Pepsi Bottling Group Q3 2007 Earnings Call Transcript

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Pepsi Bottling Group (PBG)
Q3 2007 Earnings Call
October 2, 2007 11:00 am ET
Executives March 1, 0000 ET


Bill Pecoriello - Morgan Stanley

Judy Hong - Goldman Sachs

Lauren Torres - HSBC Global Research

Bryan Spillane - Banc of America Securities

Mark Swartzberg - Stifel Nicolaus

Christine Farkas - Merrill Lynch

John Faucher – JP Morgan


Welcome to Pepsi Bottling Group's third quarter earnings conference call. (Operator Instructions)

Please note the company's cautionary statement. Statements made in this conference call that relate to future performance or financial results of this company are forward-looking statements which involve uncertainties that could cause actual performance and results to materially differ. PBG undertakes no obligation to update any of these statements. Listeners are cautioned not to place undue reliance on these forward-looking statements, which should be taken in conjunction with the additional information about risks and uncertainties set forth in the company's annual report on Form 10-K for the year ended December 30, 2006.

I would now like to turn the conference over to Mary Winn Settino, Vice President of Investor Relations of the Pepsi Bottling Group. Please go ahead.

Mary Winn Settino

Thank you, everyone for joining us today. Eric Foss, our President and CEO; Al Drewes, our CFO; and Rob King, President of our North American Operations are on the call today. Our call is been recorded and will be available for playback. We're broadcasting the call as well on our website at

Please keep in mind that all references to volume are on a constant territory basis. In addition, all numbers referenced, unless specifically stated otherwise, are on a comparable basis. The items impacting comparability are laid out in our non-GAAP reconciliation attached to our press release that we issued this morning.

As we have asked of each of you when it comes to Q&A, please try to limit yourself to one theme of questioning at a time so everyone has a chance to ask what is on their mind. If you would like to ask a second question, please get back in the queue. I would ask each of you to take note of our cautionary statement that the operator just read.

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

Eric Foss

Thanks, Mary Winn and good morning, everyone. Thanks again for joining us this morning. Today, I would like to cover some of our highlights from our third quarter, update you on the progress we continue to make against our three key objectives for the year and then spend some time reviewing PBG's priorities for the balance of the year. After I run through these items, Al will provide a review of our financial performance and update you on our guidance for the balance of the year. Following our prepared remarks, we will have plenty of time for your questions.

Let me first talk about our record-breaking third quarter earnings, led by strong top line growth of 8%, double-digit operating improvement of 12%, and outstanding EPS growth of 22%. As you saw in the press release this morning, our overall financial results put us in position to raise our full year EPS guidance to $2.15 to $2.18 or growth of 14% to 15%.

Overall, our financial results were driven by very strong business performance in the US and Canada, with operating profit growth of 11% and a robust quarter in Europe with exceptional 29% increase in profit performance.

Russia continued to lead the way in Europe, with volume up 16% and top line growth of 41%, with a currency contribution of about 6 percentage points to our revenue growth. In just two years, operating profits in Europe have doubled from about 5% to 10% of our total operating profit. Over the same time period, Europe has contributed about 30% to PBG's overall operating profit growth. Our portfolio contribution is clearly paying off, and we expect this trend to continue.

In Mexico, our business performed below our expectations. While our team there did a good job securing net revenue per case increases of 7% for the quarter in local currency, this progress was offset by significant increases in costs and soft volume, which adversely affected our operating profit. Improving our profitability in Mexico is our top priority. To do that, we need to increase ideas in the product innovation pipeline; improve capability and execution at the point-of-sale and achieve better cost productivity performance.

So to summarize our international business results, we continue to be very optimistic. In just five years our international business has increased from 3% of our operating profit worldwide to about 20%. We expect this trend moving forward, with profits from our international operations growing at a faster rate than the US and Canada and therefore, becoming even more important to our future performance.

