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Executives

Mike Nathenson - Vice President, Investor Relations

Indra Nooyi - Chairman and Chief Executive Officer

Richard Goodman - Chief Financial Officer

Mike White - Vice Chairman and Chief Executive Officer, PepsiCo International

John Compton - Chief Executive Officer, PepsiCo Americas Foods

Massimo D'Amore - Chief Executive Officer, PepsiCo Americas Beverages

Analysts

John Faucher - J.P. Morgan

Kaumil Gajrawala - UBS

Christine Farkas - Merrill Lynch

Bill Pecoriello - Morgan Stanley

Bryan Spillane - Banc of America Securities

Marc Greenberg - Deutsche Bank Securities

Judy Hong - Goldman Sachs & Company, Inc.

Lauren Torres - HSBC

PepsiCo, Inc. (PEP) Q3 2008 Earnings Call October 14, 2008 11:00 AM ET

Operator

Welcome to PepsiCo's third quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce Mike Nathenson, Senior Vice President of Investor Relations.

Mike Nathenson

Today's webcast includes a slide presentation that can be accessed at our PepsiCo.com website.

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 10K and subsequent reports on Form 10-Q and Form 8-K for a discussion of specific risks that may affect our performance. You should refer to the Investor section of PepsiCo's website at www.PepsiCo.com under the heading PepsiCo Financial Press Releases to find disclosures and reconciliations of non-GAAP financial measures that may be used by management when discussing PepsiCo's financial results with investors and analysts.

Just one housekeeping item: During today's call, our references to core EPS growth exclude the one-time tax benefit recorded in the third quarter of last year as well as marked-to-market gains or losses on commodity positions included in corporate unallocated expenses in both this year's and last year's third quarter. Also, all references to core EPS guidance exclude any commodity marked-to-market impact as well as Productivity for Growth costs.

This morning's prepared remarks will be made by Indra Nooyi, PepsiCo's Chairman and CEO, and Richard Goodman, PepsiCo's CFO. Also, after our prepared remarks, the following executives will be available to answer questions during the Q&A session: John Compton, CEO of PepsiCo Americas Foods, Massimo D'Amore, CEO of PepsiCo Americas Beverages, and Mike White, PepsiCo's Vice Chairman and CEO of PepsiCo International.

With that I will turn the call over to Indra.

Indra Nooyi

I know that all of you have had a chance to review the press release we issued this morning, and on this call we will be focusing our remarks in five key areas, which should leave ample time for a robust Q&A session. So let me outline the key points and cover each of them in more detail.

First, we had solid business results for most of our portfolio. PepsiCo International and PepsiCo Americas Foods performed very well, and they did so in the context of a challenging and volatile macroeconomic environment. As we'd indicated on prior calls, the third quarter represented our most difficult commodity cost comparison versus prior year, and so it is especially encouraging to see solid volume growth in our Snacks businesses around the world, which reflects clearly the strength of our brand, the positive impact of innovation and the successful execution of our price pack strategies. We also saw strong performance across both our Snack and Beverage portfolios in key developing markets.

The second point I'd like to make to you is that our North American Beverage business was soft, reflecting in large measure category challenges. Regaining growth is a major priority for us, and I'll be talking in a few minutes about the actions we are taking.

Third, no news to you but the macroeconomic climate is turbulent and there are uncertainties and volatility in every part of the environment. The constants, however, are the basic strength of our business model, our terrific management team, and our ability to execute at the [inaudible] level. We will be agile in our planning and in our operations.

Fourth, we are implementing a Productivity for Growth initiative which we expect will produce $1.2 billion in pre-tax savings over the next three years. This will enable us to invest in our businesses, to further improve our competitiveness and to give us breathing room to respond to changes in the marketplace.

And fifth and most importantly, we continue to have robust free cash flow, which provides a sound financial base for us at a time when the financial markets are uncertain.

So let me go into detail on each one, turning first to Q3.

PepsiCo International delivered solid performance in Q3, while lapping 20% revenue growth in the prior year period. PI's diverse brand portfolio continued to benefit from growing demand across most markets outside the Americas despite significant pricing actions to offset the impact of commodity cost increases. Revenue increased 20% and operating profit increased 18%.

Growth across the Middle East, Africa, Asia segment was broad based, with revenue up 22% and operating profit up 18%. Snack volume increased 9%, led by high teens growth in the Middle East and double-digit growth in China and India. On the Beverages side, volume increased 10%, driven by a combination of mid-teens growth in China, double-digit growth in the Middle East, and high single-digit growth in India.

In the U.K.-Europe segment, PI performed well despite increased inflation, macroeconomic challenges, and unseasonably cool weather during the summer months which particularly impacted Beverage results. Revenue and operating profit each grew 17%, benefiting in part from the weaker dollar.

The soft spot in Q3 was Beverages. The U.K.-Europe volume growth of 13% entirely reflects the benefit of two acquisitions - Sandora, a Ukrainian juice business, and the expansion of the Pepsi-Lipton joint venture in Europe. Excluding M&A activity, volume was down slightly, with a mid single-digit increase in the U.K. entirely offset by category softness across the continent and Russia, in part related to poor summer weather. Note however that in September we saw an improvement in volume as volume in the U.K.-Europe segment was up high single digits on an organic basis.

