百事 (PEP) 2005 Q3 法說會逐字稿

Good morning.

Welcome to the 2005 PepsiCo third quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS].

Today's call is being recorded.

Please note the Company's cautionary statements: This conference call includes forward-looking statements based on our current expectations and projections about future events.

Our actual results could differ materially from those anticipated in such 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 website at www.PepsiCo.com under the heading: PepsiCo Financial Press Releases, to find disclosure and reconciliation on non-GAAP financial measures that may be used by management when discussing PepsiCo's financial results with investors and analysts.

I will now turn the call over to your host, Mr. Jamie Caulfield, Vice President of Investor Relations.

Sir, you may begin.

Thank you, operator, and thank you all for joining us this morning.

Welcome to PepsiCo's third quarter 2005 earnings conference call.

Today's webcast includes a slide presentation that can be accessed at our PepsiCo.com website, and as the operator mentioned it's also being recorded and will be available for 90 days.

On this morning's call are Steve Reinemund, PepsiCo's Chairman and CEO, and Indra Nooyi, PepsiCo's President and CFO.

Following Steve and Indra's prepared remarks, we'll be glad to take your questions.

Our expectation is to conclude this morning's call by noon at the latest.

It's now my pleasure to introduce Steve Reinemund.

Thanks, Jamie.

Good morning, everyone.

I appreciate the opportunity to discuss our third quarter results and our outlook for the remainder of the year.

But before I begin our business review, let me just comment on the recent hurricanes.

The storms that hit the Gulf Coast affected all of us in one way or another.

However, the direct impact on PepsiCo was relatively minor.

Thankfully we did not lose any of our associates, but over 200 of our associates were displaced by the hurricanes.

And to help them, as well as our bottling partner employees, we established an associates relief fund with an initial $2 million contribution from the Company.

This fund is also accepting contributions from PepsiCo's associates from around the world, and we're matching those contributions in addition to the $2 million that we've already contributed.

Beyond the assistance to our people, the PepsiCo foundation contributed $1 million to the American Red Cross, and $1 million to the Salvation Army to help rebuild the lives of others who are affected by the tragedy as well.

Now from a business perspective, we had some property damage, but we did not lose any major facilities.

We had some inventory and receivable losses and these losses are reflected in the divisions' respective operating results.

Of course, the hurricanes have affected and will continue to impact fuel, energy, and packaging costs.

We've done our best to factor these into our outlook for fourth quarter and we'll get back to that later in the call.

It's too early, however, to have an accurate view into the longer term cost implications.

Now turning to the third quarter results.

As you saw in this morning's earnings release, we add strong quarter, especially on the top line.

Just to review that again, worldwide beverage volume was up 10%, worldwide snack volume was up 4.5%, revenue grew 13%, and division operating profit was up 14%.

Reported EPS was $0.51 a share, and this included a $0.27 tax charge associated with international cash repatriation that we announced on July 22nd.

And excluding the tax charge, earnings per share was $0.78, which was above our initial expectation, and as you know, ahead of our steady-state expectation for the business.

As we mentioned in the release, our international business continues to show terrific momentum, and our North American beverage business took advantage of this summer's hot weather to turn in great results.

I'm extremely pleased with the profit performance, especially in light of the marketplace investments that we're making and the input cost pressures that we're facing.

In the third quarter we increased our A&M across all divisions by approximately $100 million, and at the same time fuel, energy, and packaging costs have also been a challenge.

Now looking at the divisions' performances.

First, Frito-Lay.

Frito-Lay North America had solid top-line growth in the quarter, revenue was up 6%, and volume was up over 2% with good performance on both salty as well as macro snacks.

The Lay's trademark had a great quarter, and as you know, we stepped up the media investment behind this brand this year, and we've had solid new product performance.

The news and marketing investments drove high single-digit revenue growth for Lay's in the quarter.

The core Lay's brand grew behind introductions of cheddar and sour cream flavors.

Also, the Light -- the Lay's Light relaunch continued to perform very well.

And Lay's Stax were up high single digits behind tin trough duck shuns of Hidden Valley Ranch, pizza, and salt and vinegar.

And Lay's Kettle was up strong double digits.

Finally, baked Lay's was up high single digits.

Trademark Cheetos had another very strong quarter, growing high single digits, with core Cheetos up in the mid single digits and the new baked crunchy Cheetos contributed over three points to the growth of the trademark.

Trademark Tostitos grew mid single digits in the quarter.

We added Tostitos Scoops capacity in the quarter four last year, and because we continue to sell all we make, we're adding more capacity in the fourth quarter of this year.

And Tostitos Light relaunch is driving 30%-plus growth for that product.

Core Doritos had a good quarter with volume and revenue up low single digits behind the new Black Pepper Jack product but these core gains were offset by a decline in the Rollitos Doritos product.

We also had a very good quarter on other macro snacks, with revenue up high single digits, driven by strong performance in the Quaker snack products, with the rice cakes and the Chewy granola bars are having a very good year, and there is strong performance in cookies, crackers and meat snacks.

Our health and wellness initiatives continue to perform well.

Revenue for Smart Spot designated products was up double digits in the quarter.