To summarize the third quarter, our solid financial results were driven by top-line growth, improving our gross profit per case, and disciplined cost management.

Now I would like to evaluate and update you on the progress we have made against the key priorities that I laid out at the beginning of the year.

Our first priority was to ensure we execute a revenue and margin management strategy to take the appropriate pricing actions to cover increasing raw material cost pressures. I think the numbers depict our progress. Our pricing strategy helped us improve net revenue per case by 7% and gross profit per case of 6% with solid growth across the US and Canada, Europe, and Mexico. Each country showed reported gross profit per case improvements of at least 3% for the quarter.

Our second key priority was focused on building operational excellence through a comprehensive approach to cost productivity. To date, we have delivered cost savings of $80 million, right in line with our full-year plan to save $100 million.

Our key performance metrics improved again across the board. For the second consecutive quarter in the US, comparable SD&A was flat. This is great progress and we continue to make productivity improvements across the supply chain. We continue to adjust our route to market, increasing cases and stops per truck. These efforts decreased our transportation costs and produced more efficient scheduling. In addition, our manufacturing line efficiencies are showing improvement and as a result of efforts like these, our output per employee increased as well.

Finally, our third priority reinforces our commitment to creating value and growing our business for the long term. Specifically, we said we would continue to make investments for future growth across innovation, capability and capacity. In capability, we are investing in tools, training, and technology to ensure our organization stays focused on becoming a world-class selling and service organization. Our capital spending initiatives are geared toward lowering our production costs and providing the right capacity in growing geographies and categories. So we once again made solid progress across our three business imperatives.

But before I turn the call over to Al, I would like to spend a minute sharing with you how we are thinking about the future of this business in fourth quarter and beyond, and what we are doing to position ourselves for ongoing success. Let me share three things we are doing.

First, we are focusing on positioning and building our brand portfolio for success. Second, we are looking to achieve greater organizational effectiveness. Third, we are going to continue to make strategic investments to promote long-term growth.

Starting with our portfolio positioning, in the fourth quarter we will have a combination of brand initiatives, marketing promotions, and new products in the categories of tea, energy and hydration.

First, tea will continue to play an important role in our growth strategy. The reality is our three-tea strategy is working, with Brisk in the value segment, Lipton in the mainstream segment and PureLeaf in the premium category. We intend to expand our leadership by introducing Lipton line extensions and investing more media and promotional dollars behind the Lipton trademark. There is a lot of room for growth in tea, which is the largest category in non-carbs outside of bottled water.

In the energy segment, we are consolidating our efforts behind AMP for Mountain Dew. As you know, the energy category is fast growing, high margin and you're going to see us step up our marketing and selling efforts in a big way. We are very excited about Pepsi's new sponsorship of NASCAR driver Dale Earnhardt Jr. Dale Jr will race the Mountain Dew AMP car and will partner with us to provide opportunities for driver-branded products, advertising, at-track activation and in-store marketing.

Third, let me talk about hydration. As all of you are aware, hydration is capturing a lot of attention in the marketplace. First, we start with a strong lineup anchored by Aquafina, the number-one unflavored water. In the enhanced water category, we have three key segments: flavored water, with a strong entry in Aquafina Flavorsplash; vitamin-enhanced water, where PBG has two offerings, and we have plans to dial up our marketing and selling efforts, first with Life Water, which is currently being repositioned and relaunched with one-third less calories, sweetened with sugar, and enhanced with vitamins and herbs. We also have Aquafina Alive, which we will focus on stronger consumer benefits, improved graphics and new flavor introductions.

So while we start from a position of strength in hydration, until now we have had voids in the third enhanced water segment, fitness enhanced, as well as in the isotonics category. We are very excited to close those gaps with new products and brand extensions that included Propel in the fitness enhanced category, and G2 from Gatorade in isotonics, the biggest new product introduction in Gatorade's history. Adding G2 from Gatorade to our brand lineup gives us a compelling position in isotonics and small format. More specifically, it gives us a valuable and scalable isotonic cold drink platform. Now our customers will benefit from the availability of Propel and G2 through PBG's superior DSD system in small format.

