PepsiCo Q3 2009 Earnings Call Transcript

| About: PepsiCo Inc. (PEP)

PepsiCo, Inc. (NYSE:PEP)

Q3 2009 Earnings Call

October 8, 2009 8:00 am ET


Lynn Tyson - Investor Relations

Indra K. Nooyi - Chairman of the Board, Chief Executive Officer

Michael D. White - Vice Chairman

Richard A. Goodman - Chief Financial Officer

John C. Compton - Chief Executive Officer - PepsiCo Americas Foods

Zein Abdalla - Chief Executive Officer, Europe


Kaumil Gajrawala - UBS

Carlos Laboy - Credit Suisse

Bill Pecoriello - Consumer Edge Research

John Faucher - JPMorgan

Christine Farkas - Banc of America Merrill Lynch

Mark Swartzberg - Stifel Nicolaus

Caroline Leeney - Calyon CLFA

Lynn Tyson

…the Securities and Exchange Commission including our Annual Report on Form 10-K and subsequent reports on Forms 10-Q and 8-K.

And finally you should refer to the investor section of PepsiCo’s website under financial news to find disclosures and reconciliations of non-GAAP financial measures that may be used by management when discussing PepsiCo’s financial results.

And with that I’ll turn the call over to Indra.

Indra K. Nooyi

Good morning, everyone. First off, let me start by welcoming Eric Foss, Chairman and CEO of Pepsi Bottling Group, to the PepsiCo family. We are delighted he has agreed to be the CEO of PepsiCo Bottling North America once our transactions close. Welcome, Eric.

I would also like to take a minute to thank Mike White, Vice Chairman of PepsiCo, for his tremendous contributions to PepsiCo. Mike has served PepsiCo over the past 20 years in many leadership positions. He is a close friend, an outstanding executive, and will be a lifelong member of the PepsiCo family. We all wish him the very best as he embarks on the next leg of his life’s journey.

Mike, would you like to say a few words?

Michael D. White

Sure. Thank you, Indra. Good morning, everyone. I need to start spending those million Marriott points I’ve worked up over the last nine years running international but really I just wanted to share two brief thoughts -- one is thanks and the other is confidence. First I would like to thank Indra and really PepsiCo has been so good to me and my family. I am grateful for all that it’s done for me but for this purpose this morning, I would also like to thank all of the sell and buy side analysts -- all of the folks that over the years, the last 12 years, I recall when Peggy Moore first took me around, were kind enough to share their candor, sometimes positive and sometimes critical but always I think something that I found insightful and helpful for me as I tried to help us get better as a corporation.

[inaudible] confidence -- look, I think Indra is doing an outstanding job leading this company. I couldn’t be more delighted with the strategy and I am still a big shareholder. I think the PAB structure is coming together brilliantly. I am confident in the total leadership structure that we have announced and I believe it is going to work very well in delivering the synergies that we have talked to you about.

But I suppose I will always be most passionate about the international opportunities that we have. I believe that our international business still has tremendous growth potential and I know Zein Abdalla and Saad Abdul-Latif are going to do a terrific job. They have worked with me for the last seven years, closely. They know how to build a business and how to work through both tough times and good times and ensure that we continue to drive profitable growth in our businesses. They are true business builders who are passionate about our business but more than that, they are passionate about building people and nurturing a culture of people that want to work and grow in this business.

So it’s been a terrific run and I am grateful, Indra, for your support and I’ll be around for a little longer.

Indra K. Nooyi

Thank you, Mike. Thanks for everything you have done for us. Today I am going to approach my opening remarks in a slightly different way than usual. You have read our earnings release and seen that we delivered another solid quarter, reaffirmed our 2009 guidance, and provided a performance target of 11% to 13% EPS growth for 2010, post the close of the acquisitions of our anchor bottlers.

Our expectation is that these transactions are likely to close at the end of 2009 or early I 2010, subject to the FCC and SEC regulatory processes, as well as shareholder approval.

In any case, we hope that as of our Q4 call in February, we will be talking with you about the new PepsiCo, an almost $60 billion company. But before we sign off on the old PepsiCo and transition to the new, I want to recap the last 12 months, both the environment and our transformational work. I then want to spend some time to set up 2010 with some broad themes.

So let me start with the last four quarters. All of us have lived through the incredible changes in the global economic landscape since mid-2008. Perhaps this was an inevitable adjustment to the boom times that came before. In any event, the resulting dramatic downturn in global GDP led to huge strings in commodity prices, big increases in joblessness across most of the developed world, as well as in some developing countries, and as one might expect, considerable changes in consumer spending patterns across most of the world.

Over this period, in anticipation of structural shifts and changes in consumer behavior that we expected in the market, both in the short and long-term, we at PepsiCo were among the first to begin to transform ourselves. We launched our productivity for growth initiative early in Q4 of 2008 to create P&L breathing room for 2009 and we completed this work flawlessly by the middle of the year.

We focused across the globe on margin management to ensure that amidst all the variability from commodities and transactional for-ex and all the uncertainties in consumer spending, we would be able to sustain or enhance our margins. That work encompassed proper revenue management so that we hit the right price points, product mix and trade spending levels to achieve both volume growth and appropriate gross margins, and productivity across the entire value chain in order to sustain a competitive cost advantage.

