PepsiAmericas Q3 2007 Earnings Call Transcript

Oct.24.07 | About: PepsiAmericas, Inc. (PAS)

PepsiAmericas, Inc. (PAS) Q3 2007 Earnings Call October 24, 2007 12:00 PM ET


Sara Zawoyski - Investor Relations

Robert C. Pohlad - Chairman of the Board, Chief ExecutiveOfficer

Alexander H. Ware - Chief Financial Officer, Executive VicePresident

Kenneth E. Keiser - President, Chief Operating Officer


Lauren Torres - HSBC Global Research

Marc Greenberg - Deutsche Bank

Andrew Sawyer - Goldman Sachs

Ann H. Gurkin - Davenport & Company


Good day, everyone and welcome to the PepsiAmericas Inc.third quarter 2007 earnings conference call and webcast. Today’s call is beingrecorded. At this time, for opening remarks and introductions, I would like toturn the call over to Ms. Sara Zawoyski. Please go ahead, Madam.

Sara Zawoyski

Thank you, Melissa. Good morning and thank you all forjoining us today to discuss our third quarter 2007 results. On this morning’scall are Bob Pohlad, our Chairman and CEO; Ken Keiser, our President and COO;and Alex Ware, our CFO. Our call is being recorded and will be available forplayback on our website at

Please note that throughout our call this morning, we willbe presenting certain forward-looking statements of expected futureperformance, including expectations regarding anticipated earnings per share,as well as other matters. These forward-looking statements reflect ourexpectations and are based on currently available data. However, actual resultsare subject to future risks and uncertainties, which could materially affectour performance.

We undertake no obligation to update any suchforward-looking statements and we wish to advise you that the risks anduncertainties that could affect our actual performance are set forth in thecautionary statements found in our annual report on Form 10-K for the fiscalyear ended December 30, 2006.

We will also reference certain non-GAAP financial measuresin our call this morning. Reconciliations of these items to GAAP financialmeasures are included in our earnings release, as well as on our website.

During the call today, we will also be discussing variousmeasures, including volume, net selling price, COGS per unit and SG&A,excluding the impact from acquisitions, as outlined in our release thismorning. Acquisition impacts reflect the non-comparable territories year overyear. In the third quarter of 2007, this includes one additional month ofRomania results as the company began to consolidate those results in August ayear ago.

Consistent with Romania’s reporting, Ukraine will bereported on a one-month lag basis, resulting in roughly two weeks recognized inthe third quarter.

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

Robert C. Pohlad

Thanks, Sara. Good morning, everyone. Thanks for joining usand for your interest in PepsiAmericas. Our third quarter results continued thegood performance we’ve experienced during the first half of the year. We’ve operatedagainst our same three strategic initiatives and each is delivering goodresults.

First, disciplined pricing and positive mix continued in ourU.S. business, which more than offset cost increases. Second, our customeralignment and CO3 initiatives are improving our effectiveness as expected. Andthird, the strength of our European markets continued. Notably this quarter, weclosed the Sandora acquisition and made an initial investment in the Pepsibusiness in Bulgaria.

As you’ll recall, we raised our full-year guidance comingout of Q2, as we gained comfort around our pricing, innovation, and theacceleration of our European business. Q3, as our results indicated, justifiedthat continued confidence. Therefore, we are again raising our full-yearoutlook to an adjusted EPS of $1.63 to $1.66, representing a 23% to 26%increase from last year.

And while Q4 will be impacted by a higher SG&A cost thatAlex will discuss, as well as the Ukraine dilution, the underlying strength ofour business continues.

In a moment, I’ll talk about our individual businesses inmore detail, but first, let me step back and give you some context around howwe think about PepsiAmericas, which in turn drives how we make decisions.

At the end of November, we’ll celebrate the seventhanniversary of PepsiAmericas. We began as a company in 2000, with the contributing 100% of operating profits, and we were positioned as aconsolidator in the U.S. In fact, our first major acquisition was in the U.S.

But importantly, we also put a stake in the ground in CentralEurope, and while many may have been skeptical at the time, we reachedprofitability in 2003 and our confidence in these markets grew.

In mid-2005, we expanded our footprint with our investmentin Romania and subsequently, we have added the Baltic’s, Ukraine, and aninvestment in Bulgaria, taking the European population we serve from $75million to over $160 million.