During the fourth quarter, we're making marketing and selling investments against the hydration category to ensure we get these brands off to a great start through trial and sampling. This is a winning and an aligned portfolio for both PBG and PepsiCo. It is a great lineup to offer to consumers and to customers alike.

The second development we initiated in the third quarter was the realignment of our organization through an initiative we call Align to Win that enables us to adapt to changes in the marketplace and improve operating efficiencies. In the US and Canada, we consolidated our business units from eight down to six, reflecting the consolidation of our customer base. We made this change to more effectively align our supply chain with our customer territories, increasing the efficiency of decision-making, while also capturing more cost productivity. In addition, we have increased supply chain resources for warehouse and logistics functions to increase our speed to market and better serve consumers, who want more variety.

In the United States, this reorganization is right on track. We have completed the consolidation of the business units, effectively integrating the work, and put the right people in the right roles to lead our businesses and build our plans for 2008. We did all of this in third quarter without missing a beat on the operating front.

Externally, I am pleased to report that our organizational changes have been well received by our customers. The geographies that were consolidated matched up with our customer territories and improved the effectiveness and efficiency of decision-making and resource allocations.

Internationally, we made changes that resulted in the elimination of mostly front line positions, primarily in warehouse and production. All in, we expect to have cost savings of approximately $30 million pretax annualized as part of our ongoing cost and productivity initiatives.

Finally, we are making investments for long term, profitable and sustainable growth. You will see us continue our ongoing capability journey by investing in our people, giving them the right tools, training and technology to enhance their impact on the marketplace.

Our capital investments are focused in fast-growing geographies and categories. For example, in Russia we are building a new plant in Moscow; and in product categories such as water, we are installing dedicated high-speed water lines. In addition, we are investing in new technologies, processes and innovations to advance our environmental sustainability goals around water conservation, energy management and packaging.

In summary, PBG had a strong quarter and we are on track to have an excellent 2007. With our strong product portfolio, our solid partnership with Pepsi, and our capable, effective, and efficient organization, PBG's future looks bright as well.

With that, let me turn it to Al.

Al Drewes

Thanks, Eric. Obviously, we are very pleased with our results for the third quarter. At the beginning of the year, we were optimistic, but cautiously so, about our expectations. But as the year progresses, we have been exceeding our expectations with sequentially stronger results.

In the third quarter peak selling season, we generated top line growth of 8%, while year-to-date our top line growth was 7%. Comparable operating profit was up 12% in the quarter, and has increased 8% for the year. As a result, adjusted diluted EPS was up 22% and 16% for the quarter and year, respectively.

These returns demonstrate PBG's ability to deliver consistent performance even during adverse market fluctuations. What I find especially encouraging is that the US and Canada have been the primary drivers of our bottom line, with 9% operating income growth year-to-date. Not to be overlooked, Europe had a highly successful summer selling season, with balanced growth and good cost performance.

Mexico is our only geographic soft spot where we are unlikely to meet our profit objectives for the year. Nonetheless, our overall performance shows the strength of our geographic portfolio of countries. Even with softness in Mexico, our portfolio is delivering robust financial results.

In the quarter, foreign currency translation contributed 3 percentage points of operating income and was more pronounced than in previous quarters due to the timing of our peak selling season outside of the US. In Q4, the ForEx impact will be much smaller as we move to a seasonally lower profit quarter. For the full year, we continue to forecast about a 1 percentage point increase in operating income from foreign exchange.

Given our strong year-to-date growth trends, we have taken up our financial outlook. We now expect adjusted operating income growth of 10% to 11% including the accounting consolidation of our Russian joint venture. As Eric mentioned, our adjusted diluted EPS should grow 14% to 50% to $2.15 to $2.18.

