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PepsiCo Inc. (NYSE:PEP)

Q3 2010 Earnings Call

October 7, 2010 8:00 am ET

Executives

Lynn Tyson - SVP, IR

Indra Nooyi - Chairman and CEO

Hugh Johnston - CFO

John Compton - PepsiCo Americas Foods

Massimo d'Amore - PepsiCo Beverages Americas

Eric Foss - Pepsi Beverages Company

Zein Abdalla - PepsiCo Europe

Saad Abdul-Latif - PepsiCo Asia, Middle East and Africa

Analysts

John Faucher - JPMorgan

Bill Pecoriello - Consumer Edge Research

Kaumil Gajrawala - UBS

Judy Hong - Goldman Sachs

Christine Farkas - Bank of America Merrill Lynch

Operator

Good morning and welcome to PepsiCo's third quarter 2010 earnings conference call. (Operator Instructions)

It is now my pleasure to introduce Ms. Lynn A. Tyson, Senior Vice President of Investor Relations.

Lynn A. Tyson

Thank you. With me today are Chairman and CEO, Indra Nooyi; and CFO, Hugh Johnston. Indra will lead off today's call with a brief overview of our overall performance, and then Hugh will review our third quarter operating and financial results.

We will then move to Q&A, where we we'll be joined by the CEOs of our operating divisions: John Compton of PepsiCo Americas Foods; Massimo d'Amore of PepsiCo Beverages Americas; Eric Foss of Pepsi Beverages Company; Zein Abdalla of PepsiCo Europe; and Saad Abdul-Latif of PepsiCo Asia, Middle East and Africa. After Q&A, we will end with some closing comments from Indra.

Along with our remarks today, I encourage you to review our newly improved earnings web deck. This document is already posted on our Website at pepsico.com/investors. Our goal with this expanded web deck, which we launched last quarter is to give additional context to our quarterly results and long-term strategic initiatives. I welcome your feedback on this document.

Our fourth quarter activities Indra speaking in December at Beverage Digest Future Smarts Conference in New York. And in November, she will present at the Morgan Stanley Conference which will also be held in New York.

During today's call, unless otherwise noted, all references to net revenue growth are on a constant currency basis, and all reference to EPS growth and division operating profit growth are on a core constant currency basis. Please read our Q3 earnings release for more details.

Before we begin, please take note of our cautionary statement. This conference call includes forward-looking statements based on currently available information, operating plans and projections about future events and trends.

Our actual results could differ materially from those predicted in such forward-looking statements, but we undertake no obligation to update any such statements whether as a result of new information, future events or otherwise.

Please see our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K and subsequent reports on Form 10-Q and 8-K. And finally, you should refer to the investors 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.

With that, let me turn the call over to Indra.

Indra Nooyi

Thanks Lynn, and good morning everyone. I want to highlight three significant takeaways from PepsiCo's performance this quarter.

First, in a very challenging macro environment, we delivered great results for Q3 on the top-line, bottom line and cash flow. Second, while delivering these strong results, we are investing in both innovation in brands and these investments are already yielding returns. And third, consistent with what we shared with you in March, we are making strategic investments to transform PepsiCo in specific ways that we believe will enhance our competitiveness, solidify our growth and expand the value of the company well into the future.

So let me turn to the first key takeaway, our strong results. As we've discussed in recent calls, there's been very little improvement in the consumer and economic environment. Looking at the markets in which we operate, there is no doubt that economic uncertainty and high unemployment levels are keeping a consumer-led recovery at bay in many regions, especially in developed markets like the United States and Western Europe.

We expect these conditions to persist, and are planning accordingly with a keen eye on delivering value to customers with an efficient cost structure to ensure that we remain competitive and grow profitably.

Our ability to accelerate profitable growth this quarter in both developed and developing markets demonstrates our ability to control costs, while levering the significant advantages provided by the scale and breadth of our portfolio.

In the quarter, volume in our global snacks portfolio was up 2%, and volume in our global beverage portfolio was up 11%. That growth fuels a 41% increase in net revenue, and a 29% increase in division operating profit.

Core constant currency EPS grew 15%. Year-to-date, management operating cash flow, excluding certain items was up 29% to $5.3 billion. And this strong cash flow allowed us already to achieve our 2010 target of repurchasing $4.4 billion of stock by the third quarter.

And while developed countries are challenging, we are seeing healthy consumer spending in emerging countries, with strong GDP growth in countries such as China, India and Brazil, as well as those that are improving like Russia and Turkey. In fact, in our emerging markets, snacks volume grew at a high single digit rate, while beverage volumes grew at a mid-teens rate.

Throughout the world though, consumers remain very value-conscious. This is where the advantages that PepsiCo possesses, in granular management of productivity and local execution in the market drove differentiated performance this quarter. For example, at Frito-Lay we've launched a new urban program that targets close to 100,000 underserved retail partners.

This program is dedicated to leveraging the power of our direct-store-door delivery system to bring these retailers more relevant product categories at more attractive (price points). In markets where we have rolled out this program, our top-line has grown at two to three times the average of our base business. And now, through the Power of One, we will leverage this program across both our snacks and beverage businesses.

More broadly, at PepsiAmericas Beverages, we have worked aggressively to capture post-merger SG&A cost synergies, and we're now on track to hit above $150 million in synergies this year. Now, we're focused on operating revenue synergies that will help fuel top-line momentum going forward.

