if you compare it to almost any other category out there, you could argue the point that there’s definitely good value, if not great value, looking at a kind of historical trends.

Again in 2009, our whole approach was to try to stay very, very balanced. So we were really trying to, as best we could in a very difficult macroeconomic environment and a very difficult category environment, balance volume and pricing. And I think we did that. Again, we did have inflationary comps in 2009.

I think the good news is the commodity environment will be more favorable for the industry this year. And as you've heard me say before, I’m a big believer that the best way to take this category forward is in a balanced way where you try to get two to three points of pricing, and year in and year out effectively manage the balanced top line algorithms. So that was our approach in 2009 and that is the way we set up the pricing for 2010 as we exit Super Bowl.

Operator

Thank you. Our next question is with Ann Gurkin with Davenport & Company. Please post your question.

Ann Gurkin – Davenport & Company

Good morning.

Eric Foss

Good morning, Ann.

Ann Gurkin – Davenport & Company

I'm just wondering if I can get an update on G2 and also packaging costs outlook for the year.

Eric Foss

Regarding G2, I think as you know, we sell G2 primarily in food service channels and in CNG. So my comments will address the channels that we have actually distribution rights for the brand.

G2 is an exciting brand. It repositions the broad Gatorade portfolio in hydration with the lower calorie option. And it's being well received by consumers. And it’s a significant part of our overall Gatorade business. So we feel good about the G2 business in the past, and actually we feel even better about it going forward.

I think I will refer to Al on the packaging issue.

Al Drewes

Is your question about packaging costs in 2010?

Ann Gurkin – Davenport & Company

2010, yes.

Al Drewes

Well, I think we know that the commodity situation is better, but I’m going to let the (inaudible) guys to talk about 2010 when the time comes.

Eric Foss

Thanks, Ann.

Operator

Thank you. Our next question is a follow-up with Mark Swartzberg with Stifel Nicolaus. Please post you question.

Mark Swartzberg – Stifel Nicolaus

Yes, thanks. Hi again, guys. And it really has been a great pleasure. I want to stay on this a little bit more, Al, or Eric, or Rob. So volumes weakness makes – helps us understand why things got worse in the quarter and caused overlaps, obviously, you knew about. Are there also some spending decisions here? Because I’m just looking at the comments you made in October regarding profits for the company overall being flat on a comparable basis, on an operating income number, and of course they were down pretty considerably, and North America drove it. So can you just give us some more color? Is it fair to say that there were spending decisions here as well and perhaps even a little more color there, that’d be great.

Al Drewes

So going back to the cost thing. Let me give you just a little more detail. So in Q4 of last year, as our earnings were coming down, there were adjustments made, the compensation accruals and things like that, which we're lacking. So it's that as well as some pension – a higher pension expense this year versus last year. So that’s really what is driving this cost number. It's a fairly big piece of the earnings pressure you’re talking about.

But our overall earnings, our operating performance came in pretty much where we thought it was going to be now. The mix was slightly different, Europe and Mexico were a little bit stronger and the US was a little bit worse. But we’re essentially within the little than a few million bucks from what we thought from an operating profit we were going to come in.

So I feel like we’re track right with what we’re trying to do. But you do have these items in the cost structure, like I said, in the volume in the quarter in the North America segment was about a point worse than it had been running for the – than it was for the full year in the trend. So you have that as well.

Mark Swartzberg – Stifel Nicolaus

All right. I guess, I’m definitely dedicated to being too analytical. But in October, you said flat US dollar profits for the year are comparable 2009 versus ’08. And now they were down 4%, the fourth quarter down 20%.

Al Drewes

The volume is – me again. The volume is a little bit softer than we thought it was going to be, so.

Mark Swartzberg – Stifel Nicolaus

Fair enough. Okay. Thank you, guys.

Al Drewes

Sure.

Operator

Thank you. Gentlemen, we have no further questions at this time.

Eric Foss

Great. Again let me thank everybody for your interest and ongoing support of PBG. And I look forward to continuing the dialogue with many of you as we move forward. Thanks very much.

Operator

Thank you, ladies and gentlemen. This now concludes today’s conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.

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