Our operating free cash flow for the first three quarters of the year has been strong, up $120 million versus last year. The timing items I told you about on previous earnings calls were reversed, as we forecasted. Consistent with our upward revision in operating profit guidance, we are raising our cash flow guidance by $20 million to a range of $560 M to $570 million.

Included in this guidance is the cash impact of the organizational restructuring. Even with this impact, operating free cash flow will be up approximately 8%, in line with our objective of growing operating free cash flow in line with operating profit.

In the third quarter, we had a modestly lower effective tax rate due to favorability in our international markets. This favorability impacted our diluted EPS by about $0.02. We continue to expect that our fourth quarter effective tax rate will be lower than our full year due to timing. You may recall that this will be consistent with our experience in 2006. As a result, we now expect our full-year effective tax rate, excluding the tax benefit booked in Q3, to be in the range of 33% to 33.5%.

Also after the end of the third quarter the Mexican government enacted new tax legislation that will take effect in January 2008. We are currently evaluating the impact this law change will have on our financial results.

Now, let me update you on two important initiatives that we have undertaken. As you may have seen in our press release today, we are taking actions to improve the return on our full-service vending business. Full-service are accounts where PBG stocks and services the vending equipment; and it represents about 2% of our total US volume. Recently, we completed an in-depth review of the return on our full-service investment, and that review showed an opportunity to improve our return.

As a result, we are embarking on a three-pronged approach to strengthen our full-service business. First, for all of our full-service vending we will be increasing our net revenue per unit sold. Second, we are going to right-size our vending asset base by writing off and disposing of older, underperforming vending assets; and we will redeploy newer underperforming vending assets to higher-return locations. Third, we will look to leverage tools and technologies to reduce our cost to serve.

These steps will assure better utilization of existing assets while also freeing up capital for next year. The reduction of our vendor base represents about 10% of our total vending equipment. The corresponding charge will be approximately $40 M to $50 million. About $20 M to $30 million of the charge will occur in the fourth quarter of this year. The balance will be recorded before we enter the 2008 summer selling season. The future full-service vending business will be stronger as a result of these actions.

The next initiative was an organizational realignment that we underwent in the third quarter to adapt to a consolidating customer base and growing consumer demand for more variety. The total charge of the restructuring is now estimated to be $30 M to $35 million pretax. We recorded $20 million in the third quarter; and $8 million of the additional charge will be taken in the fourth quarter. The balance, which is primarily relocation expense, will be recorded in early next year.

During the third quarter, we booked a $46 million non-cash income tax benefit. This generated $0.20 per diluted share upside. The benefit is a result of successfully closing out the IRS audits of our 2001 and 2002 tax returns. We're using this tax upside to fund the vending and organizational restructuring.

So all in all, 2007 is a great year for PBG. We have raised our guidance for the year given the strong results, and we're taking positive concrete actions to carry our momentum into 2008. Now I will turn it back to Eric.

Eric Foss

Thanks, Al. With that, we would be happy to take any questions you might have.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Bill Pecoriello – Morgan Stanley.

Bill Pecoriello - Morgan Stanley

My question was on the volume in the quarter, US flat. If you can address on the water and the non-carb, I know trademark Aquafina was a little bit slower. How much do you attribute this to any of the PR issues in the quarter; versus you were lapping some promotions?

Then on the non-carb front, it slowed a bit also. Your cold channel was down 2%. Do you attribute this on weather, consumer environment, competitive actions? If you could just give us some more color.

Rob King

Let me address each one of those. First on Aquafina, we actually think the Aquafina brand performed quite well this summer. I think the brand demonstrated a great degree of resiliency. Our volume was soft in the beginning of the summer; and I think certainly much of that was associated was some of the negative press. But we had very good trends as we moved through the balance of the summer. Our Aquafina business was up just below 10% for the quarter. Our take-home business was up double-digit during the quarter.

