百事 (PEP) 2004 Q3 法說會逐字稿

Good morning and welcome to PepsiCo's third quarter earnings conference call.

Your lines have been placed on listen-only until the question and answer session.

Today's call is also being recorded.

Please note the Company's cautionary statement.

This conference call may include forward-looking statements based on our current expectations and projections about future events.

Our actual results could differ materially from those anticipated in any forward-looking statements, but we undertake no obligation to update any such statements.

Please see our filings with the Securities and Exchange Commission including our annual report on Form 10(K) for a discussion of specific risks that may affect our performance.

You should refer to the Investor section of PepsiCo's Web site at www.pepsiCo.com, to find disclosure and a reconciliation of nonGAAP financial measures used by management when discussing PepsiCo's financial results with investors and analysts under the heading Press Releases.

I would now like to turn the call over to Mr. Jack Callahan, Senior Vice President of Investor Relations.

Sir, you may begin.

Thank you, operator.

Thanks to all of you for joining us this morning.

Welcome to PepsiCo's third quarter conference call.

This call is being webcast and can be accessed at our PepsiCo.com site.

It is also being recorded and will be archived for 90 days.

This morning our prepared remarks will be made by Steve Reinemund, our Chairman and Chief Executive Officer, and Indra Nooyi, our President and Chief Financial Officer.

Once we open it up for your questions a little bit later in the call, Steve and Indra will be joined by Gary Rodkin, Chairman and CEO of PepsiCo Beverages and Foods North America and Don Hudson, President of PepsiCo North America.

I would like to remind you that we intend to limit the Q&A to only one question at a time.

Now let me turn the call over to Steve.

Thanks, Jack, and good morning and thank you all for joining us today.

I appreciate this opportunity to discuss PepsiCo's performance, and as I'm sure you noticed the third quarter was another strong quarter despite several challenges in the marketplace, like a sluggish North America retail environment, some difficult weather, raw material inflation, and as always tough competition.

Despite all this, the Pepsico portfolio continues to deliver a strong top and bottom line as well as healthy cash-flow.

This morning I want to make sure that you leave with three key messages.

First, the Pepsico portfolio is stronger than ever.

The international performance was outstanding, Frito-Lay stepped up their performance versus the second quarter, and the Quaker Foods had a solid third quarter.

And while the North American beverages had a tough summer, the volume will likely improve in the fourth quarter.

Secondly we received a non-recurring tax benefit worth 13 cents a share in the quarter and that was on top of excellent operating performance with revenue up 6% and operating profit up 11%.

And lastly the manufacturing consolidation that we announced today is due to the great work done over the last two years at Frito as a part of the MAX It!

Productivity program.

We now have plenty of capacity to sustain growth well into the future, and I will provide some additional details on this action in just a few minutes.

Now let me make a few brief comments on PepsiCo International, followed by Frito-Lay and then I will turn it over to Indra who will discuss North American beverages and she will provide some more detail on the numbers.

It's very appropriate that we should start today with PepsiCo International, as this division is the largest contributor to PepsiCo's growth in 2004.

International is now the largest division of PepsiCo in terms of revenues, and going forward we see nothing on the horizon that changes our optimistic outlook for this business.

I hope you all had the opportunity to hear firsthand from Mike White, who leads our international business at our recent investor conference.

And you may remember that in his presentation, he talked about several reasons to believe.

And why we have strong belief in our potential to sustain high growth for some time in the future.

Since Mike just recently updated you, I'm not going to say a whole lot more about international performance today, and if by any chance you missed Mike's presentation it is on the website.

It's a good story and I recommend that you take a chance to listen to it.

Now let's turn to Frito-Lay.

I'm really pleased with the stepped up performance in the second quarter, and there are four specific highlights that I'd like to share with you this morning.

First the core salty business continues to demonstrate solid growth with volume up 3% in the quarter.

Secondly, the performance of the Quaker snack business is improving as we outlined after the second quarter.

And most importantly the MAX It!

Productivity program is having a huge impact.

Leading us to big changes in the manufacturing network that we announced today.

And finally the leadership transition from Al Bru to Irene Rosenfeld is proceeding smoothly.

First the core salty business continues to perform well with volume growth of approximately 3% and solid price realization.

The revenue growth was a balanced mix of innovation led by Lay STAX and new packaging on our multi-packs, combined with the continued success of our core brands like Tostitos, Classic Lays and Cheetos.

Going into the fourth quarter this momentum is continuing, especially with the revamping of the Tostitos product line and renewed growth in Doritos.

As we indicated in the second quarter call, the performance of the Quaker snacks business continues to sequentially improve.

Tough overlap on the 2003 production introductions of Crisp'ums and Toastables is moderating, and the performance of the Quaker bar business did step up and due partly to the innovation from the Quaker Q-Smart bars and the reformulation to lower sugar products in our fruit and oatmeal line.

The early results in the fourth quarter are promising.

Let me turn to productivity and today's announcement.

Fritos has a great history of delivering world class productivity, and we spent a great deal of time talking about productivity with you during our last investor meeting that was held in early 2003.

From that meeting you may remember the presentation that was made by Jim Rich, the Senior Vice President of Operations.

He introduced the multi-year MAX It!

Productivity program.

One important element of the program was to increase the existing capacity of our old standard which was 150 hours a week, to a new standard of 168 hours.

The intent was to improve current processes, make selective low cost investments in capacity boosts to eliminate bottlenecks, and better leverage our information systems for production planning.

I can proudly say that the team has made great progress in expanding our existing capacity.

This progress gives us the opportunity to consolidate the manufacturing network by closing four facilities.

Closing four plants is a significant action, but remember we still have 39 other plants across the U.S. and Canada, and that's a lot of capacity.

Let me just give you a little color on each of these facilities that were impacted by the decision.

Beaverton, Oregon, was purchased as a part of the Grandma's acquisition in the early 80s, but was opened earlier than that in 1970.

It makes nonsalty baked products like cookies, and it also makes pretzels.

And then there's Council Bluffs, Iowa, and it's a small plant that just makes Fritos.

Allen Park, Michigan produces several salty products, but it's almost 50 years old and has no room for growth.

And lastly Visalia, California, is a relatively new plant.

It was built in the 80s by Anheuser Busch and it came to Frito-Lay as a part of the Eagle asset acquisition.