Now, while that’s a short synopsis, it demonstrates what Ibelieve is a thoughtful and purposeful evolution. Today, both the U.S. and Europeplay a critical but different role in our ability to continue to deliver strongreturns and create value for our shareholders.

Today, PepsiAmericas operates from three principles. First,the scale and stability of our U.S. business provides strong, consistent cashflows, enabling us to invest in higher growth markets. Second, our expandingEuropean business is our primary growth engine and it will become increasinglymore meaningful. And third, it’s the diversity and stability of these marketsin combination that can drive the profitability and growth of PAS in thefuture.

So as we report double-digit operating profit growth in thequarter, with the U.S. growing 2% and Central Europe growing over 100%, we feelvery good about this combined performance, which has enabled us to deliveryear-to-date adjusted EPS from continuing operations up 29% and a strongadjusted operating cash flow of over $200 million.

Now let me take you through some of the highlights of thethird quarter and importantly, what we are doing strategically in each of ourmarkets. In the U.S., within a difficult cost and volume environment, PAS grewoperating profits. Revenue grew over 4% from disciplined pricing and mixmanagement, through solid execution against our high margin single-servebusiness, which covered our costs and resulted in increased gross profit.

U.S. net selling price was up over 5% in the quarter,reflecting rate increases of approximately 4%, in line with Q2. Importantly,mix continued to be positive for us, adding a point to pricing, driven bystrong single-serve performance and our non-carb mix.

Our volume decline of 1.6% for the quarter was slightlylower than anticipated but consistent with year-to-date trends. Within thequarter, our CSD trend improved, driven by strong execution behind Mountain DewGame Fuel, driving our total Dew trademark to over 3% growth, and withPepsiMax, we lead the Pepsi system in distribution and share.

Innovation continues to be important to us, helping drivesingle-serve growth up over 1% in the quarter.

While our CSD trends improved and single-serve was strong,we did see our non-carb business slow a bit in the quarter, up 6% compared toyear-to-date trends of 11%. This was mainly due to flat Aquafina volume. Thetake-home water business was soft as we continued to cycle through some of theunique promotional activity of a year-ago, and we also experienced a three- tofour-week downturn during the negative tap water media stories.

Despite the flat volume, however, we continue to grow grossprofit dollars in water. Additionally, we’ve seen our take-home water return todouble-digit growth in the last eight weeks.

Excluding water, non-carbs continued to grow in the doubledigits, driven by strong execution behind our three tea strategy; Pure Leaf,Lipton Iced Tea, and Brisk. The Lipton trademark was up 26% in the quarter andwe continued to grow faster than the category and gained share, leading thesystem with an almost 50 share position in the grocery channel. In Q3, non-carbsgrew to 23% of our U.S. volume.

Customer alignment continues to be a very effectiveorganizational structure for us, combining singular focus against our channelsand field sales execution. The benefits take many forms, whether it’s ourC&G channel games, a quick response to a competitive situation in largeformat, or the single focus our field sales team has on innovation execution,such as Mountain Dew Game Fuel, customer alignment gives us a strategic view ofeach channel to make the very best decisions.

CO3 builds from that and is designed to ensure that we havethe right products in the right quantities at the right places. It’s builtaround three initiatives. It also occurs to me here that within PepsiAmericas,we like things in threes. Anyway, they are: improving production forecastingaccuracies, driving warehouse efficiencies and loading accuracy, and buildinggreater selling effectiveness.

Our implementation against each continues. First, 100% ofour domestic locations are now using the new demand planning technology andprocesses. As a result, our forecast accuracy rate have significantly improved,better by roughly 30 percentage points. This allows for more efficient andaccurate production planning, which helps ensure we have the right products forour customers.

Second, the rolling out of new technology and processes toimprove the efficiency of the loaders and the accuracy of the palettesdelivered. In our rollout locations, we’ve exceeded our 99.8% palette accuracytarget and expect to complete this rollout by the end of 2008.

The third part focuses on building additional sellingcapabilities through a new handheld technology. We’re calling it powerpre-sell. This will improve our selling effectiveness by providing suggestionsfor order optimization, as well as historical customer sales data and willincrease our efficiency, with new handheld scanning capabilities and wirelesscommunication.

We are currently in pilot mode but expect that the newhandheld will be rolled out prior to next year’s peak selling season, withfurther enhancements coming after that.