Our salty market share across all measured channels for both volume and dollars is positive both for the quarter and year to date.

Looking ahead to the fourth quarter, we're going to continue to benefit from stepped up media investment and a number of product launches that we had this year.

Plus, in the fourth quarter we'll relaunch our Doritos brand with new packaging and an extended hotline with our new Doritos habanero product, we'll introduce a Lay's brand of dips, and we'll expand our Smart Spot line with popular new flavor additions, Baked Lay's Cheddar and Sour Cream as well as Flaming Hot and Baked Crunchy Cheetos.

Now turning to Pepsi Beverages North America.

We had a great quarter, one that really demonstrated the power of our beverage portfolio.

Volume was 8% overall, with non-carbs growing 24%.

Sales of product that qualify for our Smart Spot designation grew over 20%, and comprised 70% of our sales in the quarter.

Now clearly the star of the quarter was Gatorade with volume up over 30%.

And when we spoke in July I told that you Gatorade at that point was off to a strong start.

Well, they got off to a strong start and they never looked back.

They had a much better quarter than I had anticipated even when we made those comments in July.

Clearly weather was a big factor and was a great help in the quarter with temperatures up an average of three degrees over last year.

But Gatorade continues to do a great job with advertising, innovation, and market execution.

And these factors have enabled us to capitalize on favorable weather trends.

Now, the balance of the non-carb portfolio also performed very well.

Our total water business was up over 40%, and base Aquafina grew 30% supported by the highly successful "Drink more water!" ad campaign.

Propel, which is in its third year now, grew over 50%, and this was against a number of competitive products that were launched in this new enhanced category.

Aquafina Flavor Splash added almost nine points of growth to trademark Aquafina.

Trademark Tropicana non-carbs grew in low double digits driven by the juice drinks we launched in 2004, and Pure Premium 100% non-from-concentrate orange juice volume trends showed sequential improvement from the second quarter.

Our Starbucks, frappuccino and double-shot products are up strong double digits, energy drinks under SoBe and Mountain Dew trademarks are up double digits, and Lipton ice tea in P.E.T. bottles that was introduced earlier this year, they are all performing above our expectations.

CSD growth was flat in the quarter, with 4% growth in diet offset by low single-digit declines in regular CSDs.

Now, I'll offer the following observations on the CSD performance: Clearly we're seeing the trend of diets growing outpacing that of regular CSDs, and I expect that trend to continue.

And I believe we saw some trade-off this summer from CSDs to non-carbs driven in part by unusually hot weather.

Now, within the context of the overall CSD category challenges, we are pleased with our positive share performance for the quarter.

On a total liquid refreshment beverage basis, we are encouraged with both our 8% growth in the quarter and our 3.5% growth year to date, which I think is a good indication that the overall LRB category continues to be very healthy.

Our LRB volume share performance in the quarter was positive, up 0.4 across all measured channels, and we expanded our LRB share leadership position.

Our goal for the year is to grow our LRB share as we've said before.

Through the third quarter we're down 0.2 of a point on a volume basis.

Our share is even with last year on a dollar basis.

And I feel we've got good momentum going into the fourth quarter.

Finally, a few comments on PBNA's 16% profit increase in the quarter.

This was stronger than we expected going into the quarter, with the up side largely driven by the flow-through on Gatorade's phenomenal growth.

We delivered this level of profit growth and covered more than $50 million increases in A&M in the quarter.

Now, as we head into the fourth quarter, we've got some exciting advertising and promotions.

Our under-the-cap promotion with Microsoft is in full swing, and we're giving away a new Xbox 360 video game console every ten minutes through the end of October.

And this is before the consoles are available in any stores.

More than 1.3 million consumers have registered, and they've entered more than seven million codes.

As part of our diet emphasis we've tapped Diet Pepsi as the official soft drink of the NFL, and we have a great new Diet Pepsi commercial that is airing right now, and if you're watching football you've probably seen it, the Diet Pepsi machine which is drafted by the New York -- excuse me, the New England Patriots.

Continuing our heritage of break-through marketing, Mountain Dew is now in the movie business.

The brand-new film unit, MD films, has teamed up with Universal Pictures to release a film called "First Descent."

The film traces the history of snowboarding as told through the stories of five of the world's best snowboarders.

The trailer will hit movie theaters in the next few weeks, and the movie debuts on December 2nd.

It's an innovative and economical way to reach the core Dew consumer, and a great vehicle to build Mountain Dew's equity.

Now turning to PepsiCo International.

They had had another great quarter, both in the top and the bottom line.

Snacks volume was up 7%, beverage volume up 13% with both CSDs and non-carbs growing double digits.

Revenue was up 17%, and profit was up 28%.

We had some net acquisition and 4x benefits but the numbers are still very strong when you exclude the impact of those items.

The snacks growth rate is reflective of strength across a lot of markets.

Volumes in Asia, excluding the impact of our exit from South Korea joint venture were up 20%.

China was up 50%, India was up over 30%, and Australia, which is a larger, more mature market, had had mid-teens growth.

We had strong performance against most of our Europe, Middle East, and Africa businesses.