For example, in the third quarter, we announced that early next year we will start distributing Gatorade to small format stores through our DSD systems. As you know, this is a major shift that could not have come without the Bottler acquisitions and this will bring additional go-to-market strength to the many ongoing improvements we're making to the Gatorade brand and product portfolio.

But while we continue to see improving trends across our business in North America, the power of PepsiCo's balanced portfolio may be even more evident in Europe. Our snacks business there continued to perform well with 3% volume growth driven by differentiated value offerings such as the rollout of our successful Do Us a Flavour snack promotion in Holland, Poland and Turkey.

Simultaneously, the European beverage business grew by 10% organically, where our consumer-focused commercial programs drew at least one point of CSD value and volume share in key markets such as the U.K., Russia and Turkey. Our balance is also evident geographically, where on an organic basis we grew a solid 6% in Western Europe and 14% in Eastern Europe.

In summary, all of these results demonstrate the strength and balance of our portfolio in delivering sequential improvement in business performance through a difficult macroeconomic environment. And I'm pleased to say that we gained LRV share versus our closest competitor in both North America and in Europe.

Let me turn now to my second key takeaway. Our positive performance this quarter clearly benefited from focused investments we are making in product innovations and stepped-up brand building in key areas of our portfolio. For example, Frito-Lay's salty snack value share gains were aided by the launch of Lay's all natural regional flavors. These are products that allow us to elevate our core portfolio in the near term, and we are targeting to have about 50% of our portfolio all natural by the end of 2011.

I know that some of you recently visited Frito Lay's culinary center and experienced firsthand some of the wonderful products we're developing, such as the Tostitos Artisan products. Hundred percent of our Tostitos chips are naturally made with whole grain corn. These will enable us to make our snack portfolio more wholesome while retaining the best characteristics of our snack products.

We're also expanding further into adjacencies. For example, we continue to expand our Dip portfolio, leveraging our fantastic Sabra brand and we're broadening our bread-based platforms through Twistos and (inaudible).

At Quaker, after several quarters of increased investment we have brought to market a promising combination of improved quality and value, product innovation and a creative new brand building campaign. This launches off to a good start, driving both market share gains and sequential improvement in volume, revenue and operating profit performance as we continue to turnaround this very important business.

At Pepsi Americas Beverages, in the United States we had a positive swing in LRB volume share versus our closest competitor, driven by the very successful launch of our Gatorade Performance series and strength across our tea portfolio.

Also our relative carbonated soft drink volume share position strengthened sequentially in the quarter versus our closest competitor aided by the re-launch Pepsi Max. we also launched the first natural mainstream CSD Sierra Mist Natural which is made with five simple ingredients and nothing artificial.

This is a large opportunity and allows consumers to have what they love about CSDS while removing some key barriers. We launched this product only a few weeks ago. And advertising has just kicked in across multiple media vehicles.

On October 9, we will hand out over 10 million full can samples at Wal-Mart super centers across America. The largest sampling event either Pepsi or Wal-Mart have ever undertaken.

In addition to the sampling event, we have put a full year's worth of marketing support in the fourth quarter of 2010 with continued heavy support in 2011, which leads me then to the third key takeaway I shared at the start of the call. Even as we're investing to improve near term performance, we're also investing to advance the longer term strategic initiatives we shared with you at our Investor Meeting in March.

Let me touch on two of these initiatives, Power of One and Nutrition Co. as examples of who we're building long term growth potential in shareholder value. Many of you ask us whether the Power of One is anything more than just joint merchandising or can you really change the way you go to market and service your customers in a way that drives accretion for PepsiCo?

Good question and the answers are; yes, and yes. Our focused Power of One teams have a whole range of initiatives underway designed to provide enhanced solutions to our customers, to better optimize our advantage supply chain and also to enhance organizational effectiveness and efficiency. For example, for our customers in the United States, we have streamlined our customers facing resources and shopper insight themes under one organization. And we've held joint planning and growth summits with our largest customers with the focused effort to provide Power of One insights and solutions.

We have dedicated Power on One resources in each region. And we're increasing by tenfold, the number of sales leaders selling Power of One solutions. To enhance organizational effectiveness and efficiency, in the United States, we're harmonizing our regional structures for beverages and snacks which will allow us to better balance size and scale, shed geographic boundaries and align Power of One accountability and performance targets.

On the marketing side, our teams have also driven unprecedented levels of Power of One activation in both the grocery and convenience channel. For over 70% of our grocery business, or about 200 plus customers, we have Power of One ads, growth and inventory on display and increased revenue.

From July through September, we have 20,000 convenience outlets featuring Power of One activation, all of which was incremental to last year. And while the Super Bowl has traditionally been a strong shared merchandising opportunity for us, we are kicking it up a notch next year with the joint advertising of Frito Lay and Pepsi throwback products and also Pepsi Max.

We're just beginning to scratch the surface of the vast opportunities available to us right here in the United States.

So let me now turn to Nutrition Co. I'm very pleased to announce today that we're establishing the global nutrition group within PepsiCo. The creation of this group is consistent with the vision we shared with you in March. And our goal is to take roughly the $10 billion portfolio today and grow it into a $30 billion nutrition business by 2020.

The good news is that we're starting from a strong position with high quality nutritious brands like Quaker, Tropicana, Gatorade, Naked Juice, (inaudible) Soups, Sabra Dips, Pandora and Lebedyansky Juices just to name a few.