Looking forward, innovation and marketing plans willcontinue to play an important role in our U.S. growth. Sierra Mist CranberrySplash, a successful LTL last year, is off to a good start in Q4, as we expectadditional growth from the diet line extension.

In addition, we kicked off a stronger and broader hydrationstrategy in the latter part of Q4. Anchored by Aquafina, this strong andbroad-based hydration strategy is built around four distinct brands; AquafinaAlive and SoBe Life-water in the vitamin-enhanced category, both with excitingrelaunches ahead.

The full propel lineup, covering both fitness and energy;and the new G2 in the isotonic category, which we will have in the C&G andup-and-down the street channels, providing a low calorie hydration beverageoption.

Beyond this appeal to a broad consumer landscape, this newportfolio provides scale to compete in this important category. In Q4 ,we areincreasing our investment as our activity across new products and relaunchesbegins in December and gets fully rolled out in early 2008.

In tea, our double-digit growth should continue behind ourthree tea platform, driving both volume and share growth.

The energy category continues its strong growth and Pepsi’snew sponsorship with Dale Earnhardt Jr. racing the Mountain Dew Amp car, putsus in the pole position to win a greater share of that growth next year.

Our multi-tiered approach to energy has much of our focus onAmp, but with Essentials, Adrenaline Rush, and No Fear, each played strategicroles with the combination appealing well across all energy consumers.

Turning to our markets in Central and Eastern Europe, aswe’ve reported all year, the significant contribution continued in Q3. Constantterritory volume was up 4.4%, driven by Romania, and on top of last year’s 13%growth. Double-digit single-serve growth continued to drive strong pricing, up6% in local currency, excluding acquisitions.

We generated operating profits of $46 million, more thandouble from a year ago, and we significantly expanded margins, withyear-to-date operating margins of 13%.

Central Europe volume, excluding the acquisition impact, wasoff of our double-digit trend, as the entire category slowed in Q3 due to poorweather in September and as we were lapping very favorable weather conditionslast year. This was isolated to September, as October is already demonstrating.

As our product portfolio has expanded over the past three years,we’ve also rationalized our manufacturing infrastructure and our selling anddelivery system. We’ve continued to invest in frontline selling resources andin our brands through advertising and marketing to build and reinforce brandequity in these fragmented markets, where CSDs account for less than 50% of theLRB category, and regional players account for almost 80% of that LRB category.

[inaudible] growth of our developing markets, Romaniacontinues to exceed our expectations. August and September are the first twomonths where we began to lap our results from a year ago. Let me take just amoment to discuss Romania in greater detail.

It is a highly profitable market with margins significantlybetter than our core developing markets. We continue to increase thoseoperating margins through building brand equity and increasing our single-servedistribution. Its volume growth continues to be broad-based, with allcategories growing and our tea strategy and CSD innovation performingexceptionally well.

Romania is a key part in the eight point increase in overallCentral European operating margins, but keep in mind that as we move into Q4,we won’t see these same operating margins due to the higher degree ofseasonality.

While some of our Central European markets are experiencingfaster growth than others, all are contributing. Given the double-digit volumegrowth in Romania and the 8%, two-year compounded annual growth rate in ourdeveloping markets, further appropriate investment in capability and capacityis needed. As an example, we’ll be investing in a new aseptic line in Polandand also building a new production facility in Bucharest in 2008 that will beoperational in ’09. Both projects will give us greater production capacity andefficiency.

In August, we completed the acquisition of a majority stakein Sandora through a joint venture with PepsiCo. Ukraine, with the seventhlargest population in Europe, is equal in size to our U.S. consumer base. Asthe clear leader in the juice market, Sandora has developed threedifferentiated and powerful brand propositions. The strengths of these brandsplus the capability of its distribution system, with over 90% market reach,result in Sandora’s leadership position.

In future calls, I look forward to talking about the plansto leverage this strength and to expand our product portfolio in the market.

In August, we also announced another joint venture, thistime in Bulgaria, to make, sell, and distribute Pepsi products and otherbeverages. As the market develops, Bulgaria adds to our Central and EasternEurope presence. In the same way, Central Europe givesus diversity against our, the 11 countries in which we now do business provide diversity withinthat region. Each contributes in different ways, giving us good balance andgreater flexibility.

As we experience the strong year we are having, especiallyin Europe, we consider its sustainability and correspondingly, ourorganization’s capability to keep pace with that growth. Consequently, we aredoing a great deal of work around organization requirements and structure,something that I think we’re pretty good at.