Snack volume in Q3 was largely in line with expectations and reflected visual pricing and rate hours across the category to address inflationary pressures. Snack volume grew 4% on an apples-to-apples basis, excluding a calendar reporting change in Iberia that excluded about three weeks of performance versus the year ago period. Russia led the segment with high teens growth.

Overall, Q3 was a good quarter for PI and at the end of the quarter PI closed with its [Marvel] Snack acquisition in Serbia and it's [Lebidionski] juice acquisition in Russia. We will report the financial performance of these two businesses in Q4.

Let me now turn to PepsiCo Americas Foods, where revenue was up 12% and profits were up 9%. FritoLay North America Snack brand grew volume 1.5% even as we realized net price increases from rate hours and visual pricing to offset inflation. Revenue growth of 9% was broad based. In addition to growing across all major brands, FritoLay North America sales also increased across all retail channels and gained dollar market share in major channels in the savory snack category.

We are pleased with the brand equity and pricing power of our brands, with consumer response to our pricing coming in about where we expected. In Q3 we fully realized our 2008 pricing initiatives for the year and, as is customary, we plan to implement another round of judicious pricing in Q4 as we prepare for 2009.

Quaker Foods North America experienced significant production and shipment disruptions in the quarter as a result of flooding at the beginning of Q3 in Cedar Rapids, Iowa, where a major Quaker plant is located. The extraordinary efforts of our team enabled us to restart production within four weeks and we are not operating at about 85% of capacity, but we were not able to ship some products normally due to Q3, which resulted in volume and revenue declines versus prior year. Nevertheless, productivity was up 7% in the quarter, largely because we received business disruption insurance payments related to the flooding.

Latin America Foods reported revenue growth of 23% and profit growth of 22%. Organic revenue growth was driven by net price realization, both in the form of rate hour and visual pricing across all of our businesses.

Let me now turn to PepsiCo Americas Beverages. It's clear that this business is not performing where we would like it to be, in large part because the economic slowdown continues to pressure the North American Liquid Refreshment Beverage category. In major channels category volume was down 3% and overall category revenues were flat, in part as a result of significant discounting in unflavored water.

The CNG channel remains soft, with consumer shopping and items purchased per trip both down and beverages have been particularly hard hit. In this environment, CAB volumes declined 2.5%, reflecting a 4% decrease in North America, partially offset by an increase in Latin American beverages. Net revenue was flat for the quarter and operating profit declined 11% largely due to a combination of higher input costs, particularly higher fuel costs, deleverage from the soft volume, and expenses related to the implementation of SAP.

Now revitalizing this business is a huge priority for us, and I want to assure you that over the past several months we have been busy at this and we have lined up initiatives we're going to launch in 2009. We have completely revamped every aspect of the brand composition for our key CSD brands - how they look, how they are packaged, how they will be merchandised on the shelves, and how they connect with consumers. You will see more over the next few weeks, and I think you're going to be very impressed.

We are initiating similar upgrades for the entire Gatorade line, which will have an entirely new contemporary identity. And there'll be exciting innovation for both G2 and Tiger and a renewed Propel platform. Tropicana will also be differentiated, enabling us to reengage consumers with this iconic brand. And we will be supporting all of this activity with increased investment in innovation and A&M, using savings from the Productivity for Growth initiatives that we announced this morning.

It is our belief that, especially in this economic downturn, we should be investing in the category to get consumers to stay with and some to return to the packaged Liquid Refreshment Beverage category and to our brands in particular. This is the beginning of a multi-faceted effort to restore growth and profitability to the North American Beverage business. It will take a little while to realize all the benefits of these changes, but I'm confident that you will see significant progress during the course of 2009.

So overall, solid results for most of the PepsiCo portfolio in Q3, particularly given the challenging macroeconomic situation and commodity cost overlaps. And please note that our guidance for the full year implies currency neutral high single-digit divisional operating profit growth in Q4.

I'd now like to take a couple of minutes to provide our perspective on the macroeconomic environment and its impact on our business outlook going forward. The incredible turmoil we've seen in the financial and commodity markets over the past month has given us a vivid reminder that the world is in a very uncertain place right now. We are uncertain about how the global economic situation may evolve, how it will differentially impact countries, how the Forex markets will move, and ultimately how consumers around the world will respond as they digest these events. The impact of all of this is now as much about Main Street as it is about Wall Street, as consumers in many parts of the world are indeed feeling the pressure.

One of the trends we're noticing is that the impacts are not uniform. In the Mid East and eastward, growth continues to be robust and our expectation is that it will remain so. The absolute growth rates may come down as the developed economies slow, but their GDP growth differential [inaudible] for the developed countries will probably remain at the mid to high single digits.

Turning to our neighbors in the south, Mexico is expected to increasingly feel the impact of the slower U.S. economy, and the rest of Latin America is beginning to feel the pressures, too. East Europe's outlook is mixed, and you're all aware of the unfavorable outlook for GDP in both the U.S. and the Euro zone.

Now, we do not control these macroeconomic forces, and our portfolio is not immune to their impacts. But at PepsiCo we are confident in the fundamentals of our business model, in the agility of our people, and in our ability to execute on the ground in each country in which we operate. We are able to drive growth in the categories in which we participate in. We provide simple pleasures at affordable prices to consumers across the world. And consistent with our experience during the last two economic downturns in the U.S., as consumers economize by eating more at home they tend, for the most part, to consume more of our products, particularly snacks.