Our objective is to position PepsiCo globally as a leader in wholesome and convenience nutrition. We believe we can leverage our great portfolio brands across four target platforms; fruit and vegetables, grains, dairy and functional nutrition to put PepsiCo in a uniquely advantageous position to win in the $500 billion global market for packaged nutrition.

To enable us to move even more aggressively towards our goal, today we announced several organization changes as to accelerate our progress. Dr. Mehmood Khan, our Chief Scientific Officer and Corporate Leader of Research and Development will assume additional responsibility as the CEO of the new global nutrition group reporting directly to me.

Based in Chicago, this group will collaborate with businesses across the globe to ensure rapid growth of our nutrition portfolio. They will be responsible for the following: first, the global product innovation agenda for fruits and vegetables, grains and dairy. Second, functional nutrition, expanding beyond sports nutrition into new functional arenas overtime. Third, nutrition services, providing education and incentives to help consumers change and sustain behaviors related to nutrition.

Jaya Kumar, President of Quaker foods North America and previously Chief Marketing Officer of Frito Lay North America will move into a role as President Global Nutrition platforms reporting to Mehmood. To ensure a smooth transition, Jaya will maintain responsibility for Quaker North America until the successor is named.

With this new group, we will be able to harness the best of PepsiCo by retaining the operating capability for these businesses in the sector, while centralizing very important innovation development of nutrition products based on science.

Mehmood and his team will work closely with all four PepsiCo sectors to integrate these innovations appropriately to each of the regional organizations in these sales and distribution systems. So taking a step back, I would summarize the quarter as follows. We believe we delivered balanced top quartile performance in a very challenging macro environment.

Even more importantly, we achieved this while investing in near term opportunities like innovation in brand building, and a longer term initiative that will transform PepsiCo and expand the value of the company well into the future.

With that, Hugh, let me turn the call over to you.

Hugh Johnston

As you review our results, you will see that our teams did a tremendous job balancing growth and investments while delivering on profitability and cash. Even in an economic environment that continues to be challenging, our steadfast commitment to surgical investments is producing results.

That's why we've decided to maintain and where it's warranted step up our investment plans in the second half of this year while targeting 11% to 12% growth in core constant currency EPS for the full year. This step up in investment is incremental to the $0.10 per share in strategic spending that we earmarked at the beginning of the year.

In total, these investments include: first, expanding our beverage footprint in China, which is expected will be the world's largest LRB market by 2015 and the source of more than one of ever three LRB cases in the next five years. This includes investment and routes, coolers, systems and additional capacity.

Second, revitalizing our North American beverage business with increased investments in innovation and brand building, including our partnership with Senomyx as well as increased levels of support for Pepsi Max and Sierra Mist.

Third, laying a firm foundation for our Global Nutrition Group by reinforcing a key pillar for our preeminent health and wellness brand, Quaker.

And finally, adding to our world-class R&D capabilities through building a brand new Fruit and Juice research center in Hamburg German to support our European juice businesses, expanding our salt reduction technology, and research in delivering whole grain nutrition in beverage forms using technology that is proprietary to PepsiCo.

All of these investments are closely scrutinized. Each business case must show a positive return on investment and drive directly or indirectly the long-term value of the company. And our business leaders are held accountable for the capital they request. As I review our operating results, I'll highlight in more detail some of these investments and the returns that they are already generating.

So let me start with PAF. FLNA division operating profit grew 10% on a 1% increase in net revenue. Volume growth, which was 2%, improved sequentially as did our leverage from net revenue to profit, driven by a lower commodity cost, topline performance and Frito-Lay's focus on productivity.

Units were up low single digits, which as we said last quarter is a good proxy for consumer poll of our products as the business overlaps last year's 20% more free promotion. We finished that overlap very early in the fourth quarter. So we do expect that unit growth to translate to pound growth in the fourth quarter.

In the quarter, FLNA gained 70 basis points of gained salty-snack value share and posted the fastest growth among top 20 food and beverage companies in measured channels.

As Indra mentioned, we are having great success with our Lays all-natural local flavors which helped to drive solid revenue growth for the brand. Additionally, we continue to see double-digit volume growth in our Stacy's and Sabra products as we further our expansion into adjacent snack categories.

Our Foodservice business was also a strength, driven by the very successful $2 Meal Deal promotion with Taco Bell. This is another example of how we strive to provide value offerings to our consumers through the power of one with our great customer partners, and we're looking to extend this promotion.

At QFNA, we saw improved sequential performance with volume down just 1%, net revenue down 3.5% and operating profit down 5.5%. As we said last quarter, we've been making investments in innovation and value to restage the Quaker brand as the preeminent health and wellness brand and to return the business to profitable growth.

The majority of our instant oatmeal products have been reformulated with 25% less sugar, all natural flavors, a hardier texture and improved taste. We are giving consumers the product experience that they've always loved with our standard oatmeal, but with the convenience of instant.

We've also launched new innovative offerings targeted to two important consumer groups: Hearty Medleys, a multi-grain oatmeal for boomers made with real fruit and nuts; and Mix-Up Creations, a healthy create-your-own oatmeal for kids. The early read is positive with shipments and distribution exceeding our expectations.

The fourth quarter is a key selling season for oatmeal, and we are supporting our new product launches with in-store sampling, print, digital and social media support. We expect to see continued sequential improvements in both topline and profit performance from Quaker in the fourth quarter as our new product innovation takes hold and our investments in innovation and value begin to pay back. However, we expect it will take several quarters for our restaging program to fully take hold and get us to where we want to be with this powerful brand.