Year-to-date, both gross margin and operating margins are up versus prior year.

Next, we refreshed a considerable part of our North American beverage portfolio. As a result of our efforts, I am proud to report that brand equity’s push for key brands has risen, including Gatorade with core fitness users and Pepsi with [inaudible]. And in CSDs in Q3, we have taken a leadership position in measured channels. Taken together, our brand refresh program is right on track.

We then reached agreement on the acquisition of our two anchor bottlers. Our post-merger integration efforts are on or ahead of schedule and the project management office is up and running to ensure both a seamless integration and delivery of the synergies.

And we have executed several tuck-in acquisitions in key markets around the world, which are transformational for our businesses in those countries. They include the Lebedyansky juice business in Russia at the end of last year, a dairy business in Jordan in conjunction with Almary, and the contribution of our Japanese snack business to a new joint venture with [Calbi], the leading salty snack company in Japan. And we are in the process of evaluating several more tuck-ins.

On the people side, we are also very proud of our transformational efforts. We made generational management transitions which were well-planned, well-planned in advance and executed seamlessly. We added or upgraded capabilities to accelerate our growth by bringing into our organization very talented people who have considerable experience in priority areas like R&D, digital marketing, marketing to athletes, transformational thinking, disruptive technologies, shopper insights, and areas such as these. All of these moves were intended to ensure that as a company, we are building capabilities for the future.

Through all of these changes, our portfolio has delivered. Year-to-date, net revenue grew 5%, division operating profit 7%, and EPS grew 8%. We have invested substantially in R&D, IT, and in the marketplace for the long-term and our cash flow growth has been spectacular also, which I will talk about.

I am very proud of the tremendous efforts our associates around the world have made and the results we’ve achieved in this challenging environment. I am proud of their can-do spirit and their must-do sense of responsibility.

So that was the recent past -- let me now turn to 2010 and beyond. As we think about the coming year, our planning assumption is that the rebalancing of the global economic landscape is still a work in process. Our planning assumptions include low levels of GDP growth in the developed world. However, as the outlook for job creation remains mixed, our consumer research shows that the age of thrift that we are seeing in consumers in the U.S. and Western Europe will continue in 2010 and that consumers will continue to remain very careful about their spending.

East of the Middle East and in parts of South America, the situation is quite different. We expect to see continued GDP growth below the 2003 to 2008 levels but still several points higher than the U.S. and Western Europe, and in those regions the growth in consumer spending will continue, although not at a pace that entirely offsets the slower growth in the west.

Overall, consumer staples like food and beverages have been less impacted by the economic turmoil than other categories. I guess the word staples really drove home. Looking forward, we expect continued attractive growth in most of emerging Asia and developing South American economies and growth at lower levels in the developed world, but growth all the same.

Even within that relative stability, we expect that both the pattern of growth and the shape of consumer spending are likely to be different going forward, particularly in two areas. The first is value. Consumers in the developed world are adjusting to a changing macro environment by placing value at the top of their agendas as they think about their purchases.

But value is an increasingly complex equation. Getting the right price point is often as important as getting the right price per pound around. And when we deliver value is also becoming important -- the first part of the month versus the second, on pay days versus normal days.

The second is an increased focus on health and wellness and functional benefits, as consumers look to achieve proper balance in the food and beverages they consume. They are placing an increased emphasis on prevention rather than cure. While this presents challenges in some areas, it also represents enormous opportunities to bring consistent, high quality healthier offerings to consumers who are looking for convenient food and beverages that taste great but are good for you.

So what are we going to do about these strengths in 2010 and beyond? As I said earlier, we have indicated a performance target of 11% to 13% EPS growth, assuming that the transaction is completed in early 2010. I know that some of you have us at higher numbers. However, we see 2010 as a year to reinvest in the company and continue to make important generational investment that will ensure the long-term sustainability of our top and bottom line growth.

So let me walk you through some of those areas where we intend to make those important investments. First, we will continue with high levels of investment in R&D to create products that have true science based differentiation and will enable us to accelerate our health and wellness transformation. We have put in place an outstanding R&D team with complementary skills and experience, and we have married them with our insights organization which we are continually upgrading.

While we are already seeing benefits from some of the work in our 2010 pipeline, we don’t expect immediate major breakthroughs. This is an area where sustained investment is critical.

Second, we will continue to invest in the expansion of our businesses in emerging markets through infrastructure investments, launching new products, and significantly stepping up investments behind hiring and training talent for future growth. We will also continue to make tuck-in acquisition. As I indicated earlier, our pipeline is looking very promising. However, as you well know, we will take a very disciplined approach to all acquisitions.

Third, we will step up our investments behind a few big global brands to solidify their position in an increasingly cluttered retail environment.

Fourth, we will continue our investments in SAP, both domestically and internationally, to ensure we have the IT infrastructure to support our growth and indeed to help drive top line growth and middle of the P&L productivity.

Fifth, we will also continue to invest in upgrading our people capabilities. The world around us is experiencing profound changes resulting from the macroeconomic turmoil and the growth of emerging markets. To ensure that our talent base in every market and at the leadership level remains the best amidst these changing realities, we will step up our investments in the training and development of our associates, provide more experiential learning for our key executives, and if necessary add selectively from the outside to our company’s talent base to ensure we have the right competency to lead us I the future.