Unfortunately it's located near two other larger, more efficient facilities in California.

So all in all, since these plants are either old or limited in production capacity and/or near other more efficient capacity facilities, it just makes sense to move forward with this consolidation.

Although as I'm sure you understand, we do regret that some associates will be leaving the Company.

We are, however, completely committed to care for these associates and their families, and to assist them as they start a new chapter in their lives.

Now going forward I'm confident that the MAX It! program will continue to deliver productivity, but we are not anticipating another consolidation of this magnitude in the foreseeable future.

One last comment on Frito-Lay.

The leadership transition from Al Bru to Irene Rosenfeld is proceeding smoothly.

Irene is fully engaged in the business, and her broad experience in the food industry combined with the deep understanding that we have in the salty business, led by John Compton who is the Vice Chairman of Frito-Lay and the President of salty snack division, is very encouraging.

The promise is to bring even more capability to an already world class organization.

Now let me turn the presentation over to Indra, who will discuss the North American beverage business and then provide you with some additional details on the numbers.

Indra?

Thank you, Steve.

Let me now focus on the beverage businesses.

As Steve said, internationally we saw great double-digit beverage growth in the quarter, across both CSDs and noncarbs.

But obviously the summer was just a bit challenging for the North American beverage businesses, both at PepsiCo and across the industry.

Unfortunately the weather did not help.

But I want to focus largely today on what we can manage.

First, the holiday timing, both Memorial Day and Labor Day did impact our North American beverage volume performance in the third quarter as was detailed in the release.

When you adjust for this timing, volume for Pepsi Beverages North America was essentially flat.

I want to draw your attention to the fact that the Labor Day volume would be in the fourth quarter results.

All in all, we anticipate reporting stronger volume growth in the fourth quarter.

The big question that many of you asked us or written about, is the health of the liquid refreshment beverage category.

Over the past few years, the overall category has been growing approximately 3% a year.

So far in 2004, from all the data sources that we use, it appears that the growth of the category across all channels has slowed a bit to 2%.

The key driver of this modest slow down is the CSD category which appears to be flat to down modestly.

Non-carbs are still growing strongly overall at around 5%.

Obviously PepsiCo's non-carb portfolio is a big advantage given these trends.

It appears to be two timely drivers of the decline in the CSD category this year, and these drivers accelerated during the key summer selling season.

There are tough innovation overlap and category pricing.

Let me discuss each.

Overall the innovation overlap in the quarter versus a year ago was challenging, as we were overlapping 2% CSD growth from a year ago.

For example, Pepsi Edge could not overlap the success of Pepsi Vanilla, and Mountain Dew Pitch Black timing is later in the year than Mountain Dew Live Wire was in 2003.

On shelf pricing also had a big impact as the branded products had approximately 5% price increases this summer.

This represents the most significant retail price increases in CSDs in several years.

As the retailers did not use the category as aggressively as they did last year as a loss leader to build traffic.

Furthermore, private label CSD prices were less than 1% higher than a year ago, despite the impact of higher import costs, and consequently the price gap of branded products versus private label increased.

Now remember pricing was going up across most food and beverage categories in response to input inflation.

In fact, pricing across the food and beverage categories overall is up 4 to 5%, similar to CSDs.

By another measure the 2004 consumer price index for food at home, has increased the most since 1996.

And as you well know, many categories have demonstrated relatively slow volume growth as consumers adjust to the higher pricing.

Overall this was just a mediocre summer given the innovation overlap, significant on shelf pricing and unfavorable weather.

Going forward we are focused on accelerating growth of the CSD business.

In the fourth quarter we will step up the innovation with new Mountain Dew Pitch Black, which is a limited time offering of grape infused Mountain Dew that is already off to a great start.

Pepsi Spice will be available for the holiday season, and we are transitioning our highly-successful Diet Sierra Mist to Sierra Mist Free.

And obviously we will have a lot more innovation in 2005.

One piece of exciting news is the high growth diet segment, is the relaunch of the reformulated Pepsi ONE in the first half of 2005 which contains sucralose.

Overall our bottlers continue to do a good job of managing price points to balance value versus volume, which frankly has become a bit more challenging as private label held pricing.

Now as private label adjust their price to offset input inflation, there is an opportunity to better align the gap versus private label.

And our customer teams, which include our anchor bottlers are already working with our retail partners to build instore branded excitement, behind Pepsi, Dew and Mist, to build traffic into their stores and improve lift during the big promotion.

That is something private label cannot do nearly as well.

Private label groups did not drive category growth nor did it build traffic in retailer stores.

In addition, we are also focused on building our food service business for the big win this quarter in Quiznos.

We intend to remain very competitive in this area, since it offers enormous volume growth potential.

The Pepsi business did have a tough summer overlapping 2% CSD growth a year ago.

You can see we have plans in place to improve future performance.

I would also like to point out that despite soft CSD volumes, Pepsi Beverages North America delivered solid revenue growth of 3%, in part due to the continued mix shift to noncarbs.

Now let me discuss an advantage noncarb business which posted a solid 5% growth.

Gatorade had high single-digit growth.

It was a big contributor to our growth, driven in part by the success of our new sub line, X-Factor, that will continue.

Year to date, Gatorade has delivered double-digit growth.

The brand is delivering big this year.

Our Aquafina water business did struggle in the quarter, as a key competitor decreased prices significantly, but as we said before, we are not interested in chasing profitless volume.

We remain focused on building a sustainable and profitable position in the category for the long-term.

And in the active water category, Perform continues to deliver explosive growth.

Lastly Tropicana.

The Tropicana juice drinks introduced into the bottler system, continues to exceed expectations and demonstrates the breadth of the Tropicana brand, extending on noncarb leadership.

Our chills Tropicana juice business did grow in a sluggish category, continuing to gain share, but a bigger issue is the impact of the hurricanes on the orange juice business.

Tropicana is working through some short term product supply issues, and the team is doing just a great job in working through these challenges.

Going forward, the current crop has been significantly impacted, and we anticipate upward pressure on orange costs, especially lapping the big harvest in 2003.

Perhaps there will be some better price realization across the category, to offset higher raw material costs that will face all participants.

All in all, next summer, fewer hurricanes and warmer days would certainly be welcome.

Let me take this opportunity now to update you on the outlook for our other key raw materials.