The direction that we’ve taken, especially the last coupleof years, has built a meaningful beverage position in a growing part of theworld. More simply said, we think we are in the right place at the right time.And while the macros have provided tailwinds, the improvements in these marketsin our view are sound and long-term. Consumers there are educated and have astrong work ethic. Land and labor costs are relatively low, and governments arebecoming increasingly economically oriented -- all resulting in substantialforeign investment and rising disposable incomes.

These factors support our expectation for increasing stabilityand meaningful growth in these countries over the long run.

And so I close where I began -- our geography and portfolioin this growing part of the world will be the primary growth for PepsiAmericas.This growth and the expansion is enabled by the strong and consistent cash flowof our U.S. business, and the diversity and stability of our portfolio togetherwill drive the profitability and growth of PAS over the long term.

We feel very good about our performance this quarter andimportantly, we feel good about PepsiAmericas' future growth.

With that, I will turn it over to Alex to take you throughmore of the numbers. Alex.

Alexander H. Ware

Thank you, Bob. Good morning, everyone. While we expected Q3to be our largest EPS growth contributor, it even moved ahead of our ownexpectations. With top line growth of 11%, we were able to more than offsetcontinued COGS pressures and expand gross margins. Operating profit increased27%, with the U.S., Central Europe, and Caribbean all contributing. Excludingthe acquisition impact, operating profits grew 18%.

Worldwide operating margins expanded 150 basis points,reflecting our international improvements, and adjusted EPS from continuingoperations increased $0.15, or almost 37% from last year, and 29% on ayear-to-date basis.

Now let me take you through our Q3 performance and how thesetrends related to Q4. These numbers include the impact of favorable for-ex ofroughly two percentage points to revenue, a point to cost of goods sold, twopoints to SG&A, and nine points to operating profit on a worldwide basis.

Net selling price was up 7.4% in the quarter, with U.S. netpricing increasing 5.2% and at the high-end of our guided range of 4.5% to 5%.We executed our pricing strategy with rate increases of roughly 4% in thequarter and mix adding a point.

In the U.S., we expect our Q4 pricing increase to moderateto the mid 4% range, leaving U.S. pricing over 5% full year, enabled by astronger mix performance.

We continue to focus on our global execution in pricing,innovation, and single-serve in the marketplace, which allowed us to cover thehigher costs of goods sold, grow gross profits, and expand worldwide grossmargins.

Worldwide COGS per unit was up 6.9%, with U.S. COGS per unitup 6.7%, reflecting higher ingredient costs as well as a one point impact frommix.

We expect Q4 U.S. cost of goods sold increases to moderatefrom Q3 levels, as we begin to lap last year’s significantly higher sweetenercosts. Overall for-ex is also putting some pressure on our worldwide COGS, nowdriving us closer to a plus 5.5% full year.

Turning to the SG&A line, worldwide costs were up 3.8%in the quarter and 6% year-to-date, trending at the low end of our guided rangeof 6% to 7%. SG&A costs in the U.S. were up only 1.6% due to favorable compand ben costs, and lower depreciation expense. As you know, Q3 was our easiestSG&A lap in the U.S., while Q4 is our most difficult, up just 1% last year.

In addition, our fuel costs in Q4 will be $2.5 millionhigher as we recognize the reversal of the Q1 fuel hedge favorability. And soin Q4, the reversal of these items, plus the increased marketplace investment,will lift our U.S. SG&A by roughly 10%. Plus, the addition of for-ex willraise our full-year SG&A by roughly 7.5%.

Moving to items below the operating line, interest was inline with our expectations, totaling $27 million. This amount includes theinterest from the Sandora borrowings, which closed mid-third quarter. Wecontinue to expect interest to be in the $110 million range for the full year.

Continuing our Q2 trend, our strong operating performancedrove additional improvements in our adjusted return on invested capital,resulting in a 40 basis point improvement from Q2 to 7.9%. We have benefitedfrom our strong results this year and anticipate being at the high 7% range aswe round out the year.

With a strong operating profit and cash flow this year, weare forward investing in additional capital projects to bolster our futurecapacity and capabilities. Despite the higher spend rate, we expect that ourfull year adjusted operating cash flow will be above the previously expected$200 million mark.