Lastly, we will also be stepping up our focus on environmental sustainability, particularly water conservation, energy efficiency, and packaging recyclability.

We don’t want to reduce our investment due to the economic conditions, especially since this is a time when governments need large companies to do their part and behave responsibly. We intend to make good on our promise to deliver performance with purpose.

So that’s our 2009 year-to-date journey and some overall direction on what you can expect from PepsiCo in 2010.

With that, let me turn it over to Richard Goodman. Richard.

Richard A. Goodman

Thanks, Indra. Let me turn to our operating results. In the third quarter, we continued to see strong performance across our international businesses, as well as in our domestic snacks business, and our North American beverages team did a great job managing margin in a soft market.

Our teams around the world focus on driving balanced results while optimizing cash flow from operations. They achieve this by focusing on four key priorities. First, a commitment to providing value to customers and consumers and, as Indra indicated in her remarks, by value we mean the combination of price, size, and importantly the functionality of our offerings. By delivering value, we keep the consumer with us during challenging times.

Second, leveraging the benefits of our strong and flexible go-to-market system to make quick changes in response to the environment.

Third, continuing to implement consumer preferred innovation to drive sustained growth, and fourth, operating with financial discipline, keeping the laser focused on productivity.

These focus areas, taken together with our diversified global portfolio, helped us to drive solid performance, both in the third quarter and year-to-date.

Net revenue grew 5% in the quarter and 5% year-to-date. Operating profit improved sequentially, growing 8% in the quarter and 7% for the year. EPS grew 8% in the quarter, consistent with the year-to-date performance. Both overall gross margin and division operating margin increased in the quarter, as they did in the first half of the year, and management operating cash flow excluding restructuring and the Q1 pension contribution is up 22% on a year-to-date basis.

Taking a deeper dive into each operating division, PepsiCo America’s foods continued to deliver strong results with 7% net revenue growth and 6% operating profit growth. Across DAF, we grew share in virtually every market where we operate and key long-term growth platforms outside of our core portfolio, such as nuts and seeds, bread snacks, and baked products gained traction, each growing more than 20% year-to-date.

Frito Lay North America grew volume share in the quarter off an already large base, delivering differentiated value that narrowed price gaps significantly to its competitors and taking its value message to price conscious consumers through relevant marketing campaigns.

Through the first three quarters of the year, Frito Lay was the fastest growing of the top 20 food and beverage companies in the United States.

As you’ll recall, this was Frito’s first full quarter lapping the pricing it took in the middle of last year’s second quarter to offset commodity inflation. This resulted in a more normalized spread from volume to revenue in Q3 relative to the first half of the year. FLNA grew volume 3% and net revenue 5%. Profitability grew 5% and reflects changes in product and channel mix, our 20% more initiative, and also the pricing overlap. We also made incremental investments in new center store snack aisles in grocery stores across the country.

Looking at product performance, Lay’s potato chips grew high single digits, due both to strong in-store execution and also to the Lay’s local campaign, which highlights the local cultivation of the potatoes that go into its products. We also saw significant growth in dips, including from the [SABRA] joint venture and in our multi-packs, which provide the benefits not only of variety but also of portion control.

At Frito, we stay close to the consumer and are responsive to changes in their spending patterns. Although our 20% more free weight-up initiative, we learned that volume wasn’t motivating purchase as much as price in this environment. In fact in the quarter, we saw consumers sharpen their focus on price point as the month progressed and budgets tightened. Frito capitalized on this trend by leveraging the flexibility of its go-to-market system to plan promotions and manage trade calendars on a weekly basis.

At the beginning of the month, FLNA featured promotions at higher price points while at the end of the month when budgets were more constrained, it promoted lower price point offerings. And the division is being surgical about delivering value in different ways. In large format stores, Frito is positioning its $2 value line at the perimeter of the aisles to draw traffic, while featuring differentiated value once consumers are in the aisle. And when we talk about differentiated value, we are referring not to reduced or promotional pricing. For example, if consumers find value in the functionality of Tostitos Scoops because its shape enhances their dipping experience. In the fourth quarter, FLNA will introduce Tostitos Strips, an innovation that enhances the dipping experience for consumers in a different way.

Another approach to differentiated value is product innovation, which delivers enhanced health and wellness benefits. Beginning next quarter, FLNA’s entire Tostitos line will feature whole grains, making it a healthier alternative.

At Latin America Foods, the team delivered solid results despite challenging macroeconomic conditions in parts of the region, including double-digit GDP contraction in Mexico and significant inflation in Argentina and Venezuela. LAF net revenue grew 9% and operating profit grew 11% even after taking into account the 5 percentage point negative impact related to last year’s gain from a fire related insurance settlement in Brazil.