In addition, in many parts of the world per capita consumption of our products is still relatively low, which gives us the opportunity to drive sales ahead of GDP growth. Our wide product portfolio within our categories and our broad geographic footprint helps us balance out the ups and downs in any given market. And even as the economic turmoil progresses, we are seeing our business maintain its volume momentum with consumers around the world. Overall volumes for September, for example, were pretty consistent with what we've been experiencing all year.

For all these positives, there is no certainty about how this current economic crisis will play out. While we are quietly confident about our ability to execute, we are being sober in our planning. For the last several months we've been looking across all our businesses to ensure we're doing everything we can to enhance our operating agility and financial flexibility.

A major outcome of our detailed work is the Productivity for Growth program. It's a broad-based set of initiatives that cuts across the entire company with the objective of improving cost competitiveness, simplifying decision-making, and upgrading and streamlining our product portfolio. We expect it will produce pre-tax savings of more than $1.2 billion over the next three years, enabling us to make significant investments in our future growth.

A primary focus is investment in our North American Beverage business, in A&M, to support the restaging of our key brands, and in stepped up product, package and process innovation. We will also be investing to drive additional growth in key developing markets across the world in both Snacks and Beverages. We're also making targeted marketplace investments to further secure our competitive position in developed Snack markets. And we're increasing our investments in R&D, with particular focus on long-term bets and innovation to sustain our long-term growth.

Taken together, these actions are intended to position the business for success into the future in support of our long-term strategies. It will also enable us to better handle the marketplace surprises that are inevitable in this volatile environment.

I also want to emphasize that in our planning for 2009 we have a focus on balancing premium product innovations with a corresponding emphasis on our value offerings. We are maintaining a finger on the pulse of our consumers' reality and we will not allow private label or discount brands to exploit this economic downturn at our expense.

You know, there's nothing normal about what we are seeing in the economy or in the markets. Whatever volatility in commodities, whatever uncertainty in the credit markets and financial markets, whatever uncertainty in consumer behavior we have seen for the first three quarters, it simply pales in comparison with the gyrations that we've experienced globally over the past couple of weeks.

We normally talk about the coming year's guidance on the fourth quarter call at the beginning of February. Advancing the timing given the current turbulent conditions is simply not prudent. There is no clear base for forecasting currencies, the impact of the evolving financial crisis on GDP growth rates, or the effect of all of this will have on consumer spending patterns.

Please make no mistake, however. We have full confidence in the fundamentals of our business, the capabilities of our exceptional management teams across the globe, and most importantly, the breathing room we have created for ourselves with our Productivity for Growth initiative. We are working with the highest level of urgency on the things we can control and leveraging PepsiCo's operational agility to succeed in this changing environment. The steps we are taking will position the business to maintain our competitive in the near term and to sustain leading performance over the long term.

With that let me turn it over to Richard.

Richard Goodman

Indra has covered the line of business results, and so let me focus on the below the line items, provide some additional information about our Productivity for Growth initiative, and discuss cash flow.

As we have previously discussed, our approach to commodity coverage has evolved over the past year to provide increased predictability in our cost structure for the coming year which enables us to proactively manage our pricing and price pack architectures so they work well with consumers as well as retailers. That approach means we have higher levels of coverage for next year than we would have had in the past. Most of our purchases receive hedge accounting treatment. The forward coverage that does not is largely related to energy, and we have to mark those positions to market each quarter.

In Q2 we reported marked-to-market gains of $61 million as energy prices significantly increased. This quarter we reported marked-to-market losses of $176 million as energy prices reversed course. This marked-to-market loss compares to a $29 million loss in the previous year for a net change of $147 million versus last year.

Let me remind you that over the duration of our contracts the marked-to-market impact on corporate costs nets out to zero, with hedging impacts ultimately reflected in division cost of goods sold. That's why we focus our discussion and our guidance on EPS and EPS growth, excluding the impact of marked-to-market in both the current and prior year. We believe this provides a better perspective on our ongoing business performance.

Setting marked-to-market aside, other corporate unallocated costs were up $19 million, primarily due to higher investments in R&D and the company's global SAP implementation.

Our tax rate for the quarter was 25.9%. That was down 150 basis points versus last year's comparable rate of 27.4%, a rate the excludes $115 million one-time tax benefit related to the favorable resolution of certain foreign tax matters which we reported in last year's third quarter. We expect a 2008 full year tax rate of about 27%.

Turning now to cash flow I want to emphasize PepsiCo's ability to generate cash. Cash provided by operating activities is expected to be approximately $7.3 billion and capital expenditures about $2.5 billion excluding the Productivity for Growth costs. Our management operating cash flow is expected to be $4.8 billion. Clearly, in the current environment we are placing even more emphasis on cash management, both in terms of working capital and capital spending.

I also want to point out that we maintain a strong credit rating - A plus from S&P and Aa2 from Moody's - which is a major asset in the current environment. Our commercial paper is A1-P1 and it has continued trading very well even amidst the turmoil of the past several weeks.

Through the end of the third quarter we repurchased $4.2 billion of our shares. As a result, our weight average diluted share count declined by 3.5%. Given the volatility in the credit markets, it is prudent to maintain financial flexibility, and so any further repurchases during the balance of the year will depend on our assessment of market conditions.

Turning to Productivity for Growth, total one-time charges in Q4 are expected to be between $550 million and $600 million, of which about 60% are cash and 40% non-cash. The effort is across the globe. Of the charges, approximately 45% relate to our North American Beverage business, 25% to North America Snacks and Foods, 25% to our International businesses, both PI and in the Americas, and the balance at corporate.