On our revised guidance, let me specifically recap the itemsimpacting our calendarization; first, there is $0.02 of timing items hitting Q4as the fuel hedge and depreciation expense favorability reverse from previousquarters; second, we anticipate the Sandora dilution to be closer to $0.03 andall is hitting in Q4, due to the one-month reporting lag; and lastly, we areincreasing our balance of year marketplace investments.

Excluding these items, our underlying run-rate for Q4adjusted EPS growth would be roughly in line with our year-to-date trends of up29%.

In addition, while our guidance anticipates for-ex tailwindsto continue, it should have less of an impact due to the seasonally lowerprofitability of the European business in Q4.

In closing, we have enjoyed three very strong quarters, andwhile our EPS and cash flow growth will slow in Q4, it represents ourinvestment in future growth, ranging from Sandora and Central Europe to CO3 andhydration. All-in, our newly revised full-year guidance reflects a 23% to 26%EPS growth over prior year.

As a reminder of our timetable, we are in the midst of planningfor 2008 and will provide complete guidance on our Q4 call in January.

With that, I’ll turn the call back to Bob.

Robert C. Pohlad

Thanks, Alex. I don’t have any additional comments, soOperator, we’re ready to move to questions.



(Operator Instructions) We’ll go first to Lauren Torres withHSBC.

Lauren Torres - HSBCGlobal Research

Good afternoon. I was hoping you could talk a little bitmore about any signs of improvement that you are seeing in the U.S. Looking atthis last quarter, you were helped by rate improvements, but looking into nextyear, if pricing isn’t as favorable in the market, what gives you theconfidence that we’ll see a pick-up in your U.S. performance?

Kenneth E. Keiser

Let me comment on that. First of all, as you look at 2007,we guided that we would be down flat to down one, and we are slightly off thatrate but I can say looking at 2007, I think we feel pretty good about our CSDperformance when you consider the cost environment and the ultimate pricingimpact that that had on retail pricing.

I would say as well that I think that says a lot about thepricing power and resiliency of our brands, in that given all that price in themarketplace, our CSD trends in particular stayed consistent with past trends.

Going forward, we have said that we expect our U.S. volumegrowth to be in the 1% growth range, and when you couple that with 3% to 3.5%pricing, which is lower than what we’ve had in the last couple of years, we’reokay with that top line algorithm, particularly as we get into a moderatingcost environment. So we feel that U.S.growth algorithm will produce a growing and consistent and stable cash flows.

But that moderate growth outlook is exactly why, as Bobarticulated in his comments, why we have diversified our company to a highergrowth profile with our international business.

So I think that again, given what we see as the futureinnovation potential for next year, given a moderating cost and pricingenvironment, I think given what our historical growth rates have been, I thinkwe feel fairly good about the fact that we can guide ourselves to that 1%volume range for next year.

Lauren Torres - HSBCGlobal Research

I guess you are still thinking about getting a little bitmore aggressive, I guess, promoting obviously your non-carb platform and alsosingle-serve. I guess that’s still something that you are focused on at thispoint.

Kenneth E. Keiser

That’s correct. As you look at the big new platforms fornext year, of course our hydration strategy, a much improved energy platform,and again with a great three tea strategy, we think that will continue to haveeven bigger impacts on our growth rates.

Lauren Torres - HSBCGlobal Research

And if I could just ask one more question, just on yourinternational, as you’ve added territories within Central Europe,thinking about PepsiAmericas a few years from now, profit mix, domestic versusinternational, where do you see your company going?

Alexander H. Ware

As we’ve modeled out our international business, we see thatbusiness could contribute 35% to 40% of our total profitability, based on theacquisition activity that we’ve already exercised.

Lauren Torres - HSBCGlobal Research

And that’s over what time period?

Alexander H. Ware

That’s through 2010.

Lauren Torres - HSBCGlobal Research

Okay. All right, thank you.


We’ll go next to Marc Greenberg with Deutsche Bank.

Marc Greenberg -Deutsche Bank

Thanks. Good afternoon. Bob, I would like to come back toyour comment about the focus shifting into Europe. I wonder if you could talkstrategically about what that means for your U.S. business. Have you becomemore price and profit oriented versus growing share in the U.S.?

Robert C. Pohlad

Well, I think as Ken just talked about the kind of growthrates that we have been experiencing and that we model looking forward in theU.S., we frankly don’t see a big improvement from the trends we have seen, butthat’s also okay with us. We will certainly hold on to our share and take everyopportunity we can to increase things, but we look at our U.S. business interms of the top line growth together with the different initiatives we have todrive efficiency and productivity, and the combination of those things to beable to maintain and even increase the kind of cash flows that the has generated in order to support the growth strategies outside theU.S.