The margin accretion, despite input cost inflation, reflected a combination of visual pricing and weigh-outs, disciplined cost control, and productivity improvements. In Mexico, Sabritas and Gamesa both gained market share and delivered solid operating profit growth in spite of the country’s macro challenges. This summer was particularly hot in Mexico and as a result, we saw consumer preference shift to salty snacks over cookies. This category dynamic benefited Sabritas where salty volume improved sequentially. And Sabritas experienced particularly good performance from a salty snack innovation name [Packataxos], a large bag of mixed snacks that represents great value to consumers. At Gamesa, product extensions on core cookies contributed favorably to product mix and the company also added routes in the quarter to expand penetration into new neighborhoods.

In South America, the teams drove both value share and volume share across the region. We have now fully implemented SAP in Brazil, a transformation advantage that will enhance productivity and make it easier to integrate future acquisitions.

Planned inventory build-ups to prepare for the changeover to SAP, however, muted volume growth in the quarter.

Across a number of South American countries, we recently launched product innovations such as [Twiznos] Baked Bread Snacks, which continued to perform very well. And as the team works to expand its portfolio of better-for-you offerings, they are rolling out Quaker products across the region.

At PepsiCo Americas Beverages, the North American LRB category continues to be adversely impacted by weakened consumer spending. Nevertheless, PAB strengthened its market position as its revitalization efforts gained traction.

Among highlights for the quarter, PepsiCo CSD portfolio in the U.S. achieved the number one volume and value share position with measured channels in Q3. The company’s enhanced water portfolio gained share in the quarter, reflecting high double-digit volume gains in Sobey Life Water, which benefited from extraordinary growth of its zero calorie [Sevia] sweetened line extension. And in Latin America, PAB had another very good quarter.

Turning now to Gatorade, volumes were down this quarter, as expected, but we did see a sequential improvement in volume trend and G2 continues to grow at high levels. We know there is considerable interest in the U.S. Gatorade business, even though it does represent just a small, very small part of the overall PepsiCo portfolio, so let me give you some additional color on this business.

At our last call we talked about the casual non-athletic user who would come into the Gatorade franchise between 2003 and 2007, and driven a large part of the higher-than-usual growth rates we experienced during that period. Based on our most recent comprehensive consumer research, we know that today’s Gatorade volume is coming largely from the core athletic user. Importantly, this core user continues to be loyal to Gatorade, a brand that is second only to Nike, the world’s number one sports franchise.

Since the relaunch of Gatorade and the brand refresh initiatives over the past few months, Gatorade’s brand equity scores with the core athlete have improved substantially. For example, among core hydration drinkers, the Gatorade is for an active lifestyle equity score has increased by 13% versus 2008. All of this is good news.

Gatorade’s recent volume challenge is primarily a result of the economic downturn. Comprehensive consumer research completed recently indicates that the issue is not lost penetration with the core user but some loss of frequency and that is very clearly related to consumer budget concerns. To that point, about 60% of the occasion losses went to water, both tap water, which is free, and bottled water, and another 30% went to cheaper options like juice drinks. Less than 5% of the loss occasions went to so-called competitive offerings.

Going into 2010, our plan is to keep Gatorade solidly in the athletic space and to deliver targeted innovation to that athlete.

Turning now to PepsiCo International, the PI teams again delivered solid results despite the continued headwinds in many parts of the world. The teams did an excellent job of managing the P&L, driving relevant promotions and price pack initiatives to deliver double-digit revenue and operating profit growth across both Europe and EMEA. The macroeconomic environment continued to be challenging in Europe this quarter. Unemployment approached double-digit levels in a number of key markets, including France, Russia, and Turkey, and is expected to reach nearly 20% in Spain by year-end.

However, there are signs of consumer confidence improving a bit in Western Europe. Unfortunately, we are not seeing as much of a recovery yet in Eastern Europe, although currencies have stabilized. Amidst this backdrop, the Europe division grew margins and profitability by driving productivity and maintaining tight cost controls. These actions resulted in net revenue growth of 12% and operating profit growth of 18%. Over the past year, the Europe teams have been able to deliver solid top and bottom line results by running creative value-added promotions, taking effective net revenue management actions to cover commodity cost increases, and resetting price pack architectures to hit a hot price point across snacks and beverages.

In Europe snacks, volume declined 1%, reflecting the challenging macros across the region, as well as pricing action, including weight-out, to offset commodity inflation. Importantly, the Europe division largely held or improved its competitive position across the region. In the U.K., Walker’s grew value share through disciplined pricing and the continuing success of its [grip trips] campaign. And in the fourth quarter, Walker’s will continue to build on its solid momentum through value-oriented promotions such as its gazillion bad giveaway promotion in partnership with [Tesco].

Our Russia snacks business drove volume growth and gained 6.5 share points, reflecting the success of locally relevant flavor extensions and the launch of sensations premium potato chips. The Russia team will further enhance its portfolio of locally relevant snacks in the fourth quarter with flavor extensions of its bread snack line.

In the Europe beverage business, volume grew 9% with a sequential organic growth versus the first half reflecting solid growth in Western Europe and Turkey. In Western Europe, we posted share gains in CSBs and ready-to-drink tea resulting from focused price pack initiatives, new flavor introductions, and successful marketing campaigns.

In Russia, Lebedyansky grew market share, expanded margins, and delivered solid profitability despite for-ex and commodity headwinds. One of the keys to Lebedyansky’s success is its brand portfolio, which features strong brands across a full span of price points, premium, core, and value. Its broad array of locally relevant offerings enables them to keep consumers despite the macroeconomic environment.