Poland, Russia, Saudi Arabia, Egypt and Turkey all had had double-digit growth, and Walkers showed sequential improvement from the second quarter as we had anticipated.

In Latin America we saw Gamesa return to positive growth and Sabritas also showed sequential improvement.

You may recall that our second quarter, that Sabritas initiated a wait-out, and that depressed its volume growth, but we continue to post positive local currency revenue growth and positive unit growth.

On the beverage side, we had very broad-based gains.

Our top ten markets, as a group, grew 13%.

Our next 19 markets, as a group, grew 13%.

And the balance of our markets, made up of roughly 90 markets, grew 11%.

Now, within CSDs, we had double-digit growth across all four of our major trademarks.

Pepsi, Mirinda, 7UP, and Mountain Dew.

Our double-digit non-carb growth reflected strong performances across the portfolio, and I'm particularly pleased with the growth that we're seeing in Gatorade and Tropicana.

And finally turning to Quaker Foods North America, top-line gains were realized in Quaker Oatmeal, Life, and Cap'n Crunch ready to eat cereals, as well as Rice-A-Roni and Pasta Roni.

And this was offset by declines in Aunt Jemima syrups and mixes, as well as declines in some of our regional grain breakfast products.

Some of Aunt Jemima's decline was driven by promotional timing, and you should expect to see a return to modest top-line growth in the fourth quarter.

Year-to-date, Quaker's performance has been very strong, driven by our investment in A&M, and I feel very good about this business's performance and the fact that we're making some meaningful marketplace investments that will keep the business on a positive trend.

So, summary, net, we're pleased with the quarter.

The businesses have done a great job of navigating through some very tough cost challenges.

We're posting good share gains in our key categories, and we're investing in the long-term health of our business.

So at this time I'd like to turn the presentation over to Indra to walk through some of our corporate items and our forecast.

Thank you, Steve.

And good morning, everyone.

I'll cover the items below the division profit line, review the cash flow, provide a little commentary on the international cash repatriation, and then update you on our full-year 2005 guidance including our balance of year input cost outlook.

On a reported basis, EPS was $0.51 for the quarter, which included the international cash repatriation tax charge.

Excluding the cash repatriation tax charge of $0.27 and the tax benefits in the prior year, core EPS is $0.78 compared to $0.66 last year, an increase of 18%.

So we got four points of corporate leverage between the division operating line and core EPS.

As we mentioned in the earnings release, corporate unallocated costs were up $60 million with the single biggest driver being a $45 million non-cash accounting charge to conform our inventory and employee benefits accounting policies across our division.

We are making this change as part of our SAP implementation, and I want to stress two very important points: First, there was nothing wrong with the accounting being used by each of the divisions.

But among our divisions, we used different approaches in how some costs were charged to inventory.

And that's because the divisions had different approaches that they brought with them when they were acquired by PepsiCo.

The adjustment we're making in the quarter gets every division on the same policy, which is important as we move all the divisions to the new common SAP platform.

And the second point I want to stress to you is that the charge is completely non-cash.

The other large item that partially offsets the accounting charge is the recognition of the $23 million gain on the high fructose corn syrup settlement.

I believe most of you were anticipating this credit in the third quarter.

Beyond these two items we've spelled out the other charges to the corporate unallocated line in a fair amount of detail in the release, and those charges are consistent with the corporate unallocated expectations we laid out at the beginning of the year.

Bottling equity income increased by $62 million in the quarter and this included a $41 million pretax gain on the sale of PBG shares.

You may recall that this year we initiated a multi-year program to return our proportional ownership in PBG to approximately the level of the time of PBG's IPO which was about 40% on an economic basis.

As we've said in the past we expect to sell up to 7.5 million shares this year.

Year to date we've sold 6.2 million shares for a pretax gain of $105 million, and our proportional ownership on an economic basis at the end of the third quarter stood at approximately 45%.

The remainder of the bottling equity income was driven by our share in equity bottlers earnings, an increase of $21 million, or 14%.

And this reflects earning strength across most of our equity bottlers.

Net interest expense declined by $5 million compared to last year.

Higher investment trades and cash balances offset the impact of higher debt levels.

Our reported effective tax rate is 53.8% for the quarter and 38.6% year to date.

Our core effective tax rate, which excludes the $468 million international cash repatriation cash charge, is 28.7 for the quarter and 29% year to date.

For the full year, excluding the impact of the international cash repatriation tax charge, we project our effective rate to be 29%, which is consistent with the projected rate we shared with you on the last quarter's call.

Let me spend just a minute on the mechanics of the cash repatriation as well as some anticipated borrowing and the impact it will have on our balance sheet.

For purposes of explaining this I'm going to use our third quarter balance sheet as a starting point and show the impact on the balance sheet of the repatriation and anticipated Q4 borrowing.

This is a pro forma presentation and is not meant to project our Q4 ending balance sheet.

Our cash and short-term investments at Q3 are 4.9 billion, of which most is in International.

Our combined short and long-term debt is $4.6 billion, of which most is in the United States.

The repatriation will be funded with approximately $4 billion of existing International cash and approximately $3.5 billion of new International debt.

This borrowing is necessary to create enough International liquidity to repatriate the full $7.5 billion permitted under the American Jobs Creation Act.