To improve cost competitiveness, PepsiCo Americas Beverage is improving its capacity utilization and distribution efficiency by aligning North Americas hot fill capacity. PAF is continuing to focus on supply chain efficiency and superior execution through plant rationalization and equipment upgrades. And to simplify decision-making, PepsiCo Americas Beverages is creating a unified beverage structure to eliminate redundancy and increase spans of control. PepsiCo International is continuing to evolve the organizational structure to empower regional leadership.

Over the past five years our global employee base has increased from about 142,000 to over 185,000 employees as our businesses have expanded. Our productivity actions will result in the elimination of about 3,300 positions, with the impact felt across all of our business segments globally. Relative to its employee base, a higher proportion of managerial positions versus plant and other supply chain related positions will be eliminated as we move to streamline decision-making.

Productivity for Growth is expected to generate pre-tax savings of about $350 to $400 million in 2009 and a cumulative pre-tax total of over $1.2 billion over the next three years. In total, the Productivity for Growth enhancements will enable us to invest in our businesses, as Indra described earlier, and also maintain the flexibility we will need in the current environment. We are confident that these initiatives will position the business for sustainable long-term growth and that we will benefit disproportionately when the market turns.

We have established a program management office to ensure that the individual initiatives are flawlessly executed, that we embed the organizational changes quickly, and that we realize all of the anticipated savings in the appropriate timeframes. As you may remember, we were very successful in doing all of this during the Quaker integration and we have every confidence we can do so again.

One final word on the 2008 guidance, full year 2008 guidance. The dramatic appreciation of the U.S. dollar versus just about every currency in the world will have an adverse impact on our Q4 results. At current spot rates, that translates to a potential $0.04 to $0.05 downside in our prior full year 2008 core EPS guidance of $3.72. We do continue to expect full year volumes of between 3% and 5% and low double-digit net revenue growth, including acquisitions and Forex. And please note as Indra mentioned that our guidance for the full year implied currency neutral high single-digit division operating profit growth in Q4.

With that let me turn it back to Indra.

Indra Nooyi

Thanks, Richard, and before I open it up for questions let me just reprise my opening comments. Both PepsiCo Americas Foods and PepsiCo International delivered solid performance in Q3 in a very challenging environment. We are taking major actions to restore the vitality of our North American Beverage business. We believe the macroeconomic environment will continue to be challenging, but we have confidence in our basic business model and our ability to navigate through turbulent times. Productivity for Growth will give us the ability to invest in key areas and providing breathing room in this uncertain environment, and our businesses continue to generate strong cash flow.

PepsiCo remains a great operating company and our biggest assets are the strength of our brands, our go to market capabilities, and the enthusiasm and talent of our associates across the globe. We know what needs to get done.

We'll be glad to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Faucher - J.P. Morgan.

John Faucher - J.P. Morgan

So a quick question on the long-term impact of the restructuring program. As you look at the extra investment that you're getting, you know, how shall we look at this relative to the organic top line growth you guys have been delivering over the past couple of years? And it sounds like it's mostly going to be investment in the short term. Should we expect a big ramp up in investment in '09 and then maybe a little bit more leverage off that higher level of investment as we look out over the next two or three years?

Indra Nooyi

You know, we are - as we mentioned, a lot of the saving from Productivity for Growth is going to go into North America Beverages, selected investments in key developing markets, and then Snacks in developed markets from marketplace investments and then R&D.

Now, when we talk about investments in North America Beverages, you start seeing of these benefits, especially in the second half of 2009 because we have to make the investments and it takes a couple of quarters before they start really working their way through the system. So you should start seeing the benefits in the second half of 2009.

In the case of developing market initiatives, these are not one-year bets we are making. We are reinvesting to grow our non-core positions in certain developing markets and that's going to again take the second half of 2009, 2010 before they really play out.

Our increased investment in R&D, especially our big bets, right now the little that we invested in 2008 is showing great promise and that's why we are stepping up our investments. I don't believe you'll see the benefit of that increased R&D savings - I'm sorry, investment - in 2009, but I think if things turn out the way we think they're going to turn out, starting about 2010 you should start seeing some of the benefits from this reinvestment.

Again, a lot of this is subject to how the economic situation plays out, but we are doing our part and we feel comfortable that if the economic situation improves you should see a big ramp up in our own performance.

John Faucher - J.P. Morgan

Richard, you talked about an acceleration in divisional operating profit for Q4 which you guys had kind of hinted at when you gave your conference call after Q2. So if we look at it $0.02 below consensus this quarter, $0.04 to $0.05 from currency implies sort of a $0.06 to $0.07 reduction, yet you're only taking the full year down by $0.04 to $0.05. So it seems like your expectations for the fourth quarter, at least relative to consensus, are higher. So what drives the confidence that you can accelerate the organic divisional operating profit number.

Richard Goodman

That's a good question, John. We don't govern the consensus. We had indicated on a prior call that we expected Q3 to be lower and Q4 to be higher, and excluding the impacts of the recent changes in the currency, that's where we would have been. And so if you actually just simply do the math, you wind up with currency neutral high single-digit LOB growth, and that's what we have been expecting all along to take place. So the only real change in our guidance has been the change in the Forex, and we expected Q3 to be lower and Q4 to be more robust.