Turning now to EMEA, the division again posted strong volume, net revenue, and operating profit growth. The EMEA team focused on delivering value, managing cost and driving productivity gains while continuing to invest in locally relevant innovation.

EMEA beverage volume grew 9%, reflecting broad-based gains across the region. India grew over 50%, with strong growth in both CSBs and non-carbs as a result of investments to expand cooler infrastructure, improved market execution, and the benefit of a particularly hot summer season.

In China, beverage volume growth was led by strong MCB performance, particularly in the Tropicana line of locally relevant juice drinks.

In the quarter, the China team continued to expand distribution for key products including PepsiMax, Lipton Ready to Drink Tea, and the Tropicana juicy pulp snacks drink.

EMEA snack volume grew 8% in the quarter, gaining momentum and more than doubling its growth versus the previous quarter. Growth was geographically broad-based, led by double-digit increases in India and South Africa, feeding off of strong innovation. For example, in India, the team launched [Aliva], a new savory cracker product with aggressive print and media activations. And in Australia, the team launched Brainwave, a multi-grain salty snack that expands its better-for-you lineup of snacks.

The teams also leveraged price pack architecture initiatives and promotions throughout the region to deliver value in locally relevant ways, ensuring that we maintain our competitive position with consumers across the economic spectrum.

Now let me turn to some below-the-line items and our outlook -- our third quarter EPS of $1.08 included a tax rate of 24.7%, primarily reflecting the favorable resolution of certain foreign tax matters. For the full year, we now expect our tax rate to be about 26%.

The company continued to generate strong management operating cash flow in the quarter, about $4.1 billion year-to-date excluding certain pension and restructuring payments for a 22% increase over last year. We are on target to hit our full-year cash flow guidance.

For fiscal 2009, we continue to expect to deliver mid-to-high single digit constant currency EPS growth off of 2008’s core EPS of $3.68. Based on current spot rates, foreign exchange translation would represent about a mid-single-digit percent headwind to our full-year EPS growth.

Currently we do not anticipate repurchasing shares for the balance of the year, because of the pending bottler acquisition.

For fiscal 2010, we are going out with guidance a bit earlier than usual because we would like to provide some clarity as you consider statements we’ve made about the bottling transaction, as well as the recent S4 filings.

For 2010, we are targeting EPS growth of 11% to 13%. This includes the modest one-year accretion we talked with you about in August related to the acquisition of PBG and PAS, and it also includes the potential benefits from the acquisition related accounting that you saw in the form S4s. This guidance excludes one-time costs to achieve the synergies.

Please note that if next year we find our business is tracking better than the 11% to 13% range, we will take the opportunity to make further investments in our business to strengthen our competitive mix globally.

It is very important that you understand the context in which we are giving this guidance. We are still in the midst of our annual planning process. We do not have comments yet from the SEC on the S4 filings or regulatory or shareholder approval. We are still doing integration planning and while for the purpose of our guidance we have made the simplifying assumption that we would close in early 2010, we do not have a definitive date yet. Once we have closure on these areas, we will be able to go into more detail with you about our 2010 plans.

Now let me turn it over to the operator for Q&A. Operator.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Kaumil Gajrawala from UBS.

Kaumil Gajrawala - UBS

Thank you. Congratulations, guys, on getting Eric and congratulations, Mike, on your retirement. Indra, given all your comments at the beginning on the value consumer, does that change the goals of your R&D team? In the past it’s largely been focused on launching premium products and therefore having some margin benefit from mix. Has the focus shifted to innovating and launching more on the value side? And then what does that mean for margins as we think about them going forward?

Indra K. Nooyi

If you go back to my comments in the beginning, I think we are thinking about three things -- one, clearly one part of the effort has to be on launching lower priced options and our R&D people are focused on that but more than R&D, we have people that work on price pack architecture to make sure that we hit the right price points for the consumer because it’s not just value -- it’s also delivering value when the consumer wants it. So there’s one group focused on that.

There’s another group focused on differentiated value versus competitive offerings to make sure that our products, even the Lay’s potato chip, for example, by providing a great quality potato chip with differentiated flavoring, you are provide incremental value to the consumer. So we have people focused on that.

But in today’s world where people are also worried about prevention rather than cure, and they are worried more about how they take care of themselves, we want to make sure we have a whole range of science-based differentiated product offerings targeted to key [cohort] groups, whether it’s women or boomers or athletes or kids. So we have our R&D team focused on these areas which can actually lift the portfolio. So it’s a judicious balance of all three that we think will allow us to continue to improve margins next year and deliver the [algorithm].

Kaumil Gajrawala - UBS

Got it, and then just a very quick one -- Richard, as we think about the buy-back for next year, is there a catch-up for this year and then we add on what’s been your normal buy-back?

Richard A. Goodman

That’s what we are -- we are doing that planning now but clearly we will resume the buy-back and we will look to do some catch-up from where we were this year as well.

Kaumil Gajrawala - UBS

Okay. Thank you.


Your next question comes from Carlos Laboy with Credit Suisse.