In our Latin American Foods business, volume was up 5%, net revenues were up 12% and operating profit rose 22%. As expected, we're starting to see our investments in new routes, continued focus on value, marketplace execution and innovative promotions to drive improved volume results. Also, effective net price realization drove strong volume to net revenue leverage, and the strict cost control focus drove flow-through from revenue to operating profit.

Throughout the Latin America region, macros remain mixed however. Mexico is showing moderate improvement, although they are still below pre-crisis levels. In South America, there are pockets of real strength, but Venezuela continues to be challenged. Our Latin American team's ability to navigate through shifting economic landscapes has been a long-standing capability for PepsiCo.

For example, Sabritas delivered strong volume growth through continued focus on value, strong marketplace execution and innovative programs that drive consumer engagement. Our Pake-Taxo value brand continues to show strong growth, and year-to-date the sales of this brand alone now exceed the total sales of each of our top different categories.

Gamesa grew volumes across all channels behind the successful execution of a soccer promotion which featured cash prizes. We also benefited from the marketplace investments we made earlier in the year when we added 150 incremental routes which are now fully optimized. Additionally, we gained 1.6 points of value share, a 3.6 point favorable swing versus our nearest competitor. In South America, volume growth accelerated from Q2 with strong performance in Brazil, Argentina and Chile.

Turning now to PAB, volume was up 13%, net revenue was up 118% and operating profit was up 79% as we continue to benefit from the impact of the bottler acquisitions. Acquisitions contributed 14 points to PAB's volume growth.

Despite what remains a difficult consumer and retail environment, excluding the impact of acquisitions, volume in North America was flat, a sequential improvement of 1 point versus the second quarter.

Our belief in the long-term attractiveness and resiliency of the liquid refreshment beverage category has been bolstered as we are starting to see some positive signs of recovery in the category and expected to return to modest growth this year.

We are being judicious though and will continue to concentrate our efforts on specific categories that offer opportunities for profitable growth, while also maintaining pricing discipline. We are focusing our resources, innovation, messaging and execution against these specific opportunities and we're increasing our investments in brand building to support the growth.

We are starting to see the pay off from our efforts, as evidenced by the positive swing in total LRB volume share versus our nearest competitor that we achieved in the quarter.

The integration of our bottling businesses is proceeding in line with our expectations. We're on track to deliver our full year synergy target and continue to look for further opportunities across a number of markets that will drive savings and incremental revenue in the future.

As Indra mentioned, we are moving beyond delivering pure cost synergies to now realizing top-line benefits and truly unlocking the strategic value of the merger. Let me pause here and highlight the significance of being able to distribute Gatorade via DSD and the convenience of up and down the street channels. This is an important unlock for us. With this move, we'll align our go-to-market actions in small format giving us strength in every product category and throughout the cold bulk.

This is a great example of how we're using PepsiCo's broad set of go-to-market systems to better serve our customers with more frequent service, fewer out of stocks and greater flexibility and responsiveness while improving our own economics by adding scale and increasing drop sizes.

In the quarter, we accelerated volume growth in Gatorade through our transformation of the brand which centers on innovation with the new G-series products, the expansion of our retail footprint and a targeted efficacy message aimed at rebuilding the brand's credentials.

While we benefited from favorable weather, we are encouraged by our progress as the growth was across all channels in both ambient and cold formats. Our brand health metrics also continue to improve. And both our prime and recover products continue to do extremely well. While it is still early days, we are very pleased by the marketplace reaction and our recent results.

Another example of the power of an integrated beverage company is in food service where the merger removed historical structural barriers and created new growth opportunities. We're already making great progress by getting new business via commissaries and we are not stopping there.

We're using our Power of One sales teams to sell in the entire PepsiCo portfolio across the largest workplace, healthcare and education accounts. We are already well on our way to doubling our market penetration this year, and have plans to continue the expansion.

Regarding CSDs, clearly the overall category continues to be challenging. In this environment, it is imperative that we drive differentiated innovation, targeted at the current and future profitable segments of the category.

We will do this while we are refining our price pack offerings by channel and occasion and striking the right balance between value, volume and profitability.

For instance, we are actively addressing two of the key barriers to CSD consumption, artificiality in calories through innovation and consumer engagement to rebuild our CSD momentum. Prime examples of this are Sierra Mist Natural and Pepsi Max.

Indra already touched on Sierra Mist. I'll talk a little bit about Pepsi Max. The re-launch of Max is off to a great start and we are investing heavily in our zero-calorie, maximum Pepsi taste communications.

We've already stepped up our brand building support for Max through a multi-year effort to raise the zero calorie awareness among consumers. You'll see more of this during the Power of One super bowl line up in January.

Finally, we announce the collaboration with Senomyx to develop new sweetener systems. The real challenge is to create products that are not only healthier but also taste great. And Senomyx has unique technologies to allow us to improve the nutritional profile of our products without sacrificing taste.

This will complement the work of our current partners and internal R&D teams are undertaking and will help us achieve our health and wellness goals of reducing calories and artificiality in our beverage products including our commitment to reduce added sugar per serving by25% in key brands in key markets over the next decade.

This relationship with Senomyx reflects our increasingly long-term approach through research and development as well as our belief that global food and beverage companies can play an important role in identifying new ingredients that can lead to healthier products.