Operator

Your next question comes from Kaumil Gajrawala - UBS.

Kaumil Gajrawala - UBS

First it seems Beverages are a lot more economically sensitive than your Food businesses. Can you maybe offer some thoughts on why you think that is and then also what your expectations are for overall LRB growth in North America assuming a normal economic environment?

Indra Nooyi

You know, we talked about this in our last call and I think the situation's exactly the same. In North America in particular, Beverages is a much more penetrated category than Snacks, and so what we are seeing is really the fact that it's so well penetrated some pullback.

I think the second reason Liquid Refreshment Beverages are impacted is because there's a free substitute called tap water which doesn't exist for snacks, and that's why you're seeing the Beverage category more impacted than the Snacks category.

Now coming to your second question in terms of projection, the normal growth rate that we expect for LRB given population growth rates should be somewhere between like a 0.8% to 1.5%. That's what we would expect the LRB category to grow. The last 12 to 18 months have unprecedented. For all the measuring peers we've had in this category, we've never seen a decline. This is the first time we're seeing a decline, and it's very hard to predict from the trough what the shape of this category is going to be.

But since we are such a large portion of the category, we're going to do our part. We're going to reinvest heavily in this category. We're going to give people a reason to come back to the category or stay in the category by providing more interest, more excitement in this Liquid Refreshment Beverage category and that's really what we're going to do in 2009. Based on everything that we've done so far that we've shared with our bottlers, we feel very, very optimistic about what 2009 could bring.

Kaumil Gajrawala - UBS

And Richard, a quick one for you. It looks like receivable days and inventory days have gone up quite a bit versus last year. If you could just offer what's behind that?

Richard Goodman

We had some, if you go through the statistics, we had some timing issues. Some of our international businesses actually wound up closing on a Sunday, which changed some of the patterns. So we did have both payables and receivables - payables and receivables both went up slightly. So I think almost all of the changes that we saw this quarter really are simply timing changes. There were some VAT things. There were some other things that were really temporary stuff that we would expect to - that we know that will actually reverse in Q4 and we should see much more normal levels then.

Indra Nooyi

And having said that, Kaumil, you know, in response to the current environment, we have refreshed our controls on capital spending, working capital, so the entire company is focused tremendously on making sure that we manage every element of the cash flow very, very carefully.

Operator

Your next question comes from Christine Farkas - Merrill Lynch.

Christine Farkas - Merrill Lynch

A question on pricing. Indra, you were quite clear about volumes and volume patterns around the world, but in looking at the top line and stripping our currency, there's a couple of regions that to me are unclear whether or not pricing was successful. Clearly Frito-Lay and Quaker Foods and even Middle East Africa appears to have gotten some good pricing. Can you comment on Latin America and the U.K. or any other regions and how those trends are shaping up, both in the third quarter and going forward?

Indra Nooyi

Mike, you want to take U.K., and then John, maybe you can talk Latin America?

Mike White

Sure. Good morning, Christine. Actually the U.K. has been terrific. I mean, we had solid low single-digit volume growth in the quarter and our revenue growth in local currency grew well ahead of that. And so we've had a lot of revenue management strategies in place to get more productivity out of trade spending in the U.K., and we've been very successful at that this year. So actually in terms of revenue flow through in the U.K., we were fine.

The issue in the U.K. is just the magnitude of the commodity cost impact has impacted our profit results just a tad in the quarter. But actually we're right in line with expectation and I couldn't be more pleased. We had a very strong summer with the Brit Trips promotion in the U.K. from a top line standpoint.

John Compton

Yes, Christine, this is John. In Latin America, the two big countries - Mexico and Brazil - we were able to get our pricing through. The rising commodities relative to our pricing were fairly much in balance.

In Chile, Venezuela and Colombia, the inflation stacked up pretty quickly and we weren't able to price as fast in the quarter as we had hoped, but we've not since corrected that.

So it was really just those three markets within all of Latin America that had an impact on us.

Christine Farkas - Merrill Lynch

And if I can follow up with a question, Richard, on SAP. There was a comment about SAP costs hitting the profit growth at PepsiCo Americas Beverages, I believe. Is that done now in the quarter?

Richard Goodman

Well, I think the - what we saw as we begin to implement the modules from SAP then the amortization costs and the running costs transfer from being a corporate cost, development cost, to being an actual operating cost. And we're seeing that as the roll out in all of the - in both PepsiCo Americas Beverages as well as in the Quaker, Trop and Gatorade businesses. Those costs are beginning to hit the P&L. So in 2009 you saw the first impacts of those costs.

The good news is that the SAP implementation has been doing extremely well. The execution has been really basically flawless, both with our customers and internally as well.

But yes, the costs are beginning to hit.

Christine Farkas - Merrill Lynch

And there's no way to quantify for us what kind of margin, how many basis points we might see due to that SAP amortization?

Richard Goodman

No. I mean, I think it's - we're don't want to get into that level, but it did obviously begin to delever the P&L slightly in those businesses. At the same time, we're increasingly being able to get the benefits of those both on the top line and in other parts of the middle of the P&L.

Operator

Your next question comes from Bill Pecoriello - Morgan Stanley.

Bill Pecoriello - Morgan Stanley

My question is on the '09 cost outlook, which I know is highly uncertain. But you had mentioned on the last conference call that you had some meaningful coverage in place for '09 so when we look at the first half of '09, is it reasonable to expect mid to high single-digit input cost inflation?