Carlos Laboy - Credit Suisse

The new long-term macro and consumer reality you’ve discussed, where do you think that the sustainable long-term growth rate of the combined PI markets may be able to take you? Are these still mid- to high-teen currency neutral growth opportunities?

Indra K. Nooyi

Generally speaking -- again, this is not a guidance but we are talking more about general direction, that’s about right. But I think in 2010 in particular, based on everything we’ve seen in markets east of the Middle East, what we would like to do is take some of the upsides from this transaction and step up our investment in those markets. Let me tell you why 2010 poses a unique opportunity for us.

Two reasons -- one, we will have some up-side from this transaction that we can reinvest. Second, we will have people -- very, very talented people that we will have in the system because you are putting two bottling companies together, we will have excess people, and this is an opportunity to use some of them to help us expand our efforts globally, so that’s another reason why I think 2010 should be a reinvestment year. And three, we are beginning to see because of the economic downturn in the west, that we can invest more cost effectively now than perhaps two or three years from now, so we want to take 2010 as a year that we make substantial reinvestments to sustain the long-term growth of the company. So while the mid-teens growth for international is generally the right target, I think in 2010 look for stepped up investments.

Carlos Laboy - Credit Suisse

Thank you.


Your next question comes from Bill Pecoriello from Consumer Edge Research.

Bill Pecoriello - Consumer Edge Research

I wanted to get a little more granular on Frito Lay -- you talked about consumers more focused on price points and they didn’t respond as much to the 20% more pounds. What exactly are you seeing in the large format stores versus the small format? Is large format, is it a shift to private label, other snacks that’s concerning you? In the small format, obviously you are trying to hit the right price points, but I just wanted to understand exactly what you are seeing there and as the commodities come off further in Q4 and first half ‘010, do you think we’ll see Frito more into that 6% to 8% operating profit or you will continue to reinvest heavily there?

Indra K. Nooyi

John, let me turn it to you.

John C. Compton

Sure. I think Frito Lay, if you look at the quarter in total, you have to remember that in Q3 has the two big holidays of July 4th and Labor Day, and those are two holidays that we absolutely want to win. So in the quarter, we did invest in value, in part the 20% more that Richard talked to and in part to ensure that we had the right price points for the consumer. Large format did grow faster than small format, to your point, but our small format business, primarily driven by the $0.99 line, did continue to grow, albeit at a slower pace. And we are putting some initiatives in the marketplace in the fourth quarter notably around Doritos to help take that growth back up.

If I look at the Frito Lay business year-to-date, we have 8% revenue growth in that business, reported. If you go to GDMX and look at the scan data, you would see that Frito Lay is far and away the fastest growing consumer goods company in North America, and that’s not comparing it to [Wise] or us -- that’s comparing it to other major consumer packaged goods companies. And as you well know, Bill, it is critically important for Frito Lay to keep the growth rate up because of the cash flow that it provides to retailers.

So I think the combination of ensuring that we had the right value in the market for the holidays to follow consumers as they shift their shopping behaviors, and to invest in go-to-market initiatives, primarily this quarter and racking initiatives in large format stores -- you know, I think in part we had a solid quarter over all and we continue to grow our market share.

We’ve also said from the very beginning that we wanted to price to the commodity curve and the commodity curve this year was extremely lumpy, and we’ve done that I think in the first three quarters of this year remarkably well and to your point, yes, as it starts to come down in the fourth quarter and into next year, you’ll see less pricing from Frito Lay overall and more initiatives to drive our volume growth.

Indra K. Nooyi

Let me just add one other point -- I would encourage everyone to look at the PepsiCo portfolio in its entirety because any time that we see an opportunity to invest in the business, as long as the overall portfolio works, we would like to take the opportunity because in every business there is going to be puts and takes by quarter but the bottom line is the overall portfolio works.

Bill Pecoriello - Consumer Edge Research

Thank you.


Your next question comes from the line of John Faucher from JPMorgan.

John Faucher - JPMorgan

Thank you and Mike, once again congratulations -- it’s been great working with you. Sort of following up on Bill’s question here, and this isn’t just an issue for you guys, it’s an issue for everybody on the consumer staple side -- you know, lots of pricing going forward -- excuse me, in the past -- concern about the consumer -- what gives the confidence that the volume is going to bounce back as we cycle against very difficult pricing comps here? Is it that the consumers will finally have worn off the sticker shock? Do you see the underlying spending coming back? I think that’s one of the bigger concerns that people have just from a macro standpoint.

Indra K. Nooyi

John, let me take the first part of the question then I’ll toss it to John to provide more color. One of the things we are seeing is that more and more consumers are staying at home and eating more food at home and so I think that even though the overall consumer sentiment is weak, the fundamental growth in food at home I think is going to continue along low levels but will continue to grow. And I think that’s a tailwind in our favor because they take the monies they were spending in food away from home and then bringing it back to food at home because it is still much less expensive to eat at home.

So John, given that as a background, talk about Frito Lay.

John C. Compton

John, as you see, Frito Lay had 3% volume growth in the quarter and that’s actually faster than our year-to-date performance. Now in part, that’s because we put 20% more back in packages but our unit growth continued to grow, so I have not seen any indication of volume in Frito Lay North America slowing down -- in fact, the opposite. Our volume growth is picking up.