While our cold drink business was actually down modestly for the quarter, most of that weakness was in the beginning of the quarter. We actually saw increased momentum as we moved through August and towards Labor Day on cold drink. Our Aquafina cold drink business was actually up in the last 30 days of the quarter. While the total water category was softer in the summer than we had anticipated, we actually feel good about the resiliency of the Aquafina brand, as I had mentioned before. So that is number one.

Number 2, I think you asked a question on tea and the rest of the non-carb business. The tea business still grew at a double-digit rate. If you look at our business, last year in the third quarter we grew at about a 40% rate. This year, our growth rate was double-digit, but short of that 40% rate so we didn't get the same type of leverage on the business. But the tea business is still very, very healthy and our growth rates were very, very strong as well.

I think you asked a question on cold drink as well. A decline in the cold drink business of 2% is not satisfactory for us, and it is clearly disappointing. There were three factors that I would say drove our cold drink performance in the third quarter.

First, the overall C&G category was soft and I think you know that is an important segment for our cold drink business. Second, the education segment was soft; and I think most folks would know that that is attributable to just changing student access to carbonated beverages in the education segment. Third, and I mentioned this earlier, just our Aquafina business in July was quite soft at the beginning of the summer, but that did improve towards the back end of the summer, which we felt good about. Our cold drink business actually improved at the back-end of the summer as well.

Mary Winn Settino

Let me just clarify one thing that Rob said. I had given out some numbers as well. Our total water business is up just under 10%; but trademark Aquafina is up in the range of about 6%.

Bill Pecoriello - Morgan Stanley

On the C&G comments, how much would be due to weather versus the economy, when you're saying that that channel is soft?

Rob King

Bill, I would not speculate on the weather and the economy. What I know is in C&G the total LRB segment was softer than we would have anticipated. We gained share, which I felt great about, in CSDs. But our water business was soft at the beginning of the quarter and it got stronger as we moved on. We are working to obviously improve those trends.


Your next question comes from Judy Hong – Goldman Sachs.

Judy Hong - Goldman Sachs

Eric, if you could just talk a little bit more about the new product in the isotonic segment that you're getting, the G2 and Propel. Perhaps if you can just quantify how much of an impact on EPS line that you're anticipating, either in the fourth quarter and looking out 2008? As you invest in marketing and selling expenses, if you can just quantify or just give a little bit more details in where you're spending the money and the initiatives that you have to accelerate growth of these products.

Eric Foss

As I said in my prepared comments, we are extremely excited to be adding G2 and Propel to the PBG family. I think as we think about hydration, first of all, all of the category growth, more than all of the LRB growth, is expected to come from hydration. So I think this is an area that is going to get a lot of attention from consumers, a lot of attention from customers, a lot of attention from all the beverage players, as you well know.

We are very excited. We're currently finalizing our plans. There will be minimal impact. These products will show up but they will show up late in fourth quarter. So we are just in the process of finalizing the resources, both on the marketing and brand-building side as well as on the selling and execution side with PepsiCo.

At this point in time, it is just premature for me to comment on anything in terms of 2008 impact or specifically about our plans. I think for competitive reasons, we would like to start to execute those plans in the marketplace and then I would be more than happy to comment, more than likely on our Q4 call.


Your next question comes from Lauren Torres – HSBC Global Research.

Lauren Torres - HSBC Global Research

Going back to your US volume performance in the quarter, I was just wondering if you could give us a sense if now are you more concerned about any particular category, be it CSDs or non-CSDs?

I guess more specifically, is the CSD category weakening further for you? Or is the growth rate for the non-carb category just slowing a bit? Is that what we saw in the quarter?

Eric Foss

Yes, Lauren, it is Eric. Let me try to dimensionalize what we are seeing happen at the category level. So if you think about in measured channels, let me give you some math for the categories. In third quarter, the CSD category was down about 7%. That is versus run rates we have seen at the category level down 5% to 6%. Now to Rob's point, our business was down 3% for the quarter in CSDs.