And then you had said that a majority of the savings are going to be reinvested, so should we assume you'll take incremental pricing to cover 100% of that input cost inflation or will some of the productivity savings be used to help offset that?

Richard Goodman

Bill, yes. Your assumption is correct. We have been taking, as I mentioned, we have been lengthening out our coverage and so we have a good deal of coverage in place both in the United States and outside of the United States for 2009, obviously more in the first half of the year than in the second half of the year, so we will have inflation during the course of the year. We haven't yet finalized on exactly what that amount is because we don't have all the coverage. But yes, that will be the case, and we will be taking pricing starting at the end of the fourth quarter in order to be able to offset the inflation.

What you wind up really with the inflation is it's sort of like it's a rolling inflation. Some of the benefits that we had from early purchases in 2008 were favorable - that we had done in 2007 - helped us cushion 2008. Some of the purchasing that we're now will impact us in 2009. But by the second half of the year we should be sort of being closer to market, if you will.

Bill Pecoriello - Morgan Stanley

So then just two follow ups on that. So the big fall we've seen in some of these commodities would be more  flow through your P&L in the second half of '09?

And then just on the pricing, do you worry about, in something like the Snack category with the weak consumer, any regional snack companies and more discount brands taking share as you roll through that extra pricing?

Indra Nooyi

Yes, Bill, one of the things we mentioned on the script was we will watch private label and regional competitors very, very carefully. And one of the reasons we wanted to keep some breathing room in our Productivity for Growth savings is to be able to reinvest in the value equation if we ever felt that that was going out of kilter.

Operator

Your next question comes from Bryan Spillane - Banc of America Securities.

Bryan Spillane - Banc of America Securities

A question relative to the implications to long-term growth objectives. I guess you strip out the volatility in the economy and in commodities and foreign exchange for a minute, assuming that the long-term growth objectives haven't changed, is the primary objective here to sustain the growth in international and stabilize the slide in profitability in the Americas? As we're kind of watching the effectiveness of this and we're looking to be able to mark whether or not the long-term growth objectives are still intact, is that the right way to think about it? Is the primary objective to improve profitability in North America?

Indra Nooyi

The long-term objective of our company remains unchanged, Bryan, just to repeat what you said. And there's nothing in our portfolio that indicates that that long-term objective needs to change.

Let's just come back. In the past the reason the portfolios worked very well is because if there's been a problem in one part of the portfolio, something else has picked up the slack. And that's why this combination of Beverages and Snacks, investments across developing and developed markets, has all worked very well. And I don't believe that that's going to change going forward.

What we're doing right is we're seeing an incredible opportunity to streamline our internal operations, to reinvest, one, to revitalize this North America Beverage business, because we're one of the largest players in that business, but more importantly, we are seeing opportunities in developing markets that we think we ought to invest in now. We are finding ways to double down investments in developed markets in Snacks, but more importantly we're seeing promising areas in R&D that we believe now is the time to invest in.

So a lot of the productivity program is to reinvest offensively as much as it is defensively. So overall, the portfolio is still working. The long-term objective remains unchanged. And we just want to make sure the portfolio works the way we want it to, and we want to make sure that we create the breathing room to be able to cover any challenges that happen because of macroeconomic volatility.

Bryan Spillane - Banc of America Securities

And then as a follow up, just as we're looking over the medium term without really knowing how the volatility in the economy and commodities, how long it'll last, is the objective internally different now in terms of - are we looking at targets that will be sort of excluding those items or somehow just looking at maybe different growth objectives than the long-term growth objective given the volatility?

Indra Nooyi

Well, you know, that's a tough question, Bryan, because what we do every year, let's take FX for example. We set goals for - the plans that are set for next year, budget numbers, are set based on some number that we think the FX rates are going to settle at the next year, and everybody goes off and does their planning based on some forecast of FX rates. But if FX rates, you know, widely vary from those, as it did the last couple or three weeks, you know, it forces us to stop and rethink how we want to manage the year.

And so we pick a number and we engineer the whole company around that number, around that set of numbers, and then we leave ourselves some breathing room for volatility. It's when it goes way beyond that volatility range that we have to stop and ask ourselves the question is it prudent to do something radical to deliver numbers in that extreme volatility? And the answer is no because we're running the company for the long term. You never run a company where you burn the furniture for the short term. That's the wrong thing to do. So that's how we set our plans.

Operator

Your next question comes from Marc Greenberg - Deutsche Bank Securities.

Marc Greenberg - Deutsche Bank Securities

I hate when furniture burns, so good we're not doing that. My question relates to the chronic weakness in U.S. beverages and specific steps you might take to turn things. I guess, you know, first, any sense that pricing, particularly in take home, may have gone too far and perhaps lower prices are needed to stimulate demand? Do you feel comfortable that the portfolio is where it needs to be? And, if you start to see some benefits on the cost side as a result of lower commodities, how readily can you share those savings with the trade if you felt that you needed to bring down retail prices?

Indra Nooyi

You know, Marc, you ask a great set of questions because you're right in saying that pricing has gone up significantly in North America Beverages. But then don't forget inputs costs have also gone up, so in many ways the bottlers are taking pricing to cover that input cost increase.

Now, would we like, as a franchise company, would we like prices for end products to be lower? Of course, we would like it to be lower. But we also have to make sure that the bottlers make a fair return.