Marc Greenberg -Deutsche Bank

I guess more pointedly, what about investment behind newproducts in the U.S., Amp, in particular? You talked some about the push behindhydration next year. How should we think about the idea or the opportunity setthere in light of Europe as really the growth driver?

Robert C. Pohlad

You will see us being very aggressive against the teacategory, the hydration strategy, and the energy, all of which are the bulk ofwhat makes up our non-carb portfolio. That said, CSDs, despite some pretty goodgrowth in the Mountain Dew trademark this year, continues to be something thathas, at least in our markets, declined over the last couple of years.

As we think about our business, right now we don’t see thatthat’s really going to change dramatically but also for us, as we look at ourbusiness, it really -- the success of our total business doesn’t require thattrend changing.

Marc Greenberg -Deutsche Bank

I know it’s early days but I wonder if you might just giveus some thoughts on Sandora in terms of the market opportunity versus yourexpectations?

Kenneth E. Keiser

I’ll be glad to comment on that because I’ve actually madethree trips over there in the past several months. And first of all, I wouldsay that as we finish out this year, we are on track to where we thought wewould be at the time that we actually made the acquisition. But going forward,and again, having been there in the marketplace, I’m more impressed than everwith the level of execution that we have seen in the marketplace.

As you know, we have our Sandora brands represent about halfof the juice category, and I can tell you, when you’ve seen the marketplace, welook like a 50-share business, and even more. So I think with the growth, kindof economic growth tailwinds there and with an incredible juice platform tobuild upon, just the organic growth aspect of the juice category is veryencouraging. But then, as we think about the broader portfolio, as we buildthat out over time, whether it’s with CSDs or teas or waters, I think it’svery, very encouraging.

And so as we start out 2008, we are right where we thoughtwe would be at the time we made this deal and I would hope that as we build outthis over the future years, this will even be a bigger growth vehicle than weinitially considered.

Marc Greenberg -Deutsche Bank

And just briefly, why is the dilution on the deal comingthrough timing the way it is, and maybe a little bit more than you initiallyhad thought?

Robert C. Pohlad

Mark, it’s really the calendar, the way the calendar playedout on the close of the transaction, and then the one-month lag that we had, soeffectively, we had 12 days of Sandora reflected in Q3 and the balance iscoming through in Q4.

Marc Greenberg -Deutsche Bank

Great. Thank you.


We’ll take our next question from Andrew Sawyer with GoldmanSachs.

Andrew Sawyer -Goldman Sachs

I just wanted to build on Mark’s question about Sandora andI guess the question I have is as you think about building out the portfolio,can you talk about what constraints you may or may not have, since I believe itis a different business that has the concentrate CSD rights in that market?

Kenneth E. Keiser

I am not sure if I would call those constraints, but overtime, in this joint venture, as PepsiCo is a 40% partner in this venture, so Ithink it is incumbent upon both parties to find a way to maximize the value ofthis business.

While I can’t get into the specific details, I think thatthere are not any barriers over the longer term. This business will beintegrated into our Sandora joint venture.

Andrew Sawyer - GoldmanSachs

Okay, I guess -- no significant constraint from our vantagepoint is what I’m getting?

Kenneth E. Keiser


Andrew Sawyer -Goldman Sachs

Okay, and secondly, you talked about Romania having quite abit higher operating margin structure than the rest of the portfolio, can youjust talk about what there is structurally that is driving that, and how youcan narrow that gap and drive margin improvement in Poland and Czech and thelike?

Alexander H. Ware

Well, in the case of Romania, it is a very unique market, asyou look at it versus all of the other European markets. And the dynamic ofthat is that it’s a very, it’s a much higher shared premium CSD business, asare other markets. It has a lower cost structure and a cost environment, and wefind that our single-serve business there is much, much stronger, just becauseof the evolution of the marketplace. It still has not transformed itself into amodern trade business.

I’m not sure if we would see ourselves getting our othermarkets to those margins, but I would guess that we’ll see them improve as theyhave improved again with the things that Bob talked about, building off ourportfolio, investing in feet on the street, and building out our single-servebusiness, and again continuing to maximize our portfolio.

And you couple that along with the cost structure that wehave in place, we will see our margins in those markets continue to improve.