As I have mentioned before, costs for our top ten raw materials will be roughly flat in 2004 across our North American businesses.

Which is a testament to the wonderful work of our procurement team, given today's inflationary environment.

Now within the divisions on a full year basis, Frito-Lay North America is experiencing some cost pressures driven by oil and energy costs, and this has been offset somewhat by slightly favorable costs at Pepsi Beverages North America.

Looking out to 2005 as I mentioned, we expect the hurricanes to impact orange and grapefruit prices.

For the balance of our top ten materials, we again expect to achieve roughly flat cost performance with productivity offsetting inflation.

And contrary to this year, we will probably see PBNA with some input cost pressures driven primarily by PET prices, and Frito-Lay North America showing some overall raw material improvement, driven by vegetable oil and potato costs.

This wraps up my comments on the division.

Let me now quickly turn to the financials below the line.

Our cash-flow performance which was excellent, and our balance of year guidance, before I turn it back to Steve.

Let me start with the two pieces of information that were news to everyone today.

The third quarter non-recurring tax benefits and some more details of the Q4 manufacturing consolidation.

As the release indicated, included in the tax line this quarter are tax benefits of $221 million, or 13 cents a share.

The large majority of this relates to foreign tax reserves we had established for items that have now been resolved in our favor.

The balance principally relates to an additional refund claim, related to last year's IRS settlement.

Neither of these has an immediate cash impact.

The refund claim will be used to offset future tax payments.

The plant consolidated free tax charge is expected to be about $160 million, or 7 cents a share; again, this is an approximate number, as we are finalizing the numbers as we speak.

The majority of this cost is noncash, and represents writing off the assets that we are retiring or disposing.

The cash portion of this charge will be made up principally of severance costs, and is expected to total approximately $55 million.

I expect that more than 90% of costs will be incurred in Q4 and this action has no effect on our Q3 reported results.

On a reported basis as we said in our release, Q3 division operating profit was up 11%, reported EPS was up 36%, and excluding the tax benefits EPS was up 14%.

So we got 3 points of leverage from the more customary sources, the lower effective tax rate, and from shared repurchase leverage.

And we got 22 points of leverage from the non-recurring tax rate.

Let me now touch on some of the items below the line, and update you on our outlook where it's appropriate.

Corporate unallocated costs were up $27 million for the quarter, primarily driven by pension costs, which is actually a bit better than we had anticipated when we spoke to you at the end of Q2.

On a full year, as we told you at the beginning of the year, we expected corporate unallocated costs to increase by about $100 million for the year, as a result of pension costs which increased $75 million, and our business process transformation investment.

Year to date, corporate and allocated is up 118 million, so in Q4 you should expect to see a reduction of anywhere from $10 million to $20 million, and this is driven by lapping of our foundation funding in Q4 of last year.

Net interest expense for the quarter was down slightly and was driven by favorable rates year on year and higher cash balances, offset somewhat by higher average debt balances.

The reported tax rate for the quarter is 16.5, but that includes a 13.5 point reduction from the discrete tax benefits this quarter.

If you exclude the impact of the tax benefits, the rate for the quarter is 30% and for the year-to-date is 29.7%.

Excluding the tax benefit, we now expect our full year rate to be about 29.7%, which is 20 basis points higher than the rate we were accruing to, through the end of the second quarter.

Our YTD rate is at our expected full year rate again, excluding the impact of the non-recurring tax benefit.

You will find the reconciliation of the tax rate attached to this morning's release.

On share repurchase.

We got over a point of leverage in the quarter from share count.

Our weighted-average diluted shares decreased by 18 million shares from Q3 of 2003, and decreased by 16 million shares sequentially from Q2 of this year.

Our basic share count is down, the number of options outstanding is down, and the dilutive impact of options outstanding was lessened somewhat versus Q2 of this year, as a result of the decline in our average stock price during the quarter.

Again there is a schedule attached to the release that lays all of this out as well.

Turning quickly to cash-flow, I'm very pleased with our performance for the first three quarters.

Our management operating cash-flow which includes capital spending is up over 12% YTD.

And is a function of the solid operating performance and the focus we have placed on working capital management and capital spending efficiencies.

Year to date, we have generated over $3 billion in cash from operations less net capital spending, about 344 million from net borrowings and 846 million from options exercises.

Of this we've used $28 million in acquisitions, returned $3.4 billion to shareholders. $940 million through dividends, and almost 2.5 billion through share repurchases.

And for the year, we expect to repurchase approximately $3 billion of shares.

I should also add, that on September 15, we contributed $400 million to our U.S. pension plan, which is right in line with what we had anticipated going into this year.

And this contribution is targeted to achieve our objective of maintaining our plans fully funded status.

Given the strength of our cash-flow for the first three quarters, we now expect to exceed our full year target of $3.4 billion in management operating cash-flow, and this is after we cover the cash costs of the Frito-Lay North American restructuring.

Finally, a few comments on our full year guidance.

We've been pretty consistent with our full year EPS guidance of at least 2.29.

As you saw in the release this morning, we have revised this guidance upward by 6 cents, to at least 2.35 on a reported basis.

This revision for the full year takes into account the 13 cents from the non-recurring tax credits this quarter, and the 7 cent restructuring charge we anticipate in Q4.

The strength of Q3 certainly makes us feel more confident than ever in being able to deliver on this.

As you build your 2005 models, however, you should base your numbers off of 2004 that excludes the 6 cents from non-recurring items.

Now I'm aware that some of you have been a penny or two ahead of our guidance, and I will deliver a penny better in Q3.

However, I would caution you against taking your estimates up on an operating basis higher than the current consensus.

As our Q4 overlaps are challenging, particularly division operating profit overlapping almost 15% growth from last year, and particularly in Pepsi Beverages North America, where the profit growth was 26% in Q4 of 2003.

So in summary, I'm very pleased with our financial performance.

Taken as a whole, operating results across our portfolio of businesses is balanced, consistent and solid, and cash-flow is robust.

As we close out 2004 and enter 2005, I think PepsiCo is stronger than ever.

Let me now turn it back to Steve.

Thank, Indra.

Just two quick final comments before we open up to questions.

I want to update you on PepsiCo's most recent developments in our corporate-wide health and wellness strategy.

That is the Smart Spot initiative that we announced in August.

We want to make it easier for consumers to find better for you, good for you product alternatives, through the use of our Smart Spot labeling.