Turning to Europe, we delivered a very strong quarter with sequential improvements in top line growth across both snacks and beverages. Year-over-year snack volume was up 3%, beverage volume up 17%, net revenue up 55% and division operating profit up 45%.

Europe's results continue to be positively impacted by the inclusion of the Bottling acquisition. The macro environment we faced in the second quarter remains largely unchanged and we expect only modest GDP growth across Europe.

Unemployment remains high and the impact of austerity measures in a number of markets continues to depress consumer confidence. Despite the mixed economic picture however, we're seeing underlying growth return across snacks and beverages in several key markets.

Our snacks business improved significantly in Eastern Europe and matched the strong growth we saw in the second quarter in Western Europe. This performance was underpinned by the success of our incremental investments this year in strong commercial programs.

We built our flavored cup promotion around soccer in the U.K. and expanded our Benenuts nuts products into Poland. We continue to offer consumers differentiated value by leveraging successful concepts such as “Do Us a Flavor” which ran in Holland, Poland and Turkey as well as new programs such as travel promotions in Russia.

Beverage volume grew 17 points, but importantly we delivered 10% growth excluding the acquisition impact. This represents a six point sequential improvement in organic growth over the second quarter.

While there was a sequential improvement in volume growth in Western Europe, the majority of the six point sequential improvement came form Eastern Europe where we've been aggressively adding new routes and colors.

A strong commercial calendar helped us capture share while an unusually hot summer helped to drive category growth. Our consumer focused commercial programs continue to drive strong volume growth. And we delivered dollar share gains in key markets such as Russia, Turkey, Spain and the U.K. As with snacks, most markets focused their activity around soccer and our promotions continued to generate a very positive response from consumers.

We also have kept up the momentum on our differentiated value programs, with our text message programs in Turkey enjoying strong consumer uptake.

While the unusually hot summer in Eastern Europe has helped our beverage volume, it has also affected crop harvest in the region. As a result we absorbed higher than planned input cost for our snack business in the quarter and this will continue into the fourth quarter.

Turning down to AMEA snack volume was up 16%, beverage volume rose 4% and net revenue grew13%.

As expected, Division Operating Profit declined 19% as AMEA overlapped more than 30 points of operating profit growth associated with the contribution of our snacks business in Japan last year to form a joint venture with Kelbey Foods Company, the snacks market leader in Japan.

Profit growth was also impacted by our decision to invest in longer term strategic initiatives in both our snacks and beverage business in this key growth region, especially in China.

AMEA delivered top line growth across both snacks and beverages and we successfully defended our CSB in savory share positions in many markets despite competitive challenges.

Snack volumes continue to grow in the mid-teens, driven by double digit gains in India, China, the Middle East and Indonesia. In India, volume growth was up over 20% behind the continued success of our marketing efforts such as Lay's “Give Us Your Delicious Flavor” promotion, new product innovations like Kurkure which is tailored to local consumer taste and the strong performance of our Quaker brands.

In China, snack volume grew 15% driven by potato chip growth and distribution gains on Quaker. Across the balance of the region our results were supported by new product introduction such as SunBites in Thailand, Nori Seaweed flavor Lay's potato chips in Vietnam and Doritos Tandoori Chicken in Egypt.

In beverages, volume growth was driven by double digit gains in Egypt and in Thailand. China's growth of 9% reflects continued strong growth NTBs and high single digit growth in CSDs as we stepped up our marketplace investments in Routes, Coolers and brand building.

Adding to the NTB growth was the national launch of our Tropicana Pulp Sacs product, which is helping to drive record high brand scores as well as share gains. While the CSD category in China continues to be challenged, we grew our CSD share behind gains in Mirinda and 7UP, and we remain the leader in the (Cola) segment. We are well-positioned to realize the long term potential of the many developing markets in this region.

The investments we have in place are bearing fruit and we still have a long way to go. We will continue to invest in innovation and build scale businesses to expand our footprint across beverages and snacks especially in China and India. And increase our sales and go to market capability.

China is expected overtake U.S. as the world's largest packaged foods market by 2014 and as the second largest food and beverage company in the world, it is imperative that we expand our footprint in this critical market.

Now, let me turn to our outlook for the year. We are on track to deliver EPS results within our original target range. With three quarters of the year now behind us, we are tightening our range to our 11% to 12% growth in core constant currency EPS for 2010.

We expect to deliver on our full year EPS target while also investing in many of the initiatives that we've talked about this morning. As the result of our strong operating productivity, focused investments and working capital discipline this year, we now expect to deliver about $8 billion in cash flow from operating activities with management operating cash flow excluding certain items and net of capital expenditures of about $6.1 billion. That is about $500 million higher than our previous forecast.

Net CapEx should total about $3.3 billion which includes about $200 million in capital investments related to the bottler acquisition. We expect to capture about $150 million in synergies from the bottling acquisitions of this year with $400 million in annual savings once following implemented by 2012.

And lastly, we still expect our full year reported tax rate to be roughly 23% to 24% which reflects a benefit of about four percentage points from non-core items.

Before we get to Q&A, let me leave you with the few of my own observations about the quarter. First, we delivered on our EPS commitments while responsibly balancing growth, investments, profitability and liquidity. Second, we are making clear strides in the revitalization of our North American beverage business in key strategic areas and we are delivering on the benefits of the acquisitions. Third, our scale geographic footprint and broad product portfolio positions us well to capture growth and improve our performance across all the regions in product categories.