I think the real challenge for all of us how do we figure out how to make our overall system more efficient by stripping out all of the redundancies and additional costs in the system so we can then take that extra cost and reinvest it back to provide more value. And then, from PepsiCo's perspective, the additional arrow we have in our quiver is how can we leverage our Power of One programs to provide more value to the consumer through some sort of bundled deals, which is what we've done very effectively.

So, you know, this is a work in process. And I wouldn't use the word chronic weakness in the U.S. beverages. I'd just say that the U.S. beverage business is going through some interesting times. And as a leader in the business, it behooves us to do our part to figure out how to revitalize it.

Richard, one follow up please. The credit crisis is obviously top of mind for a lot of us. Can you speak to whether or not you, PepsiCo or any of your bottlers are having any challenges there with regards to lines or banks? Do you still feel as though you've got enough dry powder if the right M&A opportunities were to arise?

Richard Goodman

Yes. I mean, in the current circumstance, our commercial paper and that of our bottlers has been trading very, very well. Obviously we have a high credit rating. We have cash in a number of different locations that we can access and we have credit lines as well. So in the current circumstance, neither us or our bottlers has experienced any issues so far.

As far as M&A is concerned, obviously most of the deals that we do are relatively small deals and those are both very attractive and usually very accretive, and we have the ability to continue to do those. And larger deals, you know, we just closed on a very large deal in Russia and have been able to - and that just happened at the beginning of the fourth quarter, and we were able to finance that.

So I think we feel pretty good about our ability to maneuver, recognizing that obviously [inaudible] has changed over the last couple of weeks out there, and we'll see how recent bond offerings and other things are going to fare in the marketplace. Hopefully, the intervention that we've just seen from some of the governments to provide liquidity is going to settle the markets and make it easier for all of us.

Indra Nooyi

Yes, but Marc, so far so good. So far we're okay.

Operator

Your next question comes from Judy Hong - Goldman Sachs & Company, Inc.

Judy Hong - Goldman Sachs & Company, Inc.

Just going back to Marc's question about your effort to revive the U.S. beverage trends, if I look back at your comment, Indra, about the total LRB category growth outlook, I think you're now expecting growth to be more in line with the population growth rather than getting some lift by shifting from tap water, etc., to a commercial package beverage category. So first, whether that assessment is correct.

Secondly, as you emphasize reviving also your carbonated soft drink part of the business, I'm just wondering sort of your confidence level in increased ANP, kind of, you know, restaging all of your brands, etc., how confident you are that this time around that you are going to actually see improvement in the carbonated soft drink categories as we look out six to 12 months out?

Indra Nooyi

I'll make a couple of points, and Massimo, if you want to add something, please do.

You know, Judy, for a couple of years now we've been saying that the underlying growth of the LRB category has come down to population growth. I think the shift from tap water to LRB, that existed when the category was growing 2%, 2.5%, 3%. When the category growth slowed down to 0.8% to 1.2%, 1.3%, that shift from tap water was gone, so it's just population growth, so let's just say that's the underlying category growth rate.

Let's now turn to confidence in CSDs. Let me be clear. CSDs are declining between 3% and 4%, all right? And we're not talking about beginning to have the CSD category grow at 1% or 2%. That's not what we're talking about. We're saying goal one is to stem that decline and make it decline maybe 1% to 2% and then get it to flat. If we did that, that would be enormous because we're talking about a 20 billion 8-ounce case LRB business, of which 10 billion 8case is CSD. Most of the bottler [inaudible] are committed to CSDs. So it's a critical source of productivity and it's very, very important that we don't let the slide get out of hand so that people completely switch out of the assets that are really in the ground.

So what we are trying to do, step one, slow down the decline from down 3% to 4% to down 1% to 2% and then get it to flat. To really get it to grow requires a breakthrough, and we've talked about this many times. We've said CSD is a combination of caffeine, bubbles and sugar. People love the caffeine. People love the bubbles. We have to address the sugar. There are people who like the non-nutritive sweeteners like aspartame in Splenda and there are those that want a natural low-calorie sweetener. Once we have a breakthrough on natural low-calorie sweetener that can be used in colas, we have a reason to talk about this category growing again.

So I think we have to take this in steps. Meanwhile the focus should be on the overall LRB category without taking our eyes off the core CSD business.

Massimo, did you want to add anything?

Massimo D'Amore

Judy, the only thing I can add to what Indra said about our confidence in reviving CSDs, I can tell you that last week had a major convention with all our bottlers. There were over 500 beverage experts with us. And the overall energy was very positive. Their confidence was very high. And many [drink] people said that they had not seen plans as strong as this for a long time.

Judy Hong - Goldman Sachs & Company, Inc.

And just following up on that, as you think about, then - I mean, obviously your clear focus is to improve the systemwide profitability, but is there any changes to your thinking in terms of sort of how the profit, systemwide profit gets split up between you guys and the bottlers and whether you're thinking about taking higher concentrate prices up or anything of that sort?

Indra Nooyi

Even if we took up concentrate prices a lot, it's going to go through to bottler pricing increases, volume will go down. This is a loop that continues on. So I think the fact that there's a bottling system and there's a franchise company and both of us are independent is in a funny way a system that keeps the whole beverage business in equilibrium. So we have no issues with the core breakout between the bottling system and the franchise company.