We are transitioning to these new labels right now, and you will start to see this in the stores soon, as we outlined in the release a few weeks ago.

This is just one more step in our long journey to expands the nutritional choices of our product line.

And secondly we are not ready today to provide any new guidance on 2005, since we are just completing our planning right at this point.

However our North American businesses are outgrowing the sluggish retail environment, and the years of investment that we've made in international are truly paying off right now.

I believe that PepsiCo's portfolio is stronger than ever, and it gives me confidence that we will be able to continue to deliver our long-term algorithm.

Just to repeat that algorithm in terms of expectations for 2005 and beyond, we are looking for mid single-digit volume growth, mid single-digit revenue growth with a spread to volume, and low double-digit EPS growth.

So with that let me open up the floor to questions.

Thank you. [Caller Instructions] Our first question comes from Jeff Kanter.

Sir, you may ask your question and please state your company name.

Prudential Securities.

Good morning everybody.

Steve, I know that you're unwilling to talk about 2005, but there are some concerns about how you're thinking about the year with respect to what your competitor on the beverage side may do given their thoughts that they may go for a little bit of volume here.

Given that context, can you let us know how you're thinking about the competitive landscape on beverages, how you're thinking about that space?

And also this $160 million, what type of savings are you expected to get from these closings and does that give you flexibility to get a little more defensive in the CSD category, if necessary?

Thank you.

Thank you, Jeff.

I'm not unwilling to talk about 2005.

I'm just not ready to give you specific numbers.

Fair enough.

First of all I think we are managing this business as I think you've seen over the past several years as a portfolio and we are going to invest in those businesses where we think we need to invest for the long-term growth.

And that is what we've been doing and that's what was actually part of our announcement today was all about that, as we talked about investing in Frito.

And there's no question, we've got our ears open to hear what's going to be happening in the next few weeks on the beverage front.

We certainly have some thoughts about that.

And we clearly will have some savings from the investment that we are making in Frito-Lay.

But I would just say that the long-term guidance that I outlined, is what we would expect for 2005 and how that comes together in the portfolio is something that we will have a better view on in the next few weeks, and the next time we are together we will probably provide a little bit more guidance there, maybe not as much, Jeff, as you'd like but we certainly understand the question and we think we have the flexibility to continue to manage the portfolio for the long haul, and make the investments where we think we need them.

So if things get a little competitive in CSDs, you feel like this double-digit earnings growth, that the P&L has enough flex that you are going to hit this double-digit earnings growth potentially?

Jeff I would say again that we feel very comfortable about the portfolio and the ability to manage the volume and the EPS number, and specifically the EPS number in the low double digits.

Thank you very much, Steve.

Thank you.

Bill Pecoriello, you may ask your question and please state your company name.

Morgan Stanley.

Good morning, everyone.

My question is in North America with many of the CPG companies are stepping up market spending pretty significantly, it could be Coke directly in your category, but we are also hearing many of the other players in adjacent categories with significant step newspaper market spending, a lot of company's chasing the same display space and retailers.

You couple that with the food retail environment where you had mentioned they were cutting back in some investment in your categories, with the elasticities, what is PepsiCo doing to address these challenges, with the rising cost of doing business and the realities of the pricing power and the elasticities in the category to adjust things going forward?

Bill, we think that the constant focus that we have against both the top line and the bottom line allows us to make the kind of investments that we need to, to continue the long-term health of the business, and the investments like we are making today in Frito,and investments we've been making allow us to come back and spend in those categories where we think we need to.

And clearly we are conscious of the importance of building brands and building brands cost money, and we feel like we have prudently invested in those brands and sometimes from year to year we may shift a little bit of that spending from one set of brands to another.

But overall constant, consistent quality investment in our brands is what our Company is all about.

So we don't think turning it on and turning it off is good, but we do know that from time to time we have to make shifts in that focus.

Can I answer that, Steve?

This is adding to what Steve said.

A couple of areas that we are really focusing on, as Steve said, besides investing in brands, we are also doing a lot in the area of innovation, because we realize that news drives all of our categories, and to really win against this cut edge marketplace, we really have to make sure that our news speaks to the consumer a lot more.

We talked about our increased focus in innovation and that's going to continue through 2005.

But the even more exciting thing we've been doing is working at the retail shelf to see how we can break the zero sum game on the shelf and make sure that we utilize the shelf space we have very efficiently in all of our categories which have very high velocity.

The biggest issue we have had is our out of stocks in our category, and with the launch of hand-held Three and Frito-Lay I think we are doing a lot to reduce out of stock so we can actually improve our sales, from the shelf space we already have.

And the third area is Steve gave you an update on our Smart Spot program.

I think the whole health and wellness focus and the launch of the Smart Spot is actually going to allow us to get some additional space in the shelves in the stores so that we can get our products out to consumers in an even more thoughtful way, as they focus on their health and wellness needs.

So overall taken together, we recognize that the retail environment is cluttered but with a combination of investment in brands, our innovation focus, and what we are doing to improve our execution at the shelf, I think we've got the right programs in place.

And, Gary and Dawn, do you want to?

Yeah, Bill, I would just say as good as our marketing has been historically, we are significantly raising the bar in terms of the effectiveness, the vehicles that we use, the power of particular programs, be them promotion, advertising, that we will have in front of the consumer.

So not only are we investing the resources against it, but those resources should be even more productive as we look ahead into next year.

Hi, Bill, the only thing I would add too, is this has been a strategy of ours over time, so we haven't had Ying/Yang years where we have pulled back, we have continued to increase our marketing investment because we believe it is absolutely core to our business in driving our brands, and therefore we will continue to do this going forward, and it is a continuation of what we've done over the last few years.

Thank you.

Thank you.

Caroline Levy, you may ask your question and please state your company name.

UBS, good morning, everybody and great quarter.

I just, I wanted to know how many Power of One activities there will be in this quarter, versus last year, and how it might play out in '05 if you are planning to step up the number of those sort of activities.

And also wondered if you can comment on what you think the appropriate price gap to private label is in beverages?

I think it's around 38% in IRI right now.

Well, thank you, Caroline.

Let me start with the first one, and then Dawn, you want talk about the second one.

The Power of One is more than just what we talked about a few years ago, where we would talk about doing promotions together with, between Frito-Lay and Pepsi.