In addition we plan to pay down $2.5 billion of U.S. debt during the fourth quarter, primarily commercial paper.

After the transactions I just laid out, our pro forma total cash is $5.9 billion, and the pro forma total debt is $5.6 billion.

Essentially, we've done is moved the cash to the U.S., increased International debt and decreased the U.S. debt.

And if you focus on the net column at the right of the slide, the net cash position remains at $300 million.

And the total debt and total cash each increased by $1 billion.

Going forward, the international debt will be serviced with cash we generate outside the United States.

Moving on to cash flow, our management operating cash flow through the third quarter was $3.8 billion, an increase of 26% versus last year.

This improvement includes the favorable lap of a $760 million tax audit settlement payment we made last year.

We generated $707 million from option exercises and returned $3.3 billion to shareholders in dividends and share repurchases.

We repurchased 38.5 million shares of common stock at a year-to-date average price of $54.45 per share.

And we now expect our share repurchases for the full year to be at the top end of our original target of $2.5 to $3 billion.

We're also pleased with our operating working capital performance in the quarter with all our key metrics comfortably within our targets.

Days sales outstanding and days in inventory were even or showed sequential improvement in the second quarter, and they showed improvement compared to the third quarter of last year.

Days payable outstanding were essentially flat compared to the third quarter of last year.

We remain on track to deliver our full year cash flow guidance of $5.7 billion in cash from operating activities, and our net capital spending target remains at $1.6 billion for the year.

As we announced in July, we've increased our pension funding contribution for 2005 to $800 million, and that contribution will be reflected in our Q4 cash flow.

Our 2004 cash flow -- I'm sorry, our 2005 cash flow guidance includes this increased funding amount.

Let me now wrap up with some comments on our balance of year outlook including the outlook for foreign exchange and input costs.

In the third quarter, benefits from year on year strengthening of the Mexican peso but partially offset by a weaker pound and the Euro was essential flat all of which contributed to a slightly positive for-ex impact.

For Q4, our expectation is for the peso to be flat to slightly stronger year-on-year, and both the pound and the Euro to weaken somewhat, driving a fairly neutral net for-ex impact.

I think we've done a good job this year of managing through the inflationary pressures of fuel, energy, and PET resin.

However, as most of you know, some oil capacity was eliminated as a result of Katrina and more capacity was affected by Hurricane Rita, and these events have put added pressure on these costs.

Our current guidance reflects our best estimate of these costs for the fourth quarter but the situation, as Steve mentioned earlier, remains fluid.

Be assured that we're working constructively with our suppliers to ensure adequate supply at the best available cost.

Over the next several weeks, I believe we'll get more clarity around the impacts of the production interruption, and if our outlook changes materially as a result of how things develop, we'll certainly let you know.

Now, let me update you on our P&L guidance.

As you saw in this morning's release, we updated our core EPS guidance to $2.64 to $2.65 which excludes the impact of the 53rd week and excludes the international cash repatriation tax charge.

This essential takes out the low end of our previous guidance by $0.08 and the top end by $0.06 and implies a Q4 core EPS of $0.63 to $0.64.

We expect full year division operating profit growth of 9 to 10%, and this compares to our previous guidance of 8%.

Clearly, the third quarter came in much stronger than we'd expected, and we're flowing the Q3 upside through to our full-year guidance.

We feel very good about the business, but we don't want the strength of the third quarter to overheat the expectations of Q4.

Our guidance appropriately reflects the strong momentum of our business, tempered for the input cost pressures I just mentioned, and given the strong year to date profit performance, we intend to continue to prudently invest in the marketplace initiatives that are good for the long-term health of the business.

And now we'd be glad to take your questions.

Thank you. [OPERATOR INSTRUCTIONS].

The first question comes from Bill Pecoriello from Morgan Stanley.

Good morning, Steve and Indra.

Couple questions on Frito-Lay/ With the revenue per pound up 3.5% in the quarter, can you talk about how much you're getting on mix versus any contribution from weight-out or any rate that you took, and also, are you getting the top-line return on that big step up in advertising that you were expecting for the year, and then just lastly on Frito, anything -- any read on the consumer here in September, PBG had mentioned strong beverage volume sales in September.

Are you seeing the same thing on snacks?

Any impact on any channels?

Good morning, Bill.

Let me try to answer the three questions and let Indra add what she would like to it as well.

First, on the mix and the weight-out.

Actually, it's hard to break out the specifics on that, but I'd say anecdotally both are contributing.

We are trying to be very careful as we take pricing in any form, and we've been very careful as it relates to the weight-out, but we do believe it has contributed -- we're confident it has contributed, but we also very much would like to see mix be the primary method of getting that net revenue, and we are seeing that happen.

As far as advertising is concerned, as you, I know, are aware, advertising, for the most part, is not an immediate reaction.

It takes time and it's investing in the brand.

All that said, we have a pretty short tolerance for waiting, as I know all of you do, and I would point to the strength of the Lay's brand as one indication that the advertising is probably having an effect on the business.

But I would say that, you know, Irene and her team's plan is to continue this investment to strengthen the brands over time, so that we can continue to see that performance.