Overall, we feel very good about PepsiCo's performance and also about PepsiCo as an investment. We deliver strong steady cash flow and we convert that cash to shareholder return with a solid dividend yield plus an attractive share repurchase program.

Further, we have both geographic and product portfolio diversity that offers the prospect of growth and durability in operating performance. In some, even while the consumer, financial and economic environment difficult and challenging, we believe that Pep is an equity that is built to perform.

With that I would like to turn the call over to the operator for questions.

Operator

Our first question is coming from John Faucher of JPMorgan.

John Faucher - JPMorgan

So, Indra, I guess this is the second fourth quarter in a row where we have seen guidance come down for additional spending. And so, we're generally seeing a high level of competitive spending across consumer staples right now. So I think if you look at this there is some concern that the reduction in guidance for additional spending is simply a reaction to higher competitive spending levels what have you, or potentially just simply if you look at the margins heading out to 2011, they are still too high.

So we've talked about this before, but what will see on top-line as we look out into 2011 and beyond that really highlights the fact that this is additional investment? And this is this is being done from a position of strength as opposed to a position of weakness.

Indra Nooyi

John, I am just going to make some opening comments and then pass it over to Hugh to really address it. First, I am troubled by the word reduction in guidance. We are saying we tightened the guidance. We gave you a range 11% to 13%. All that we're doing now is tightening the guidance.

So we feel very good about where we have been so far in the year. And we feel good about the fourth quarter. And in today's macro economic environment, to deliver 11% to 12% EPS growth for a company of our size and scale I think is fantastic performance. So that's the first point.

Point two, we are managing the company for the long term. And when we see opportunities to make investments which we think will pay off may not be in the next quarter or two but over the long term because many of these require investments in platforms and R&D, we are going to make those investments because we have to make sure that we are looking at innovation 24 months to 36 months out.

Because as we move more and more into the nutrition space, it's no longer mere line extensions but we have to think about products backed by science. And science takes some time to be proved and authenticated, and that's what we are focusing on. But that's just a word by way of preamble. Let me turn it over to Hugh to give you a much more detailed answer on this topic. Hugh.

Hugh Johnston

Thanks, Indra. Yes, John I am glad you asked the question. In terms of tightening the range, first and foremost, we gave you a border range obviously back in the spring of 11% to 13%. We are now tightening it to 11% or 12%. As we have now gotten into Q4 in the latter part of the year we obviously have more line of sight as to where the year is ultimately going to come in.

The second point on that is, we're seeing signs that the investments that we have been making in the business really are creating payback, whether you look at things that are going on within NAB or the things that are happening internationally with China and India and developing markets.

So as we see that positive response, we do view it as an opportunity to invest more, and frankly an opportunity to get good payback over time.

In terms of the specific investments, what we are really doing is investing I think in a couple of places. And a lot of it is additional relative to we've talked about in the past, which is further investments in things like China and Russia in areas like selling coolers, racks, and systems infrastructure.

Second, in brand building, particularly in NAB around things like Max and Sierra Mist. And third, as we talk about this Global Nutrition Group, its making investments in things that will support our future in nutrition, things like Quaker brand-building and innovation and investments around fruits and vegetables, salt reduction and grains technology.

So these are the types of investment that as Indra said are things that are going to pay back over time, but they are the types of investments that really do drive the long term value of the company.

Regarding your question specifically on 20/11, we are really not prepared to share guidance on 20/11 just yet. We'll do that in the fourth quarter, as has been our previous practice.

Indra Nooyi

John, I can just close by saying, if you look at our revenue performance even this quarter, it's a very robust revenue growth. And this is a result of investments we made last year. And so I think, wait for guidance for next year. But I think you are already beginning to see the revenue pick up.

John Faucher - JPMorgan

Yes, I understand. I mean, I am not looking for guidance again. I guess what I am saying is, and it sounds like you sort of answered that a little bit with your last comment, which is, as you put this additional investment in, you are modeling out additional revenue that goes along with this, right? So it's not just going to be sort of, you know the investment continually ramping up, but the top-line looks relatively static from an expectation standpoint.

Indra Nooyi

You know, the revenue is coming but John all of this has to be moderated with where the economies are headed because we believe we are doing the right things with investing behind the right initiatives. But sometimes we also need the macroeconomic-led tailwinds.

And we don't know yet how to model that; we can model scenarios, we don't know how to model that. But based on sort of a middle-cut economic analysis, we think sequentially this will start accelerating.

Operator

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

Bill Pecoriello - Consumer Edge Research

The $150 million in synergies, if you can give us a feel for, because it's hard to get a read obviously on the underlying profit for PAB without having the pro forma, how much of that is going back into PAB for all this brand-building you're talking about on Gatorade and Mist etcetera?

And then also, in the quarter you talked about Gatorade and tea growing strong, and just wanted to get a feel for how much of a drag CSD, juice, water, some of those other segments were? Thanks.

Indra Nooyi

I'm going to toss it to Hugh again to give you the details. Bill, overall I'll tell you, on LRV we're managing the portfolio of brands and products and categories. And what we feel good about this quarter is that we gained LRV share versus our nearest competitor, and the momentum was looking good.

And so rather than get into individual products, let's just say, the overall portfolio is working. With that let me just toss it over to Hugh.

Hugh Johnston

Bill, we've talked about in the past the $150 million in the context of the overall $0.10 that we're looking to invest in the business this year. And no big change in that other than to some degree in dimension. And what we've talked about in the past are, number one, putting money into brand-building, into NAB. And it's not an insignificant percentage, but we've also talked about investments in China, investments in India, investments in Russia in order to build out those businesses, which is also getting a pretty good percentage.