We are now including all of the businesses.

So you think, it's like the breakfast bundling that we've done this past month, primarily around Quaker, but including all of our businesses, is one example, but probably a more powerful example is the Power of One teams that we are doing against our retail customers, and really this is taking the Power of One to an all year 365 day program, rather than just a few discrete events during the course of the year.

So it's a little difficult to answer your question because we can't quantify that coordinated activity in each one of our retailers.

But the largest retailers in all of our channels are now being led by Power of One teams that are doing coordinated activities on a constant basis.

All that said we still have the standard major holiday programs, we have the Halloween coming up, and we are planning the Superbowl and the standard ones that we've talked about in the past.

I don't know, Gary, if you want to add anything to that before Dawn talks the second piece, but this idea of Power of One activities, I think is what Caroline's question is.

I think it's one of the biggest competitive advantages that we have and we are learning how to get that leverage more and more across all of our businesses and even beyond just the Pepsi and Fritos side.

You can take it into the Foods business, the bundling of our food products and Tropicana has been extremely successful.

And is in large part responsible for the good results we've had in Foods this quarter.

Hi, Caroline, let me respond to your question regarding private label, first by making a comment in the totality regarding private label in the beverage businesses.

First of all relative to other categories, private label continues to be small, about 4.2% of the total beverage category, and 11.5% of CSDs, which is in line with the history that we've had in the category.

Again our point of view obviously on pricing, is the gap is important, our bottlers are expert with many years of experience in watching that gap, and focusing on making sure our branded products and services are value to the consumer.

Obviously we have had raw material price pressures and the private label manufacturers will have those as well, and we are starting to see that in the marketplace.

But what's most important to us, is focusing on growth in the category comes from branded products, putting branded products at good retail feature prices on the front page is what drives category sales, and what drives traffic into our food customers.

And this is what we are really focused on going forward.

Thank you.

Andrew Conway, you may ask your question and please state your company name.

Hi, Steve and Indra.

CSFB.

Steve, looking out a little bit to '05, strategically with the Frito-Lay North American business, you've continued to be very proactive at managing cost structure with incremental productivity savings and costs fairly benign, any strategic tweaking of how you are going to balance revenue per pound and volume in light of the terrific pipeline of innovation you have, how should we look at the constant focus on being competitive and getting the right products to market?

Andrew, I think it's probably a little early to be giving specifics about '05, but we think that the focus that Fritos has right now on the salty business is very effective.

We are very pleased with the performance of the salty business at the top and the bottom line, and I think that in the new year we will start to see a continued improved performance on the convenience food side; which will obviously be beneficial to the overall business at Frito.

But in terms of changing the strategy on the salty side, I don't frankly see a lot of major changes going forward in that area.

Thank you.

Thank you.

John Faucher you may ask your question and please state your company name.

Yes, JP Morgan, good morning, everyone.

Wanted to ask a quick question about promotional levels, in particular, are you seeing a dramatic shift in your promotional prices, particularly in terms of, feature and display activity, relative to your every day prices, and if that is the case, how much farther do you think the retailers wants to move promotional price points up, in terms of maybe limiting some of their margin losses?

I guess the question is, is that what you're seeing and if that is, how long do you think this continues and how much farther do we have to go?

John, it's Gary.

Clearly this is a balance that we are constantly managing across all of our businesses, and I think we have it under pretty good control, obviously delivering the right price value, and the right interesting promotions for our retailers is critical, but we also take a great deal of care across all of our businesses to manage the revenue.

The revenue mix, and we can do that with different packages across different channels, different products, and that enables us to be somewhat competitive, more competitive than you might think otherwise because we are able to do that blending.

I guess the question is, though, are you seeing on the retailers side, are you seeing a change in how they are handling these things and if so do you think that continues?

As opposed to your response?

I think the retailers are, the grocery retailers in particularly, are obviously looking to a high/low strategy, to combat the unmeasured channels, and that's a fairly difficult proposition and it's important to us to spend the resources where we get the most bang for the buck.

John, I'd also say I think the retailers are more than ever looking to the supplier community to come in with recommendations, of strategies that work for their particular individual strategies for their companies.

So we find that our, particularly our Power of One teams being an important part of our retail partners, development of their individual strategies on promotions and on product introductions, and basically on all aspects of the business, in a way that probably is a higher level than we've seen in the past.

And I don't see that changing and I think really it manifests itself differently in a high/low customer than it does in an everyday low price customer.

But I think our role as a supplier, is to help the retailer come up with the right set of programs to meet their strategic direction, and I think we are doing a better and better job of that, and that's really one of the major benefits going back to Caroline's question, of the Power of One teams, is we have the functional resources on each one of these teams, to go in and solve the strategic challenges that each individual retailer has and that's where the value-added is.

Okay.

Thanks.

Thank you.

Nick Booth, you may ask your question and please state your company name.

Yes, Wellington Management.

Indra, a question on leverage.

It would appear that you have more room for leverage on the balance sheet, and I know you've raised the dividend sharply.

Any feeling about accelerating the share repurchase pace?

At this point, Nick, we are using all the cash that we generate to buy back shares and pay dividends at a higher level.

There's no plan at this point to do anything beyond using our cash that we generate, to return it back to the shareholders with dividends and share repurchases.

The only time we may borrow money in the United States is against international cash balances.

And that's the only strategy that we plan to deploy next year.

So you're satisfied with your debt levels now?

Yeah, we are absolutely satisfied with our debt levels.

Okay.

Thank you.

Thank you.

Bonnie Herzog you may ask your question and please state your company name.

Good morning, everyone, Smith Barney.

I would like to go back to something that's been talked about a little bit, which is the retail price environment.

I'm trying to get a better understanding of exactly what is going on at retail in terms of the CSD pricing.

Indra, you did touch on this in your opening remarks, but I would like to better understand what exactly the retailer is doing in your opinion, with the higher prices that the bottlers are taking, do you think the retailer is taking margin or is the retailer just passing on the bottler price increases?

I basically get the sense from PBG that the retailers are not taking margins.

What do you expect to happen in the future as relates to pricing and retailer actions especially given your take on the economy right now.

Thank you.

Bonnie, Dawn Hudson will answer this question.

Bonnie, first of all obviously how you look at pricing in the retail environment, wether it's feature and display, gondola, how it's mixed is very, very complicated.