And as for as the consumer is concerned, the trends, and Indra mentioned this in her comments, the trends that we've seen from the consumer are continuing -- I would, however, want to temper that by saying the summer is heat was an unusual occurrence, and I don't think we could expect to see that kind of demand on the beverage side of the business.

But as far as the snack side of the business is concerned, it's been pretty steady, and we really haven't seen much impact -- actually, we haven't seen any at this point, change in the demand side of the business.

And, in fact, to anticipate one of the questions that may come up, we haven't seen any change in the small format demand in the convenience store channel based on fuel prices.

At least, we haven't seen it yet, and there's probably a lot of thoughts as to why that's the case.

We could talk about those, if you'd like.

I don't have any facts to prove it other than to tell you that the volume in the small format convenience store has not changed throughout the year.

It's been pretty steady from first quarter, second quarter, through today.

Indra?

Nothing to add, Steve.

I think you covered it all.

thank you very much.

The next question comes from Bonnie Herzog from Citigroup.

Good morning.

Obviously you're generating very strong volume growth in your global beverage business.

Therefore, I'm curious, do you have specific objectives or innovation planned in certain categories to ensure that strong volume growth will continue?

In other words, are there specific beverage categories where you plan on increasing your spending or ramping up your innovation next year such as the energy category?

I'm also curious about any special areas of focus on beverages internationally.

Bonnie, I'm taking your question as being an international question, so let me answer that on an international basis.

Starting with just sort of the general philosophy, and we've talked about this before, but we treat the portfolios by country and by our current position in those countries.

So in those areas where we have very strong market position and very big shares in carbonated soft drinks, like, say, the Middle East, then we're aggressively moving new brands into the portfolio, and specifically in the non-carb area.

Whereas in other markets where we have smaller share positions or smaller markets we may more focus our attention against CSDs.

And so it really is a country by country, market by market decision, but we do have a portfolio of opportunities that the countries can choose from with general strategies and advertising and marketing campaigns and global opportunities to follow, and it's -- I think Mike and his team have done a very good job of sharing across all the businesses is what's out there, and then having each of the business units recommend the kind of portfolios and support levels that they should have to grow their businesses.

And the piece that I -- and I commented on it in my opening -- that we feel very good about, is that the broad-based growth of the business across our top markets, the ones that are most strategically important, as well as in the second tier and third tier markets, all of them grew in double digits, but they grew with different strategies and different portfolios, and obviously different investment levels.

Bonnie, if I can just address your question on North American beverage innovation, clearly it's very hard to tell you our innovation plans, given the competitive nature of the market, but rest assured that our goal is to provide industry leading innovation in this whole beverage category.

That's what you've been seeing the last couple of years and that's what you should continue to see over the next few years.

specifically you mentioned I think energy.

Obviously, that's a red hot category right now, and we're pleased with the portfolio we have, but I think it's safe to say that you haven't seen it all, and that you'll probably see more.

All right.

Thank you.

Thank you.

The next question comes from John Faucher from JP Morgan.

Yes, good morning, everyone.

There have been talks of Gatorade shortage in capacity during the quarter.

Wonder if you could give us an idea where you stand from a retail inventory standpoint and does this make you think of bringing more of the Gatorade production inside, instead of co-packing, and would that lead to any change in terms of capital commitment from the Gatorade business?

Thanks.

Well, we did press hard this summer, given the extraordinary volume, and there were capacity shortfalls, availability shortfalls in the U.S.

That's starting to mitigate a little bit, although I would say September in some parts of the country have been even more unusually warm than even the summer.

So we're hoping to catch up with demand here in the next month or so as we start to pre-build for next year.

We have anticipated the need for producing more product in-house, and there are several reasons for it.

One is the demand, the other is the efficiencies of our internal production, so we are increasing the capacity of our internal capability next year as well as into 2007.

Got it.

So it sounds from your commentary that it's safe to say that Gatorade is off to a good start in this quarter as well.

Very safe to say that.

Good to hear.

Thanks.

Thank you.

The next question comes from [Phillipe Gosin, CSFB].

Good morning.

Phillipe Gosin, Credit Suisse First Boston fixed income research.

Two questions for Indra, if I may, this morning Indra, you mentioned about 3.5 billion of borrowings in the fourth quarter.

Any early indication in terms of what currencies and maturities you may be looking at?

Secondly, if I do my math correctly, you may have actually a little bit more debt outstanding internationally than domestically after this exercise is completed.

Have you had any discussions with the rating agencies whether this could bring up any issue of structural subordination given that you will have more international debt outstanding?

Thank you.

On the first question, Phillipe, I think that's a level of detail that's just too early to talk about.

And once we've finished the repatriation, we will put it out in our annual report and 10-K.

That level of detail I think is too early to talk about.

As far as the rating agencies are concerned, there is no issue at this point on where the debt is because our overall cash flow is very, very strong, so there is no issue right now.

Great.

Thanks so much, Indra.

Thank you.

The next question comes from Christine Farkas from Merrill Lynch.

Thank you very much.

A question on the International segment.

The margins picked up substantially this year versus a year ago, and you ran through international volume markets in terms of volume growth.