Beyond that, we really haven't gotten into the specifics for competitive reasons as to where the money is going.

Indra Nooyi

Eric, did you want to add anything?

Eric Foss

Bill, the only thing I would add is that again, I think we feel very good about the quarter in a difficult environment. You've seen the top-line and volume improve the last couple of quarters. And if you think about the segments, water was positive, led by enhanced water. Non-carbs were strong across the board.

The CSD category did experience some softness, but as Hugh mentioned, we feel great. I think Max is exceeding our expectations, and we actually feel very good about the top-line performance across beverages broadly.

Operator

Your next question comes from Kaumil Gajrawala of UBS.

Kaumil Gajrawala - UBS

Two questions, both also on North America. First, can you give us a read on how much of that $150 million you achieved so far? I believe that's a number for the full year.

And the second thing was Gatorade going into the Bottler and then also into the independent Bottlers. I believe there's some sort of food service component attached to the contract. So some context on what that means and how it's progressing?

Indra Nooyi

Hugh?

Hugh Johnston

So let me handle that one. We've got right now about $120 million in. But with the switch for Gatorade from warehouse to DSD, there is both cost and benefits in the fourth quarter. So I wouldn't necessarily take that $120 million and try to project it on any kind of a straight line basis.

Indra Nooyi

Look, we're not providing the details on exactly what you're asking. Let's just say that we are trying to work out a transfer of Gatorade to our independent Bottlers in a way that makes sense for the overall beverage business.

Kaumil Gajrawala - UBS

Okay, got it. And then, can you maybe provide some context on how much the incremental spend is, which obviously led to the change in guidance?

Indra Nooyi

There's no change in guidance, Kaumil, there's just tightening of the range. I want to be very, very clear; 11 to 13 we're saying, where into fourth quarter it's 11 to 12. The guidance has not changed; the range has tightened.

Do you want to say anything, Hugh?

Hugh Johnston

No, I think that captures the essence of it. I mean obviously this is a balance that we are trying to strike, but frankly as we see good investment opportunities for the long haul we're going to make those investments, particularly when we're delivering within the expectation that we set out for ourselves in terms of delivering EPS for the year.

Operator

Your next question comes from Judy Hong of Goldman Sachs.

Judy Hong - Goldman Sachs

Thanks. I don't want to get hung up on this guidance versus investments here. But just to follow up, on the synergy number this year, it is coming in at the high end of the $125 million to $150 million. So it sounds like you've got investments that are in addition to what you've laid out as part of the synergy target.

So what's driving this year's synergy target increase? And does it give you some comfort around maybe getting more realization over the next three years?

Indra Nooyi

I think we fine-tuned our post-merger integration processes a lot Judy. As we have mentioned to you, we have a very well-tuned process. And so when we start our PMI work, the team's going to action, and when they start executing programs rapidly, you start getting the synergies a little bit earlier.

Again, let the year finish. Right now we are saying we could come in at $150. Let the year finish, then we'll start talking about what the next year will bring in terms of additional synergies or like thereof.

But it's too early to tell you what next year is going to be.

Did you want to add anything, Hugh?

Hugh Johnston

Yes, I'd add to that. Judy, as we go into these things, there are two variables we are planning for; number one is the amount that we'll get out of any initiative, and number two is the timing that we'll get out of the initiative.

In terms of the amount, some of them are exceeding some of them are falling. Short, the net is that they are coming in about where we would have expected to. The things that we are seeing is we are actually able to get some things done faster than what we had previously planned. So from the standpoint of the three-year number of 400 no real change in that. We really seem just good opportunities to accelerate timing relevant to our original planning.

Judy Hong - Goldman Sachs

And then just following up on North America beverages. You've talked about CSDs softeners but categories like sports drinks and water improving. So do you think there is more of an impact from the weather just being pretty favorable in the summer? How much of the improvement that you are seeing on some of these non-carb categories do you think is really sustainable if you look out over the next 12 months?

Indra Nooyi

Hard to say because here's where the weather has been bad, we have had decent volume growth when the weather's been good. We haven't had decent volume growth. So I don't think there is a predictable number we can assign to the weather.

The good news is that even in Gatorade which did exceedingly well this summer, the growth came not just from our core Gatorade but also came from the launch of our new product Prime and Recover. So that says to us that the core franchise is doing well. And if Prime and Recover did well it's because the sports enthusiasts really believed in those products to enhance their performance.

Similarly, lot of the other innovation that we have like Sobe Life Water, I'm not sure they are just weather related. So let's wait and see how the fourth quarter and the first quarter of next year evolve. And then we should be able to talk more about the weather and its impact on the business.

Hugh, did you want to add anything?

Hugh Johnston

Yeah just one further thought on that, Judy. Typically, of course when the weather is hot you see a nice jump in the cold channel business. I think the thing that makes us feel good about the non-carb business right now is we've also seen nice pickup in the ambient channels as well, the large case back channel.

So that suggests that it is more than just weather that there really is good brand building effect and it's having an impact in the marketplace.

Eric Foss

I can just say two words on Gatorade to reinforce what you said. We are seeing a growing trial as we (keep) level of our products, as well as some improving numbers on the base business. So we feel good on the long term sustainability of the Gatorade performance.