But I think it is true that the bottlers have experienced raw material cost increases, have passed on those costs.

Our grocery retailers in particular are under a lot of economic pressure themselves, and so they are looking for opportunities for price.

Buy when you get into the exact details, it's very, it's an Art, it's very detailed and difficult to look at exactly what's happening.

But let me give you my perspective when you look at this summer, where we saw the slow down, and particularly look at the Fourth of July, where relative to past performance, some of the retailers did creep their feature prices up, and the result of this was an -- and at the same time they took the higher retail prices and said I am not going to put CSDs on the front page as much.

I am going to move them into the middle of the circular.

And the combination of those two factors, particularly taking away front page features, caused softness in the category at an accelerated rate, and caused traffic softness.

So I don't think it's a strategy well played with that's going to sustain for either branded companies or for retailers.

See going forward we would expect some other things to be looked at, well fundamentally there being raw material increases that need to be handled in the pricing of our products.

Thank you.

Thank you, Mark Greenburg, you may ask your question and please state your company name.

Deutsche Bank.

Good morning, my question relates to the future growth of Pepsi International by geographic region, the opportunities for margin improvement in the international beverage business.

First within Asia, can you discuss some of the factors that are driving such high Asia growth, and at some point do you feel that consolidation of both bottling and distribution into one larger bottler begins to make sense?

And secondly but somewhat related, can you give us an update on the operating margins for the international beverage business relative to those within North America?

And perhaps quantify what it means in dollar terms as you close this gap.

Thank you.

Let me take the first part and Indra you want to pick up the second piece.

Clearly Asia is a very important focus of our attention right now and for many years to come.

We think there are a couple of things happening simultaneously, all positive at this point.

The economies of those countries, many of those countries, is very favorable.

And the investment that we've made over many years in our people, have come together to give us the kind of leadership that we need in that part of the world to take advantage of the growth opportunities.

And we've invested in growing these businesses in India, China, primarily, but in other countries as well, to the point where we are starting to get some real scale and some momentum behind us.

So I think if you combine the consumer with our capabilities, I think that's why we are seeing the kind of results that we are seeing now.

And frankly I'm very optimistic that this will continue going forward.

And as far as consolidating, I think, Mark, you were talking primarily about consolidating the bottlers.

There really isn't any plan afoot right now to do that.

We think that the way we are set up is pretty effective and we are getting good results.

And frankly, in a growth area you really want as many people going after that growth as you can, as focused as you can be, and I think that's what we are getting.

So we really have no intention at this point to make a change to that environment.

Yeah, Steve, building up on that point, if you look at the growth in China which is in the double digits, solid high teens and India is also at that rate, to put it into an anchor bottler in that region, Mark, and there is only one person that can be the vehicle today unless we create a new one, the financial resources required cannot be generated in the equity market there at this point.

So we are going to have to step in and help India and China get its growth rate.

So our plan is to keep over the strategy we are on right now for those two big group markets.

As for the rest of the region, I think the bottling partners we have there are pretty good.

We have some decent positions in some of the markets, and more meaningful positions in markets like Thailand, where where we have good bottlers,and our plan is to just stay with that bottling strategy, so as Steve said, there is no roll-out strategy that we have planned at this point.

Let me address your question on margins.

Between 2003 and 2004 Q3, margins in international have improved over 200 basis points, and we've had tremendous productivity improvement and volume growth that has flowed through to profit improvement.

And as long as our businesses keep performing and leveraging the scale has already been built, and the infrastructure that has been put in place in many markets, I think will you continue to see steady margin improvement.

Now, coming to the margin levels in North America, clearly margins in North America and countries like the U.K., reflect highly developed economies, and if our entire international portfolio gets to that highly developed economy type of per capita growth, we could reach the margins of North America.

I think that's going to be many, many, many years in the making.

And in the interim what you are going to see is, the developed market like Walkers and Sabritas could get to the North American margins, and all the other countries will slowly creep up to the North American margins over the next decade or so.

But overall what you should expect is a consistent and steady improvement in the international margins, barring any unforeseen macro economic shakeup like devaluation of currencies.

So we feel pretty good about international prospects at this point.

Before we go on to the next question I would like to jump back to Bonnie's question and maybe some of the thoughts that were embodied in some of the other questions too, and that has to do with the retail environment.

I think a lot of us are trying to understand what's going on in the retail environment.

And it is confusing.

And I'd say, just to give you my perspective and maybe Dawn and Gary and Indra, might want to chime in as well, because I think it's tough to read but there's two or three things that I think are true and I think you are probably hearing it from a number of companies.

First there is a skittish consumer out there.

It's hard to read because it has between May and September, the patterns have been very, very unusual.

I don't know that they represent the future, but I think they have been unusual.

Secondly, and I think probably the biggest single thing that's causing problems, is this shifting in channels.

And the measured channels as we've known them in the past are getting to be a smaller and smaller factor in understanding what's going on with the consumer.

Because there's just not enough information in these nonmeasured channels to be able to make the kind of reads that we've historically been able to make, and I think you can see that in our numbers.

If you take the measured numbers versus our reported numbers there's a dramatic difference.

So clearly that shift is having an impact.

And lastly, I think there's an aberration in the beverage performance this summer that I think has made it even more difficult, particularly in our business, and that aberration is caused by several things, but a couple of the reasons are the weather, I mean we've had a cooler summer by almost any statistical measure it's been one of the coolest summers in a long, long time.

We've had a wet summer and those two things make a big difference in the consumption of beverages.

Secondly, the pricing is certainly a factor.

We've talked about it.

It's somewhat difficult to understand as Dawn talked about, and thirdly the innovation overlap in the segments of the beverage category has made the summer difficult.

So I don't think you can read too much into the beverage summer as the future, although obviously you and we and everyone else is watching it very closely.

So those are a few thoughts that I have, Bonnie, just to add a little color to what I think was your question.

Gary, you might want to add something?

Just one last point.

The price of gas is critical for our beverage business, because we sell so much in what we call our cold channel and the dramatic change this summer versus year ago, clearly leaves people with less change in their pocket to go in and by another Mountain Dew.

So that can't be discounted enough, and it's really a pretty big delta for people.

Bonnie, is that closer?

Move to the next question, please.

Thank you.

Robert VanBrug -- one moment while we locate Bonnie.