Can you comment on to really what was the biggest contributor?

Was it just the improvement in the mature markets or are some of your more emerging markets really starting to contribute to the profit line?

Christine, we've talked about this before, and we realize that we need to come forward with a much better explanation in detail for you all to understand the nature of our international business, and Mike and Indra and I have been talking about how we can find the right format for that to happen but just suffice to the say that on the snack side of the business, because all the products are manufactured locally, the scale buildup as our volume goes up disproportionately favors margin expansion, and if you just think about the average margin for our salty business internationally, against the margin of our biggest businesses, U.S., Sabritas and Walkers, we have a long way yet to go to get the margins up and those margins improve each year as the volume goes up.

So when the volume is as strong as it's been this year then we obviously move at even more rapid pace but we have models which we've developed over time which give us an indication of what those margin levels ought to be with volume improvements.

And so the -- that's the salty snacks side.

On the beverage side, clearly the strong performance of the top line drove our margins up even though we disproportionately invested as we said we would in driving that business.

Can you comment on --

So we think if you just look at the margin overall as international versus domestic, over time we would expect that to come -- come closer together, not by the U.S. declining but by the international businesses continuing to move up.

Indra, would you like to comment?

I think, Steve, in addition to our excellent business performance and the fact that all the scale that we've built into the businesses are now beginning to yield results I think we shouldn't forget that you've got incredible macroeconomic stability around the world, and the fact that we don't have any currency that is creating a major issue, like in the past if you look at the last two or three years there's always been a country or two that was running into some sort of recession or a crisis, currency crisis.

We don't have that today.

So the basket of currencies is also working in our favor, and the global macroeconomic stability is also working in our favor.

So the combination of the very, very good opinions performance plus the macro economics is what's propelling this continuous share gain.

Great.

That's great.

You indicated disproportionate investment.

Did you, or can you quantify what the increased A&M spend was in the quarter for this division?

I don't think it's something that we'd prefer to put out, for competitive reasons, but it is in line with what we had anticipated at the beginning of the year and we still intend to increase that investment through the balance of the year.

And it comes in the form of advertising as well as innovation and new product introduction.

Thank you.

Thank you.

The next question comes from Lauren Torres from HSBC Securities.

Good morning.

You noted that the 53rd week will give you $0.04 to your full-year numbers.

I was wondering, looking at your fourth quarter, and knowing you history do you plan on reinvesting that back, and if you're not I was just curious, just longer term thinking about your business, if it's getting harder to reinvest upside in quarters or if you still see a lot of opportunities there.

Lauren, as we mentioned at the beginning of the year the 53rd week was worth about $0.04 to $0.05 and we plan to flow through about $0.04 to the bottom line.

The numbers we talk about usually is on a 52-week basis.

The 53rd week is a $0.04 flowthrough that you should expect to see in our Q4 numbers.

In terms of reinvesting the business, going back to the beginning of this year we played out all of our plans for stepped up reinvestment in our businesses through the year and we put out an operating guidance of 8% based on stepped up reinvestment levels.

The good news is that the business has performed extraordinarily well through the year and we had upsides and we flowed a lot of the upsides to the bottom line and we've made prudent investments along the way to make sure we keep that strength of the business going forward.

At this point I think we've been very prudent in reinvesting the business in a stepped up way both in terms of competitive activity and to ensure the health of our business and delivering earnings to the bottom line.

But do still believe there's room to make further investments like this, or at this point you're at a point where you're going to basically flow it through?

Well, in the fourth quarter we've got several planned investments and we intend to milk them, and the guidance we've provided you right now is already anticipating the investments we've already planned to make in the fourth quarter.

but also I'd add that we're -- we're facing, as everyone is facing, increased costs, and that's -- that is also factored into our fourth quarter, so if the nature of your question is given the current trend let's extend that into the fourth quarter, I would strongly, as Indra did, caution you not to get out ahead of us, because we really believe that the fourth quarter performance is as we are forecasting it to be, and if you look back in the third quarter, clearly the biggest single upside that we had in the third quarter could not have been anticipated with the weather.

So I think to try to flow through that increase on to the fourth quarter and beyond would be -- would not be prudent.

Thank you.

Thank you.

The next question comes from Caroline Levy from UBS.

Good morning, everybody.

Couple of questions.

One, can you comment at all about any hedges you have in place for '06?

I'm sure this is on everyone's mind.

I'm sure you don't want to get into too much detail, but have you done anything about locking in fuel or PET and so on for '06?

Anything would be helpful.

The second question, on Frito North America, how do you feel about the 2% volume number?

Is that something you think is a good achievement in a tough environment or is that something we should expect to see to accelerate over time?

Hello and welcome back.

Thank you.

In terms of hedges, in the normal course of business we do selective hedging of -- not PET.

Fuel, natural gas, some of our commodities, and that continues.

There isn't anything extraordinary in place right now.

We are comfortable with our hedging strategy today but we don't want to competitively disadvantage ourselves by telling you exactly what hedges are in place for how long at what price.

Rest assured that it's continuation of business as usual.