Andrew Sawyer -Goldman Sachs

Going back towards something Alex mentioned earlier, youtalked about some capacity build-outs in 2008 -- can you give us a rough senseof how much CapEx is going to be stepping up into next year?

Robert C. Pohlad

Andrew, we are -- historically we spend in the 4% to 5% ofrevenue range, and I think as we look out, based on the preliminary plans, wewould be in the 5% to 6% range in 2008, potentially in 2009, based on the needsof -- the capacity needs in other markets.

Andrew Sawyer -Goldman Sachs

So just for a couple-year period there?

Robert C. Pohlad

Yeah, I don’t think it’s -- it’s not a structural change.It’s more of just to address the near-end capacity requirements of thepackaging.

Andrew Sawyer -Goldman Sachs

And just one more question, just looking at the U.S.-- CCE talked about a commodity cost inflation in the next year of about 4%,but at the same time, they talked about being a little more judicious in theirCSD pricing and said that would be up low single digits.

I guess one, it doesn’t sound like CCE is taking a fourthquarter price increase. Have you seen any impact of that in the market? Andtwo, how are you thinking about planning for pricing in the next year, in lightof what CCE is talking about?

Robert C. Pohlad

As I commented, that was Lauren’s question, is one is wehave announced our pricing in the fourth quarter, and the timing of that variesbased on various retailers lead times. And of course, that is all built on whatwe anticipate our cost environment and the ultimate retail price value equationthat that generates. That is something that is really customary and routine.We’ve followed that pricing strategy over the past several years and as 2008unfolds, we’ll assess that with where we are in the marketplace from acompetitive standpoint.

So that’s the sequence that we go through and with the levelof pricing that we took, or are planning to take in 2008, we feel prettyconfident that that pricing will be sufficient and it will stick in themarketplace.

Andrew Sawyer -Goldman Sachs

Any quick preview on ’08 COGS?

Alexander H. Ware

As I mentioned, we’re in the middle of our planning processat this point. Based on the early returns, the visibility that we’ve got so farsuggests that our commodity rates will be a bit favorable to this year’s rateof increase, and one of the variables we’re assessing now is the mix impact, aswe’ll be selling more -- we’ll be -- our cost of goods will include morepurchased product versus produced, so we are working through what the miximpact will be on that.

Andrew Sawyer -Goldman Sachs

Thanks a lot, guys.


(Operator Instructions) We’ll go next to Ann Gurkin with Davenport.

Ann H. Gurkin -Davenport & Company

I was wondering if you could talk about potential foradditional savings with SG&A over the next couple of years?

Alexander H. Ware

We have, as Bob mentioned, the CO3 initiative that we aregoing through right now with a heavy focus on warehouse improvements, as wellas forecasting improvements on the manufacturing side.

What we expect to see from that is improvements in inventorylevels and out-of-stock activity, so largely a working capital favorability, aswell as some top line favorability as we address the out-of-stock activity. Alittle bit less of an SG&A, a direct SG&A favorability as we roll thatout through 2008.

I would mention during 2008, we will see some higher levelof expenses associated in the front half of the year as we roll out the system,but then reaping some of the benefits in the back half of next year from that.So we’ll see even greater SG&A benefits that do come -- the benefits thatare there will come through more clearly in 2009.

Ann H. Gurkin -Davenport & Company

Great, and have you completed discussions regardingconcentrate pricing from parent Pepsi for 2008? And if so, is that numbercoming down from what we saw in 2007?

Alexander H. Ware

We would expect it to be more in line with historicinflationary levels, but we have not completed those discussions at this point.

Ann H. Gurkin -Davenport & Company

And third, can you comment on the strategy, or potentialstrategy for a water brand in Central and Eastern Europe?

Kenneth E. Keiser

We are in the water business in all of our markets with theexception of Ukraine at this point. We have local, regional water brands ineach of those markets.

Ann H. Gurkin -Davenport & Company

And you’ll stick with that strategy?

Kenneth E. Keiser


Ann H. Gurkin -Davenport & Company

Okay, great. Thanks very much.


It appears we have no further questions at this time. I wouldlike to turn the call back over to our speakers for any additional or closingremarks.

RobertC. Pohlad

Thank you, Operator and thanks everybody, for your interestin PepsiAmericas and we look forward to talking with you again for our fullyear results.


Once again, that does conclude today’s call. We doappreciate your participation. You may disconnect at this time.

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