In water, again, the category in measured channels was up 6%. Historically we have seen the category be low double-digit. Again, our water business was up 9%.

In non-carbs, the category of non-carbs in the quarter in measured channels was up about 3% versus what we have historically seen, which is more 4% to 5%. Again, our non-carb portfolio performed at 4% for the quarter.

So I would tell you that Rob touched on a couple of these, but three key issues. One, July was much softer than we had anticipated. Second, as you just mentioned, the category was softer, the LRB category. Third, pricing at retail is higher than we have seen in recent years.

So if you think about this, again the game we were playing this year in light of tremendous commodity pressures was to make sure we captured that with pricing. What has happened at retail is, if you looked at just feature pricing on cans, if you looked at 2005 and 2006 you saw about a dime get passed through at retail. In 2007, we are seeing about $0.20 get passed through at retail. So I think the combination of softer July, the category being a little softer, and pricing at retail, all three contributed to some of that softness for Q3.

Having said that, as you have heard me talk before, we still are very optimistic on the category to grow 2.5% to 3%. We think in a more normalized commodity environment, where you see more like 2 to 3 points of pricing as opposed to what you have seen this year, more like 4 to 5 points, we think the long-term prospects for the category continue to be very encouraging, certainly at the category level and definitely for PBG.


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

Bryan Spillane - Banc of America Securities

Just looking at Mexico, you know it's another quarter where profit growth was below last year. '06 was a good turnaround off of '05 and there was some actions taken there to begin to turn that. Are we at a point now where you are readdressing that business? What is the potential that you're going to have to take more actions in order to shore up the profitability there?

Eric Foss

Let me talk about Mexico. As I mentioned again in my comments, it was below our expectations. What we did well was we actually did get rate to cover COGS, so we actually did see gross profit per case up about 2% in local currency. Having said that, there are a couple of key issues we have got to address. So I don't know that there are more actions, but these are the actions we need to take.

First, we need to get some volume growth into this business. To do that we need to do two things. One, increase the amount of innovation ideas we have in the pipeline with PepsiCo. Second, we need to improve our execution at the point-of-sale. I think we have got good plans the rest of this year; and certainly as we set our sights on 2008 to do that.

The second thing we need to do is we just need to achieve better cost and productivity performance in Mexico. Now some of that started with what we did with Align to Win. But at the end of the day, what we are seeing is the combination of more volume and better cost productivity performance. Quite honestly, just a more moderate commodity environment can put this business back on track just like you saw in 2006.

Our number one priority is to improve our profitability in Mexico. I would tell you what I feel good about is, even with the softness we experience in Mexico, I think it proves the strength and diversity of our geographic portfolio to deliver double-digit profit and EPS for the quarter.


Your next question comes from Mark Swartzberg - Stifel Nicolaus.

Mark Swartzberg - Stifel Nicolaus

A question on the take-home channel. As you look at '08, Coke, CCE, other Coke bottlers are going to have relative pickup in volume there because of the vitamin water shift. It looks like your incremental volume is going to be more in the cold channel. Can you just talk a little bit about whether and to what extent that implies a need to get more promotional just in that channel to deal with the obvious volume edge, if you will, that the Coke system is going to have next year in that channel?

Rob King

When we look at the business, first and foremost I would say we look at it broadly across the entire LRB segment. Number 2, we look at it across brands. Number 3, we look at it across packages. We are well aware, obviously, of the volume implications of vitamin water moving into the CCE and the KO system; and we are quite familiar with the volume implications of not only the hydration portfolio that we have, but the balance of our portfolio as well.

Our objective would be to execute a consistent category of, number one, growing our volume at a rate that allows us to defend our share and in fact grow our share in the LRB category. Number 2, to have a pricing architecture that represents consumer value, but also allows us to achieve our revenue and margin objectives.