Caroline, as far as Frito is concerned, our guidance long term for Frito, and particularly relating to the salty number, we're actually performing at a little over 2%.

We rounded it down to 2%.

But 2 to 3, 2 to 4 is what we target, so we're operating at the lower end of our expectations and we do have every reason to believe that the model that we've used for Frito this year is the model that we're going to continue to use.

Clearly there's been cost pressures, unusual cost pressures, and our decision to hold the line and not passing those through was one that we took after careful thought that a lot of these pressures are one-time pressures, unusual ones, and that we chose not to pass them on to the consumer.

So as it relates to longer term, you know, I still think we're operating within that envelope on a volume basis, clearly we'd like to see it north of 3, but we're certainly, given this situation in the marketplace, we're pleased with where we were so far this year.

Thank you.

Thank you.

The next question comes from Marc Greenburg of Deutsche Bank.

Good morning.

My question relates to the recent cash repatriation.

I'm wondering if this kind of balance sheet movement impacts your borrowing capabilities for business investment or strategic acquisition in any way.

Should we infer anything about international acquisition opportunities because of this repatriation?

Marc, even after this borrowing we still have enough financial flexibility to execute on our acquisition strategy which we've talked to you about several times over the past few months and years, so at this point, as I look at our acquisition strategy, I don't see any constraining of our financial flexibility.

Thank you.

But let me just add one comment on that.

The nature of the repatriation that we did, I might just add to -- which I'm sure you already know -- that the monies that we brought back are used to -- for certain types of activities, and we incurred a substantial tax charge of almost $500 million to bring it back.

So if you look at that closely, I think it can sort of give you some indication of the kind of acquisitions that we may be thinking about, at least on the short term.

Thank you.

The next question comes from Carlos Laboy from Bear.

Hello.

Can you guys hear me okay?

Carlos, good morning.

Actually this is Gerry Gallagher.

I have a couple of questions.

Over the last year plus or year and a half, a lot of your competitors have recently been employing some new strategic initiatives in regard to raw material costs.

I'm wondering if could you provide some color in this commodity-driven economy on what you guys are planning to do to reduce raw material costs throughout your entire supply chain?

Gerry, I tell you, I think we have one of the best global procurement groups.

I would venture to say, amongst the CPC universe.

We have ways to keep our cost of goods at a reasonable number and to give you the specific initiatives that we've been working on or have already been implemented in the marketplace I think is a level of detail that may not be quite appropriate for this call, but rest assured that if you look at our top ten raw materials, we have strategic programs in place with every one of our key vendors to think through either new materials, new ways of manufacturing them on our line, or to lower the cost to the benefit of both of us.

So this is an ongoing program we've had for several years and we keep refining it and improving it all the time.

And that's one of the reasons we've been able to weather the input cost inflation better than anybody else.

Let me just add one thought.

Break it into four pieces.

If you think about it internationally, Mike and his team have done -- are doing a lot of work to consolidate the purchasing around the world and to really take advantage of scale, and that will continue.

If you look at the U.S., in the PepsiCo and North America organization, Dawn is working very hard with the bottlers to work together in a way which we've never done before, to capitalize on opportunities in both purchasing as well as supply chain, and I know that over time we'll have more to say about that, but it' very encouraging.

As it relates to Quaker and Gatorade, through the merger we've had a lot of opportunity to take costs out of the system in supply chain and raw material purchasing, and that has been a huge part of our ability to fund the growth of Gatorade, and in Frito, I think Frito has a long history of being on the leading edge as it relates to supply chain and purchasing, and they've got a number of major initiatives underway to fight the head winds that we're seeing in the inflationary environment that we see ahead of us.

Thank you.

The next question comes from Andrew -- Mr. Sawyer, your line is live.

Andrew?

Thank you.

The following question comes from Robert van Brugge from Sanford Bernstein.

Good morning.

I was wondering, Indra if you feel after the $800 million pension contribution that you're anticipating for Q4, is the worst behind you at this point and should we expect a significant reduction in those contributions in '06 and beyond?

Robert, that's the plan right now.

Our expectation is that our next year contribution should be coming down to the $400, $450 million range.

A lot of it depends also on what the macroeconomic assumptions are.

If the discount rates keep going down, as they did this year, we want to make sure that the pension fund remains fully funded, on an ABO basis, that's what we focused on.

And that's why we made the additional funding this year.

But at this point our anticipation is that next year it should come down to the level that we talked about this year, which is the $400, $450 million.

Wouldn't it actually get you beyond ABO funding at that point in time?

Not at this point, right now we are funding right at the ABO levels.

Next year, again, remember we have historical investment losses we are still hedging in.

We all implemented the actuarial assumption changes that we talked about last year so all of those did cause the pension costs to go up and our funding is consistent with 100% ABO funding.

Great.

Thank you.

Thank you.

The next question comes from Alec Patterson from RCM.

Yes, a question for Indra and for Steve.

Indra, probably the fastest growing line item for you guys the past few years has been corporate unallocated.

One, just to be clear, the 45 million non-cash charge is one time, goes away, don't expect it again, even with future SAP changes?

Secondly, can you give us an idea what's going on with that line item '06 and beyond?

For Steve, just a quick question on Gatorade.