Now in Latin America, most of our pricing initiatives -- sometimes we do visual pricing, i.e. raising the price of the Peso, but in many cases we do this through weight-out. So we did have volume softness in Latin America but we had a very positive spread between volume and revenue.

But overall, I think the volume initiatives are on track and we had volume growth last year in Frito Lay North America and we are seeing good, solid volume growth this year.

Richard A. Goodman

I think this is really also about innovation -- this is about our ability to continue to innovate to be able to draw more consumers in the category. It’s something that certainly in our snack business, as we’ve done exceptionally well over the last decade in being able to make sure that we can drive positive volume growth and our goal is to have that balance between positive volume growth and positive profitability.

Indra K. Nooyi

Let me also toss it to Zein Abdalla, who runs our Europe business, to give some color on the consumers in Europe and what you are seeing there, Zein.

Zein Abdalla

What we have seen is a lot of the pricing actions that we took throughout the end of late 2008, early 2009, through weight-outs as well as through smart pricing architecture, are now actually built into the space of the business and they were there clearly to cover the commodity cost increases as well as cost increases driven by for-ex.

Now through that, what we have managed to do through our programs of differentiated value and innovation actually has maintain relatively stable volumes, so we are now getting to a point where we won't need to take as much pricing going forward and we are lapping the pricing that we did take.

We’ve also through that time built gross margin and built A&M levels, so we are pretty confident about our ability now to invest that to drive growth going forward.

John Faucher - JPMorgan

Great, thanks.


Your next question comes from Christine Farkas from Banc of America Merrill Lynch.

Christine Farkas - Banc of America Merrill Lynch

A question, if I could -- just actually a follow-up on Frito Lay before I move to beverages; I was just wondering, Richard, if perhaps you can give us your outlook for your basket of commodities and how that is shaped up for ’09 and looking into 2010, if you can maybe compare the inflation, and is there a difference overseas versus the U.S.?

And then Indra, my question on beverages, we’ve seen volumes decline now in line in the third quarter with the first half, profit and revenue trends similar in the third quarter to the second quarter -- what should we be looking for here with respect to progress as you’ve indicated in your comments? Thank you.

Richard A. Goodman

Just to answer the first question, on the commodities side we are still seeing mid-single-digit inflation for -- overall for the company. It was a little bit -- it was probably a little bit less than we had expected just for the open positions, the commodities that come down during the course of the year but it was still pretty significant and it was more in the food businesses than in the beverage businesses and I think that that was true both domestically and internationally because a lot of it related to cooking oil and potatoes and stuff. So next year, we don’t -- I mean, we’re still in the process of working on next year but clearly we expect it to be deflationary next year and some of that depends upon what happens in the balance of this year but we would expect it to be deflationary, although we don’t have particular figures to share with you at this point.

Indra K. Nooyi

And on beverages, Christine, it’s an interesting time because of the bottler deal and the fact that we are going to have all of the efficiency and the productivity improvements that will result from integrating the anchor bottlers into PepsiCo. But let’s look at the marketplace for next year because when you ask me about what to expect, we have to start with where do we see the category growing in 2010? Now unfortunately in beverages versus foods, there is a free alternative called tap water and so one has to be very cognizant of that as we think about the outlook for a beverage business, not just PepsiCo's beverage business. And so what we have to be careful about is to make sure that those functional efficacious beverages targeted to specific [cohort] groups keep their razor-like focus -- laser-like focus on that [cohort] group. So for example, Gatorade to the core athlete. We have to make sure we don’t cheapen Gatorade and now we’ve restored it back to the core athletes, we need to build on that core athlete and make sure that we don’t take short-term actions which dilute the brand versus the long-term.

Similarly, as we think about products like Sobey Life Water, Zero Calorie, Propel, we want to make sure each brand is focused against a target group and we maintain a pricing architecture consistent with that.

So going into 2010, our strategy is to deliver positive profitability I hope, because versus this year where we are overlapping negative profit growth, next year should be a much better year than this. But why don’t you wait until about January, so that we can give you a better idea of where we think the category is going and where we think our profits will end up?

Christine Farkas - Banc of America Merrill Lynch

Thank you very much.

Richard A. Goodman

Christine, just let me clarify -- for next year, we are seeing more deflation on the food business than on the beverage business and there are some places internationally where as you know, sugar prices have gone up pretty considerably over the last couple of months and so that -- and so -- and those will affect our beverage businesses, particularly in some of the international, particularly some of the developing countries.

Christine Farkas - Banc of America Merrill Lynch

Okay, got it. Thanks for that, Richard.


Your next question comes from Mark Swartzberg from Stifel Nicolaus.

Mark Swartzberg - Stifel Nicolaus

I was hoping Indra or Mike, if you could help us get a little more granular, specifically in the area of Russia, the Leb effect kind of goes away from this point forward and you’ve been quite clear about how acquisitions have been aiding volume and profit growth in Europe generally. Can you just talk a little bit more about what you are seeing in Russia, A in the beverage business and B in the snacks business, and then talk a little bit more than you’ve told us about what you are doing to improve trends there when we of course know that the environment is tough but you also have a number of distinct advantages, including your route to market.