While it is premature for us to get into specifics on 2008, what I would suggest is that we think that we have got a track record of the right balance between revenue promotion and volume. Our plans for 2008, Mark, would have consistent approach to consumer value and defending our share in the marketplace. But I wouldn't assume that means it is an aggressive or an excessive rate of promotion versus what you have seen historically.

Eric Foss

Mark, I was just going to add to that. If you look at our take-home business, we have grown our take-home business again in third quarter and year-to-date. As you well know, one of our trademarks is at PBG we like to play our game and control what we can control. I think our plans, if you think about our plans, we just came from the Pepsi bottler meeting a couple weeks ago; I think we are excited, as the other bottlers are, about the marketing and innovation ideas, not only on cold drink but on take-home as well. I think our ability to execute across CSDs, non-carbs, and water, both cold drink and take-home for 2008, I wouldn't see any need to be any more promotional than you have seen us in the past.

Mark Swartzberg - Stifel Nicolaus

That's very helpful. So then it sounds like, Eric, that 2%, 2.5% type number you have spoken about as being more of the historical average in terms of retail price growth, versus the 4% or 5% we have seen this year, it sounds like you think that is a reasonable assumption for next year, at least in terms of your own intentions.

Eric Foss

Well again, let me just say I didn't make any assumptions on next year. What I said was the way this works is 2.5% to 3% LRB growth in an environment where you are seeing 2 to 3 points of net revenue per case improvement. To me that is the model that ultimately everybody in the industry wants to get back on. So we still have a lot of work to do in terms of 2008; but yes, I think I'm optimistic about what I have seen so far.


Your next question comes from Christine Farkas - Merrill Lynch.

Christine Farkas - Merrill Lynch

Just a follow-up on Mexico if I could, Eric. Specifically, can you comment on your CSD performance relative to the industry? Then along with that, is the overall mix a drag then, based on the growth of some of the other products? Just to understand the strength in the top line and what might have dampened that a little bit.

Eric Foss

First of all let me give you some numbers. Our CSD business for third quarter was down about 2%. The softness, if you really want to focus on the softness, CSDs is down 2% and our jug water business is down 2%. We actually had strong performance, double-digit growth out of our bottled water business; and strong double-digit growth out of our non-carb portfolio. If you look at the category, I think the category year-to-date is growing CSDs about 2%. So our CSD performance was softer than the category.

Christine Farkas - Merrill Lynch

Any particular regions? Or just as a broad statement, is there any particular pocket there that you are focused on?

Eric Foss

The softness, if you want to focus on geography, is largely in the North. Actually, our business in Mexico City is stronger. As a matter-of-fact, we have actually had pretty decent share performance in Mexico City proper. But the softness we have experienced is focused on the North region.


Your next question comes from Bill Pecoriello – Morgan Stanley.

Bill Pecoriello - Morgan Stanley

My question was on the pricing. You usually take pricing post-Labor Day. Just wanted to get some color on what you did this year. I think the Coke system had indicated that they had taken all their pricing and wouldn't take any post=Labor Day. So I was just wondering if you had taken or are you seeing competition falling here? Thanks.

Rob King

I think we have been pretty public on this year in and year out, that we take pricing every year post-Labor Day. By the way, that happened again this year, where we have published pricing. I would say we have about 70% to 75% of our pricing in place for next year at this stage of the game.

The second thing I would tell you is that we play our game. We build a pricing strategy based on an understanding of consumer value. We also incorporate, obviously, enough rate to cover anticipated commodity price increases and concentrate price increases.

Third, we make sure that the pricing that we take can stimulate an adequate amount of consumer demand to drive our volume. So we play our game. We have published our pricing, and we are confident that the pricing environment is going to remain rational. We are comfortable in our revenue strategies for the balance of this quarter and going into next year.