Ms. Herzog , your line is open.

Our next question comes from Robert VanBrug.

You may ask your question and please state your company name.

Good morning, Sanford Bernstein.

A question about the Quaker snacks.

Obviously it's been a tough year this year with lapping some of the introductions from last year.

What gives you more confidence that the new product introductions that you brought to market this year will be more successful than the ones from last year?

Well, Robert, we had some issues with two primary products, the Crisp'ums and the Toastables, and the overlap of that is moderating through the balance of the year, and we are going back on the short term to focus primarily on the light snacks and on the bars.

And that's really where our emphasis has been over the past quarter and as Irene gets closer into the business, I'm sure she is going to have more to say in the coming months about the future of the Quaker snacks and the convenience foods.

But on the short term we've got plans in place, the management team has plans in place, and we are starting to see the benefit of those plans, in both the overlap of the products that didn't work as well as strengthening of key brands that we think have future potential.

Okay.

Thanks.

Thank you.

Mark Swartzberg you may ask your question and please state your company name.

Legg Mason, Steve, that commentary you just gave was very helpful and I wonder if we can probe a little bit more on the channel shift.

It seems they have accelerated in calendar '04 year to date, relative to a trend that I think we all know, has been in place for while.

As you look out at your, and I'm really focused specifically on Frito-Lay North America, as you look out at your gross margin prospects for that business in particular, given these channel shifts, is there incremental pressure on that particular line of the P&L, and if there is, does that impose incremental burdens on you from a productivity standpoint to get to the same absolute level of operating margin outcome?

And related to that, how, Gary, I think you might have alluded to in talking about beverages but it seems like obviously you are going to be changing or are changing the dollars spend against a given channel.

Can you give us a little bit more insight on how those particular decisions are changing?

Mark, it's a good question and I would say that the real key to this margin, I mean channel shifting maybe accentuates it, but the key focus is on innovation and building the brands.

The channel shifts actually give us more opportunity to focus our innovations, specifically against channel needs, because as you look across the channels those consumers, many times they the same consumer at different occasions, have different needs.

So if we can get innovation that works specifically against the customer in that channel, then we can realize the kind of margins that make the business work.

So frankly our margin in Frito-Lay this year we are quite pleased with the performance of our margin and margin enhancement programs.

And clearly productivity is a part of that, innovation is a part of that, market is a part of that.

And good customer selling is very critical.

So you put all that together and we are very optimistic that we can maintain the margins in the Frito-Lay business going forward.

Gary, I don't know you in want to jump in on the money piece, the dollars spent.

Again, we are, we are looking to put the money behind the places where we can get the most return on investment, and I would say we are doing a better job than we ever have in terms of running the business, not just channel by channel, but customer by customer, so our folks are not just looking in a big broad way across the whole country.

They are very knowledgeable about what is it going to take to do it right at Kroger on Gatorade this quarter.

So that kind of a focus against the customer and the focus on the particular products for specific accounts, is really a return on investment mentality that I think has really taken hold.

I think what Gary is saying and I would certainly accentuate it, as it relates to all the businesses, is the days of just putting a program out across the entire business with a standard deal, those days are gone.

They are not effective.

They don't move product.

They don't help our customers.

They don't sell our products.

Really what it takes is individual customer by customer programs that are tailored to those individual customer's strategies, with their appropriate spending to make those programs work.

It's a lot of hard work.

It's tough.

It takes a lot of planning.

It takes skilled people who know the business, who know the customers, who know the consumers, but it really does pay off, and I think that's what the future is going to be in terms of spending.

And it sounds like implicitly, Steve, you're, specifically on the gross margin line, the ability to drive mix through the combination of package, channel and so forth, the level of gross margin opportunity you see out there for your SL&A businesses, is pretty much what you might have seen three years ago, recognizing that the environment of course is going to be different in the future than it's been in the past?

Well, Mark, I absolutely agree with that, and if you start with the premise that we have a great margin for for the Company, we also have a fabulous margin for our customers.

Our business is very profitable for our customers.

So for them to grow the margin that we already give, and to be aggressively supporting that kind of growth is very helpful to them.

As we have talked about many times before, PepsiCo in our total portfolio is the most profitable supplier that most of our customers have.

So to work together to find ways to move that product at the existing margins is a very profitable proposition for the retailer.

Thanks, guys.

Thank you.

Christine Farkas, you may ask your question and please state your company name.

Merrill Lynch, good morning Steve and Indra.

My question has to do with Frito-Lay.

The profit growth in the third quarter improved by about 100 basis points it looks like from the second quarter, despite tougher profit growth comps.

If we assume continued cost pressures in commodity costs in the quarter, can you quantify what was the big driver, how much of that improvement came from productivity or improvements in macro snacks, the channel shift, the price mix or other SG&A items?

And on the back of that, Indra, you mentioned I think that the year over year outlook for Frito-Lay's costs could be improving in '05.

Is this based on your outlook for commodities or actual hedges that are in place?

Thank you.

Well, Christine, let me target the first part and then Indra can pick it up.

I would really say, Christine, you answered the question by all the items that you mentioned , because it wasn't one single change.

It was really good management by the Fritos team on a number of issues.

So it would be -- I couldn't even on the top of my head, think among those that you mentioned, which one had the best contribution to our improvement.

I think it was the combination of all of the items that you mentioned.

And in terms of commodity costs, Christine, our outlook is based on largely hedges in place.

So at this point, we are comfortable that the year over year Frito-Lay commodity costs will be slightly down going into 2005.

Thank you.

Thank you, Eric Katzman, you may ask your question and please state your company name.

Hi, it's Deutsche Bank.

I want to follow up on the question that Marc asked earlier.

As international becomes a bigger piece, and I think you've been kind of letting the investment community know that it's becoming greater in scale, I was wondering if maybe longer term, you could kind of frame it for us from a financial perspective, meaning do you have the opportunity to lower your tax rate as international becomes more profitable?

Does capital expenditures have to change or can you move, let's say, what I assume is written off assets off of these plants that you're closing overseas, does that affect CapEx in total, just kind of what a consolidated perspective growth in the international business means?

Let me paint a top line picture, and then I would like to get Indra to dig down a little deeper.

As we've said before, we didn't say it today but we said it in the past, we really expect our international business to grow at least twice as fast as our North American business.

And we don't see a reason why that shouldn't be the case.