Obviously a great summer and great execution but at least the measured channel data would suggest you guys have been slipping on share.

Obviously from a high point.

At what point do you guys start to feel like that share shift is not exactly what you want to see, and what are you going to do about it?

Let me take the corporate unallocated question first.

The first thing, Alec, you should feel very good about is core corporate G&A.

Department expenses are flat year over year and been for several years, so we feel very, very good about how we manage the corporate function.

The $45 million cash charge was a one-time non-cash item as we talked to you about.

We felt it was prudent to get all of our accounting policies in conformance with each other even though they were correct in each of their own ways, we just wanted to bring them all together so that our SAP implementation could happen flawlessly.

And as far as the SAP implementation is concerned, we're a large company with DSD with a very complex operating model.

It takes multiple years to implement SAP.

The good news is that we have not taken any extraordinary charge for the SAP implementation.

We are still delivering our algorithm and investing behind the SAP.

We've invested over $250 million so far, and we'll give you guidance on our 2006 investment as we give you guidance for the overall 2006 year later on in the fourth quarter.

But at this point, the program is proceeding on schedule.

We are scheduled to go live with our first release in January, and then a major release in June of next year.

So at this point we feel good about where this is headed.

And as far as Gatorade is concerned, I've said on a number of calls, and I'll repeat again, losing market share in any business at any time in any way you look at it is not acceptable to us, and we're very, very conscious of this measured channel performance.

The unfortunate situation this summer was that we were capacity constrained, and the share we lost we, frankly, were just not in a supply position to be able to do anything about it, but I can tell you we watch that very, very closely, and the team, the management team there has done a great job in driving this business this year but they understand that the one place where we have not reached our expectation is in maintaining the share, and so our ongoing expectation is that not one-tenth of share loss in any business is acceptable, and I think everybody in the organization understands that.

So I'm not making excuses for losing share in the quarter.

I would just tell that you we don't like it and we don't expect it to continue.

Okay.

Thank you.

I think we have time to take one more question.

Thank you.

The final question comes from Mark Swartzberg from Legg Mason.

Good morning.

Question, Steve, regarding Walkers and Sabritas.

Wonder if you could give us a little bit more detail, a little bit more color on what you believe is going on specifically with those two businesses and how much of that is the macro environment you're in, in each market.

And then, of course, if you could share with us how you're thinking about the outlook in a little more detail than what we've heard so far that would be great.

Let me start by saying those of you who have followed us for a long time know in that prior times, when those two businesses -- when either one of those businesses didn't perform we did not have a good year.

And the great news is that is not the case.

Neither one of those businesses is are performing to what we would like at the top line this year, but but despite that the rest of the businesses are doing quite well.

Now, I wouldn't lump the two together because the issues are different.

Let me start with Sabritas.

As we said before we took a weight-out in Sabritas, and that is part of the issue, and we also said earlier in the year that we would see sequential improvement throughout the year, which we have seen.

We think that Sabritas has the opportunity to continue to get that momentum back to the positive on a volume basis.

They were already positive on a unit basis.

So if you think about it in terms of units sold or consumer uptake, it's a different picture.

But at the end of the day we're not changing the measurement.

We're still looking at volume.

And it is improved, and we think that that business is quite healthy and with the marketing plans we have coming up we think that will continue.

Walkers, the first quarter was a very disappointing quarter.

It is substantially improved since the first quarter, and that's been through investments in the market in advertising as well as innovation.

Clearly the consolidation of the retail trade in the U.K. is putting pressure on all of the food businesses, and I think as we start to see equilibrium in the trade that's going to make a big difference for us and for other companies in the marketplace.

But I would tell that you that the team is working hard, the market plan that we're seeing for next year includes continued innovation, and in the latter part of the year, some, I'd say, more market changing types of innovation without getting into giving a competitive advantage away, we expect the second half of the year to have a different type of innovation that will meet, I think, the changing consumer in the U.K.

But both businesses are healthy, and in the case of Walkers they're not only working at the top line, they're making some substantial investments in productivity changes in the way they go to market to allow us to fuel increased spending in that business.

So I think the short term is encouraging.

The longer term is even more encouraging at Walkers.

Thank you.

Well, Steve, before we sign off, I just want to make some overall closing comments, mostly to reiterate something I said on the Q4 guidance.

As we've mentioned to you in my script, we updated our core EPS guidance to $2.64 to $2.65 for the year which excludes the impact of the 53rd week, and excludes the international cash repatriation charge.

I want to make sure that I was clear in saying that our full-year division operating profit growth we expect it to be 9 to 10%.

The full-year division operating profit growth.

And this compares to our previous guidance of 8%.

And as I mentioned to you in our script, as the third quarter came in stronger than we expected we are flowing the Q3 upside and we don't want to let the strength of the third quarter to overheat the expectations for Q4.

Thank you, Indra and thank you all.

I'm sorry we ran over a few minutes, but I appreciate the questions and the interest in our business, and we're happy to have with you us today and we'll look forward to talking to you again soon.

Have a great day.

Thank you, everyone.

This does conclude today's teleconference.

You may disconnect your lines at this time, and have a wonderful day.