Indra K. Nooyi


Zein Abdalla

The environment is [inaudible] in Russia clearly a macroeconomic environment and the fact that disposable income has declined in recent months. What I can tell you is, you know, being involved with businesses in Russia across the last couple of decades is that this downturn is quite different to previous ones and that there is many more levers that the economy has to pull to turn around and I was there earlier in the week and as you go around the shopping malls, you still see people in the malls, you still see people transacting and the shelves are stocked, which is clearly different to previous downturns.

What we are doing in our business clearly is driving cost control very tightly, leveraging the strength of our combined businesses. We have a common go-to-market system across snack and snack and beverage, and clearly as the Lebedyansky asset, which is a tremendous asset with a very broad brand portfolio, covering premium through value and a tremendous capability in reach in terms of its go to market system, it gives us the ability to leverage that across all three lines of business. And through that we’ve managed to grow our margins on Lebedyansky. We are actually growing our profit base on Lebedyansky.

On snacks, we are leading the market in terms of growth. As Richard mentioned, we gained 6.5 share points of share growth on snacks and we feel very well-positioned that as the economy does turn around, that our businesses will benefit.

Richard A. Goodman

I’d just add, Mark, if you look at on the positive side, the Rubel has stabilized -- in fact, strengthened in the last month or two. The government is projecting positive GDP growth, albeit low-single-digits, for next year. And when I look at the power of one opportunities once we closed the PBG transaction, particularly in the East of Russia, I think we’ve still got lots of levers to pull and frankly our snacks business has powered right through this recession. It’s just been amazing what the team there has been able to do, so we’ve still got good innovation ideas and I am confident we will have a good year next year in Russia.

Mark Swartzberg - Stifel Nicolaus

And if I could, actually owning PBG versus having this approach you’ve had in the past, highly integrated in the past but more integrated going forward -- any significant benefits you expect to get from that complete ownership of PBG?

Zein Abdalla

It clearly significantly simplifies the overarching structure that we put in place. If you think about it today, we have actually three different entities in Russia -- a joint venture on beverages, a joint venture on Lebedyansky and a wholly owned snack business. Clearly by simplifying that, we can push [inaudible] one actually to new limits.

Mark Swartzberg - Stifel Nicolaus

Great. Thanks, guys.


Your next question comes from Caroline [Leeney] with [Calyon CLFA].

Caroline Leeney - Calyon CLFA

I am going to ask to dig into China a little bit -- you didn’t mention volume growth there and I am just wondering if the government stimulus there has had any benefit on your business, be it for volume or pricing? And if you can just talk about local competitors in that region -- is [Tengyi] gaining ground? It appears to be gaining ground, and just a little background on China would be great.

Indra K. Nooyi

And Caroline, you know, I spent a couple of weeks in China earlier this summer and the targeted stimulus spending that the Chinese Government has done has clearly taken root in the market and you can see the activity, especially in interior China, where there’s many, many projects that are evident on the landscape. And so there is spending being targeted and those markets are growing. The question is can they be sustained? I think that consumer spending will go up in China because the government is encouraging it and we feel quite bullish about China going into 2010.

You know, China is sort of a very interesting market -- in fact, it’s a market that we ought to use as a learning place to take ideas back to the rest of the world. Innovation abounds. It’s not just innovation for the Chinese market -- the speed in which they fast follow anybody else’s innovation is also spectacular. And so local competition abounds. Western competition, innovating for China also abounds and I think companies like PepsiCo, while our brands are highly respected for their quality, for their safety, for the fact that they provide a great eating experience, eating and drinking experience, our brands will always do well but I think we also have to adapt our model for the local Chinese market.

So China for us represents the biggest opportunity, the biggest learning country, and a [inaudible] that they can write an incredible story on.

Caroline Leeney - Calyon CLFA

Thank you. What about volume and pricing, Indra? How’s it been looking there?

Indra K. Nooyi

In which business?

Caroline Leeney - Calyon CLFA

May I go for both?

Indra K. Nooyi

Well you know, it depends. Across the board on beverages, the CSD market is really western competition so there’s different kinds of pricing dynamics there than there is in snacks. In potato chips, you have less local competition so we were able to get good pricing but in the area of non-carbonated beverages where you have a lot of local competition, we have to make sure that we remain very competitive with the local players.

Caroline Leeney - Calyon CLFA

Thanks, that’s great.


Thank you. I will now turn the call over to Indra Nooyi, Chairman and CEO, for closing remarks.

Indra K. Nooyi

Thank you, Operator. Let me close by saying that I am exceedingly proud of our teams around the world for delivering consistently strong results so far this year. I am even more enthusiastic about the tremendous opportunities we have to grow over the long-term.

Our bottler integration is just one step on our journey to extend our leadership in the North American beverage business and we are positioning ourselves to deliver on the potential of our merger.

At the same time, we remain focused on driving long-term sustainable growth by investing in key markets around the world in brand building and in R&D to drive innovation. These investments, together with our ongoing focus on cost discipline, operational excellence and productivity, make all of us very optimistic about our ability to continue to grow and prosper.

Thank you very much for your time.


Thank you. This concludes today’s conference call. You may now disconnect.

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