Your next question comes from John Faucher – JP Morgan.

John Faucher - JP Morgan

I am trying to triangulate a couple of different things here, following up on Bill's question about pricing and also your comments on volume in North America. It seems as though the gross margin came in at least better than we were thinking, which may have been maybe a little bit more pricing, a little less volume. You talked about taking pricing post-Labor Day; yet you talked about accelerating the volume growth as well.

Can you maybe walk us through the balance between pricing and volume in the back of the year, and the implications that is going to have on your gross margins relative to what you did in the third quarter? Thanks.

Eric Foss

There are a lot of questions in there. Let me try to answer it; and if I don't, specify where I am missing one of these. I think what you are seeing us articulate is that 2007, as a result of the commodity pressures, was a different game. I think we have tried to clearly articulate that since the beginning of the year, that in light of that we had to get pricing to cover that cost inflation. We have done exactly that. We have executed that play and that plan, and done it very, very well.

To Rob's point, as we think about 2008 now, but any year post-Labor Day, we really believe and this I think has been proven out, given we have had over eight years of quarter-in, quarter-out, net revenue per case improvement in the US, we believe that that is absolutely the right time to put pricing into the marketplace. (a)You will see how much of it sticks or not. (b)You'll see how the consumer and the trade responds to it. And (c) it will give you a chance to see how competition reacts. So, as Rob mentioned, we did send pricing letters out. That pricing was effective pretty much the 1st of October.

Having said that, we really believe that balanced top line is what we are trying to do here. I think in 2007, some of that has been impacted by the fact that a lot of this pricing has been passed through at retail. But having said that, I think if you're thinking about Q4, our hope is that we see better balance at the top line than we have really seen through the first three quarters.

John Faucher - JP Morgan

I think I understand exactly what you guys are trying to do. I guess what I am going on here is if you over-delivered at least relative to my expectations; I don't know about yours , on the gross margin line in the third quarter, as you try to pull more of that balance into place, a little more volume, a little less pricing, do we see maybe a little less upside on the gross margin over the next couple of quarters? Because you say we are trying to get that balance back a little bit.

I guess I am trying to understand why the gross margin was so much better in the third quarter and sort of how sustainable you think that is.

Al Drewes

Again, I think the key thing is that actually the gross profit per case trend we have had this year has been pretty strong. It has been stronger sequentially; but it's been quite strong all year. Again, this was just a year where we knew we were going to have a whopping COGS increase. The COGS increase that has evolved is essentially what we said it was going to be at the beginning of the year, so we called that right. The key thing we wanted to do was make sure we delivered our bottom line objectives for the year. That was going to require driving the pricing to cover the COGS. The other piece was delivering on the COGS numbers. Again, you know, we have had really kind of a step change in our cost performance versus where we had been in '06 and even in '05. We feel terrific about that.

So let's see what the coming quarters bring here. I think we would like to see a little bit more balance to the top line, as Eric and Rob have both spoken about. We will see how it all evolves. I think the key thing here is that I've got to feel pretty darn good about how we are performing this year. I mean, we are going to have mid-teens EPS growth in a year in which the environment is just a very, very difficult.

I think that is a lot to feel good about. I would hope that investors would say, geez, these guys have said what they were going to do at the beginning of the year and they have executed against it, and get some confidence that we've got a good handle from an operating capability on what we are trying to do.

Mary Winn Settino

Eric, I will turn it back over to you.

Eric Foss

Great. Well, let me close down and just mention a couple of things. First of all, again, I just want to echo what Al just said. I think 2007 as on track to be a great year for PBG. I want to just say how extremely pleased I am with the progress our teams have turned in this year.

We are focused, beginning our focus, as we typically do this time of year on 2008. In looking ahead, we are going to be hosting an investor day in New York on December 13. We hope you will be with us to join us on that day.

Again, thanks for joining us today and your ongoing interest in PBG.

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