Now we are going to do everything we can to support that kind of growth and we will do, we will support it by moving assets like you mentioned and other things, but that's not the primary objective here.

The primary objective is that we have a very good business with growth potential in the North American operations.

But we have a huge population that we don't serve outside the U.S. which we see as a major growth opportunity.

And we are in several categories which we think transport very well with a management team that has been in development for many years.

So we think that this international growth is going to be done prudently.

We understand it, as we've been at this a long time, it's not easy but we do think we have the team to do it and we are very optimistic about it.

Let me turn to the sort of financial algorithm for international.

If you get get a chance again, to go in to the website, Eric, and look at Mike White's presentation from the conference, let me take a slide from his deck and summarize it for you.

I've talked about the fact that the international profit margin in Q3 versus last year and if you want to look at the long-term trajectory for PepsiCo International, Steve talked about double the rate of the U.S. operations.

I just add that double the rate was sort of amid double digits as the floor because I think that's sort of the range of profit growth that we would expect from PepsiCo International.

Let me break that out just a little bit more.

As you know the PepsiCo International business is both the international beverage business and international snack business, and within beverages there are franchise operation and company owned bottling operations.

The franchise operations are about 10% of PepsiCo international's revenues, and the margins consistent with franchise operations is extremely high.

As you get to sort of the Big 3, which is our Sabritas, Gamesa, and Walkers, it represents about 40% of PepsiCo International's revenue, and current margins are slightly above 20%.

Then you've got the whole range of developed economies, like western Europe which represent about 25% of PepsiCo International's revenues, and again the margins that are above 10%, and the long-term profit growth expectation is a double-digit profit growth there.

While for the first two categories, it's sort of a high single-digit profit growth expectation.

Emerging markets represents about 25% of the revenue of PepsiCo International today.

The current margins are less than 10%.

And we expect long-term profit growth in the high double digits.

And with G&A growing slower than sales, we think total PepsiCo International can sustain profit growth in the mid double digits and above that.

Now regarding Capital expenditures and cash-flow.

This year alone PepsiCo International would deliver about $1 billion of cash flow just from PepsiCo International operations, and franchise operations clearly don't require much capital expenditures, and in terms of all of the other markets, what the PepsiCo International people have done a very good job with, especially in the snack business and the beverage businesses where we have company owned operations, they have really gone in for a lower cost capital expenditure algorithm where they source the materials locally and they figure out how to build lines, and how to execute operations with lower cost capital.

Not compromising on quality, not compromising on our global standards, but they do it in a much more capital effective way.

So as a consequence I think from an ROIC perspective they are over 20% already with a lot more upside potential in the years to come as Mike discussed in his conference.

So we feel very good about the prospects of international.

That's very helpful.

Just one follow up, again, related to the finances in international.

The, a few quarters ago I asked about the NOLs on the, I think it was several billion dollars on the books.

Were most of that international in terms of losses you've incurred in the build up stage and did those then kind of go the other way, and add to deferred tax benefits going forward?

Matt McKenna, our Senior Vice President of taxes is right here will take the question.

Eric, most of those NOLs are for state tax purposes not international tax purposes.

Okay.

Alright.

Thank you.

One follow up to your question and also an earlier question, in terms of the margin in the international business, we are pleased with the profitability in margin improvement in international, and as you'll notice from our current quarter that we moved up almost 200 basis points in our margin.

And as we look at our businesses individually and they start replicating the kind of scale that we see in our North American operations we have targets that we expect that we could eventually reach, and we are starting to see that -- we are continuing to see that kind of improvement around the world.

And that gives us that opportunity to have a wider spread between our revenue growth and our profit growth, because of that expanding margin which we think will be slow, steady improvement over the years.

Thank you.

Thank you.

Alec Patterson, you may ask your question and please state your company name.

Yes, RCM.

Just on the international beverage area, fighting from a position of not always close share comparison to Coke, how have your share trends evolved over this year, say, on a value share basis across these three major regions?

Alec, we are proud to report that in every country international beverages we have gained share.

In Latin America, in the Middle East, Africa region, western Europe and Asia Pacific.

And that trend, based on innovation and execution seems to be continuing as we speak.

Is that primarily in the noncarbonated area, how does it break down between CSDs and the rest of the business.

I'm talking about shared growth in CSDs, it has been pretty impressive across every region of the world, and every country, I may add.

And in particular in Germany, you highlighted that as an area which has been a problem for Coke and obviously for everybody.

What are you doing differently there?

How do you see that evolving?

First of all I'll start by saying we have a very small business in Germany.

We are less than 10 share of the market.

It's profitable for us.

We've made good progress there.

We are very pleased with the German team.

We are making progress in all the channels.

The heart discounters and the other channels as well, but it is off a very small base.

It is improving and we are quite pleased and we think there's a number of years of continued improvement available for us in that market.

Okay.

Also just for Dawn, I don't think she answered Caroline's question directly about the price gaps with private label.

What are those price gaps currently and what is the comfort zone on that?

Again, I would say our bottlers have the core expertise in this area and you can't generalize across all package,s but they are in the vicinity of mid to high 30% range and traditionally they have been between 30 and 40, and as private label manufacturers have to handle their added cost increases, we think you are going to see that come down, but again in the long-term range that they've always been.

Great.

Thank you.

Thank you.

I would now like to turn the call over to Mr. Steve Reinemund for any closing comments.

Thank you all for sticking with us.

I know we've run over a little bit.

We wanted to take all your questions and we are happy to be able to talk about the quarter.

Let me just close by saying that were we are very pleased with the third quarter, but we are also very optimistic about the future.

I think that the momentum we have seen this year, we have no reason to believe it won't continue.

I know there's been a lot of questions about 2005 and we haven't given you the specifics for 2005, because we are still working on them.

But I would want to make sure that you leave with a sense of optimism that we have about the future, and that the long-term guidance that we've talked about for a number of years now, we are very committed to and we feel comfortable with, as it relates to 2005 and beyond and that is, just to repeat it for the sake of clarity, that we believe that the mid single-digit volume growth, the mid single-digit revenue growth with a spread to volume, and low double-digit EPS growth is something that you should expect from us next year.

We are certainly expecting that from ourselves.

So with that, let me close and say thank you for your attention this morning.

And we look forward to talking to you again at the end of next quarter.