All that we have to do is step one, not fight for a larger share of a shrinking pie or a constant pie, but we have to talk about how increase the pie. Obviously, the elegant way to increase the pie is to grow the volume. But when volume growth is not robust, we have to increase the profit pie so that we can then use the savings to fund higher volume growth. So I think we have to change our mind-set.

And we had a brilliant bottler meeting last week, as Massimo just explained, and we talked about how to increase the profit pool at that last meeting. So I'm optimistic about where we are with our bottlers. We have an outstanding group of bottlers, a great partnership with them, and I think we will make progress in this area.

Judy Hong - Goldman Sachs & Company, Inc.

And then just my final question. Indra, I think you said in September you saw a better volume growth for some of the international markets in your Beverage business. Can you talk about what you think drove that improvement in September?

Indra Nooyi

Mike, you want to take this?

Mike White

You know, I think, Judy, as we mentioned in both the release and in the script, the European business, including Russia, is very seasonal with the summer, and the weather this summer in Europe and in Russia was quite poor. So frankly, when you kind of work your way through that and you get to September, you know, the weather was fine in September so I mean, a big part of it is that we saw a stabilization of our volume growth rate in Russia. We're still not growing at the rate I'd like to see, but we stabilized it and Europe came back quite well. So I'd say those are the biggest drivers in September.

The rest of the businesses are performing pretty much in line. China's performing similarly. India had a terrific September. Middle East is still strong. When I look around the world, frankly both in Snacks and Beverages, the trends are still very consistent with what we've seen really year-to-date as opposed to the quarterly trends, I'd say.

Operator

Your next question comes from Lauren Torres - HSBC.

Lauren Torres - HSBC

I guess as a follow up to some of your comments on the International business, you know, a lot of consumer products companies are talking about a slowdown in trends. I was just curious. Obviously, you're benefiting from acquisitions for brands, territories and whatnot, but I was just curious as far as just general trends here, you know, why you're not seeing that. I mean, it seems like you're very optimistic here and I'm hearing some rather negative comments from other companies. Kind of what's the difference here and where is that upside coming from?

Mike White

Well, I think Indra said it in the script, Lauren, that the trends are not uniform. I'll give you a good example. Take CSDs in the U.K. Our CSD business this year is up double digits. I mean, we're having a terrific year with Pepsi Max in the U.K. Clearly I would say in Australia, where there has been some significant macroeconomic issues, I'm not saying we're immune to anything going on in the external environment by any means. I would say Russia has seen some softness, although our Snacks business has held up very, very well in Russia.

So, you know, I think again you've got to remember the categories outside the United States - CSDs in the U.S. is unique. You've got 850 8-ounce per capitas per person. You know, the highest in any country other than Mexico outside the U.S. is probably 300 and in most emerging markets it's less than 50. So the penetration levels are much, much lower, and we are still, as Indra said, an affordable treat, both in Snacks and in Beverages.

Certainly, I'm keeping a close eye on private label trends in Europe, particularly on Snacks but, again, continue to find that our brands are holding up very, very well. So I'd say we're not without some challenges in a few pockets, but I don't think you could call it, by any stretch of the imagination, uniform. And as Indra said, the Middle East and Asia in particular are still very, very healthy growth rates.

Lauren Torres - HSBC

And I know you didn't want to get too involved with respect to next year's outlook but, you know, in the past you've talked about division operating profit around this 8% plus level. Seeing what we're seeing here in the U.S. maybe versus what you're seeing at your International business, do you feel that a lot of the weakness here can still be offset by your International business or is that number at risk?

Indra Nooyi

Well, you know, the International business, as Mike said - and again, we all look at international as Mike's businesses in PI as well as our Latin American businesses - and I think taken together they continue to perform very well.

And our outlook for the future, again, let's be very careful. We don't know where these macroeconomics are going, but given what we are seeing today, we still seem bullish about our outlook for our international businesses. We're also feeling good about our North American Snack business. And believe me, going forward we're feeling better and better about our North American Beverage business, too.

So we're not providing guidance for 2009 as yet because we want to see where the FX ends up, where the macroeconomic situation ends up, but at this point we feel pretty good about our future.

Richard Goodman

Just to echo, I spoke to investors in early September at a conference and I think I was pretty clear and I think I was the only person who said be careful about the Forex rates. Now even I didn't predict how much they would change in the last two weeks, but excluding Forex I feel very good about our plans for next year in our International business and I think we'll have another very strong year.

Operator

Thank you. At this time I would like to turn the call back to management for closing comments.

Indra Nooyi

Yes. Thank you all for participating in our call today.

Let me just close by saying we feel very confident about the fundamentals of our business, and we are facing challenges that are really out of our control that affect others as well. But we feel very confident about the capability of our people, our brands, the investments we are making, our go to market systems. We feel very, very good about all of that. Our Snack business globally is performing exceedingly well. Internationally, our Beverage business is performing very strong, too. Our North American Beverage business is our only work in process and, based on the plans we have in place, the reinvestments we are making, we think that's going to be a great success story next year, too.

Our portfolio balance is a great asset, and we think our Productivity for Growth program is far reaching and gives us the breathing room to reinvest in the business. We are focused on sustainable long-term growth and we've created the flexibility to weather any short-term challenges. So we remain a great operating company. And our biggest assets, as I said, are the strength of our brands, our go to market capabilities, but most importantly, the tremendous people we have in PepsiCo and we know what we need to get done going into the future. So thank you.

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Source: PepsiCo, Inc. Q3 2008 Earnings Call Transcript
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