And the other thing, as you know, on juices Trop50 is growing double digit. We launched a new packaging. We have extended beyond orange into cranberry and apple. And all of these new products are really there for the long term. So we feel pretty good about it.

Operator

Your next question comes from (technical difficulty).

Unidentified Analyst

So I guess I want to stay on this tightening of the range if we could, Indra. I guess I'm trying to figure out simply, what's the bottom line?

What business is specifically or regions are not delivering the level of earnings acceleration in the second half that you're expecting back in July? And we've heard a lot about causes and what's going on. But if you were to kind of just put something at the top of the list, would you put something there?

And then secondly, is your view of 2H revenues for the totality of the company the same as where it was in July? Is it above where it was in July? Is it below where it was in July? I am just trying to get a bottom line here.

Hugh Johnston

I really question the characterization of anything not delivering as we expected, to be perfectly honest with you. From our standpoint, we gave a range of 11% to 13%, we've consistently said 11% to 13%. And we're now staying within that range of 11% to 13%.

What we've really talked about here is much more geared towards making investments in good opportunities in the marketplace, some of which are nearer in nature, some of which are a little bit further out in nature, but all of which are geared towards building the business, and all of which have good returns on them.

So in terms of any expectation that we had, frankly, it's exactly in line with what we had been communicating. So no big change from our standpoint, the July reference is, well, puzzling to me.

In terms of where we expect revenue to go, obviously we saw a good solid performance in the third quarter. And we're expecting to continue to see good solid revenue performance. So, we feel good about the operating performance of the business right now.

Unidentified Analyst

And is spending a fair basis for viewing this? Again, we're talking about a point here, but is it fair to say it's more about that incremental spend in spite of the incremental synergies? Can you help us a little bit there?

Indra Nooyi

So, (Mark), let's just talk about some of the spending areas. Hugh talked about spending in China; accelerate spending in China, stepped up levels.

Look, when you spend in China and for in coolers marketplace investment, you are not going to get the profitability impact in the next 12 months or 24 months. It takes a longer time because we are still in a massive of investment mode in China. This is got years and years of growth.

When we step up investment in India, again, you are not getting the returns right to way, but it's a must invest market because the demographics and the fact that per capita levels are so low gives you many years of growth.

So we are making stepped up investments in these countries because either we've got the permission to invest, or we see an opportunity to go in with a new product or a marketplace investment at favorable terms today. So we are looking around the world, and wherever we see the opportunity, we are ramping up the investments.

But just remember, the international market is not like the Unites States where you get a return within the quarter. It does take two, three, four years before the top-line starts ramping up in a meaningful way.

Unidentified Analyst

Okay. And then, I may have missed it, but incremental to that $0.10 could you give us an amount of what that is in terms of EPS equivalent you are spending incrementally here?

Hugh Johnston

No. What we've said is, we were between 11% and 13% and we're now sighting to 11% or 12%. And the increment is geared towards investing in largely developing markets and in NAB brand-building. So that's really where we are.

Indra Nooyi

I guess the difference is that when we talk about 11% to 13%, you assume its 13%, we think its 11% to 13%. I think we just have to have a conversation about this.

Operator

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

Christine Farkas - Bank of America Merrill Lynch

I wanted to dive into North America a little bit more with respect to the products. We did see some sequential improvement at PAB for sure. Was that really driven by Gatorade or did we also see improvements in CSDs and in the non-carbs relative to the second quarter?

Eric Foss

Well, as I said earlier Christine, I think if you look at the composition of growth in third quarter, what you would've seen is an increase in the performance of our water portfolio largely driven by enhanced water. The non-carbs performed well and improved broadly. Certainly, Gatorade had a great quarter. As I mentioned earlier, tea, energy, ready to drink coffee, all had solid growth.

The CSD category in total was soft in third quarter, and within our portfolio I mentioned Max was a big positive for us. The Core Dew business performed well, and so at the end of the day, water and non-carbs performed extremely well and the CSD category was softer and we kind of performed in line with the category.

Christine Farkas - Bank of America Merrill Lynch

And on the Tropicana side, with the growth of Trop50, did we see improvements there?

Massimo d'Amore

Absolutely. So Trop50 is performing ahead of expectations as I said earlier, and as you know is a higher margin product than the Core PPP business. So every case of Trop50 is accretive to overall algorithm. And across the portfolio we are now in line with expectations, and we have some strong innovation plans for the juice business for 2011.

Christine Farkas - Bank of America Merrill Lynch

Thank you. If I can round it out with a question on Frito, the unit growth which is still up low single digits as mentioned. On the margin, is that about the same as the second quarter? Did that slow, or are we seeing a pick-up in sea stores?

John Compton

Slight improvement from Q2 to Q3 in the unit growth. We've said low single digit unit growth. Now that 20% more free is behind us, that should become the proxy for volume growth, which as you know has been the historical volume growth in the company.

Indra Nooyi

So let me just wrap up this call. And let me give you some headlines that you should take away; macroeconomic environment, U.S. and Europe sluggish, rest of the world improving to buoyant. Our category reflects the economic performance of the countries. Our company performance is ahead of the categories and industries. Our operating approach, invest to transform our businesses consistent with changing lifestyles and society; second, judiciously balancing the short term and the long term. And the overall sentiment in PepsiCo: prepared and confident. We are feeling good. Thank you.

Operator

And ladies and gentlemen that concludes PepsiCo's third quarter 2010 earnings conference call. We appreciate your time. You may now disconnect.

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