百事 (PEP) 2006 Q3 法說會逐字稿

Good morning and welcome to PepsiCo's third quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] It is now my pleasure to introduce Mr. Jamie Caulfield, Vice President of Investor Relations.

Sir, you may begin.

Thank you, operator, and good morning, everyone.

Thanks to all of you for joining us this morning.

Today's Webcast includes a slide presentation that can be accessed at our pepsico.com Website.

Before we begin, please take note of our cautionary statement.

This conference call includes forward-looking statements based on 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 Investors Section of PepsiCo's Website at pepsico.com, under the heading "PepsiCo Financial Press Releases," to find disclosure of any non-GAAP financial measures that may be used by management when discussing PepsiCo's financial results with investors and analysts and a reconciliation of those non-GAAP measures to the related GAAP reported measures.

This morning's prepared remarks will be made by Indra Nooyi, our CEO; and Richard Goodman, PepsiCo's CFO.

Indra and Richard are joined this morning by Mike White, CEO of PepsiCo International;

John Compton, CEO of PepsiCo North America; and Dawn Hudson, President of Pepsi-Cola, North America.

Following the prepared remarks, Indra, Richard, Mike, John, and Dawn will be glad to take your questions.

It's now my pleasure to introduce Indra Nooyi.

Thank you, Jamie and good morning everyone.

Thanks for joining us for this morning's call.

As most of you know, we will be hosting an investor meeting in less than two weeks to talk about our business in a lot more detail.

So, we'll keep our comments short today.

That will also allow us a bit more time to entertain your questions.

I trust you all saw the press release this morning.

To recap the numbers, we had a very good quarter.

Growth was again balanced on the top line between snacks and beverages.

Revenue growth was very strong and ahead of our mid-single digit long-term target, up 9%.

And earnings per share were up 73% on a reported basis, and up 12% when you adjust for the impact of last year's tax charge.

Division operating profit was up 6% in the quarter, which was below what was in most of the sell-side models.

So, I'll provide a little more detail on this in a moment.

I'd like to highlight four key themes to characterize this quarter's results.

One, we are very pleased with the top-line growth.

As you saw in the earlier slide, revenue was up 9% in the quarter and 10% year to date.

We are seeing balance between snacks and beverages and every division contributed to the growth.

Two, we delivered a very solid quarter, despite the fact that we faced our most difficult comparison of the year in the third quarter.

Among the divisions, Pepsi beverages North America clearly faced the most difficult comparison.

Three, in addition to the difficult comparison to last year, PBNA experienced the most pronounced cost challenges and I'll go into this in more detail in just a moment.

And fourth, despite the cost challenges at PBNA, our approach to managing the divisions as a portfolio worked and we delivered very solid results, both for the quarter and year to date.

So let me briefly recap each of the divisions' performances, starting with Pepsi beverages North America.

To put the overall PBNA results in context, this slide shows how PBNA's growth accelerated in the third quarter of 2005 versus the first half of 2005, driven primarily by the terrific summer Gatorade had last year.

And this created the tough comparison in the third quarter of this year.

Despite the tough comparison, we were very competitive in the quarter and grew overall volume 4% and successfully lapped the 34% growth we had in Gatorade last year.

Net revenue was up 3.5%, so there was less net price realization Q3 than you've seen earlier in the year.

There are a number of factors contributing to this.

First, Gatorade has a much higher revenue per case than PBNA's beverage portfolio overall.

And because Gatorade contributed less to the growth this quarter as it was lapping over 30% volume growth from last year, you are seeing less mix benefits in the revenue line.

Second, we stepped up our trade investment in the third quarter.

This was a conscious shift in the marketplace spending and it's reflected as a reduction in net revenue.

And third, concentrate shipments were lower than our reported case sales growth.

So, the case sales reported exceed the amount of revenue we recognized.

Turning now to profit performance.

PBNA's profit declined 4% in the quarter, which is below what we had anticipated when we last spoke to you and below what was in most of your models.

So let me take you through the drivers.

PBNA's profit in the quarter was impacted by, first of all, higher orange costs.

As most of you know, orange costs have been a head wind all year.

When we spoke to you in July, our expectation was for orange cost inflation to actually abate somewhat in the back half of the year.

But exactly the opposite happened, and we saw a substantial increase in orange costs in the quarter.

Our orange contracts for pricing mechanisms is tied to FCOJ's futures.

And since we last spoke, futures prices have risen significantly.

This cost increase, and the fact that we could not price immediately to cover it, accounted for the large majority of PBNA's operating profit miss this quarter.

Because the inflation of oranges now appears to be more structural than temporary in nature, we recently announced a price increase on Tropicana Pure juices.

And this action will help offset some of the recent cost increases as we go forward.

But we're not addressing the cost increase through pricing alone.

I feel good about our innovation on Tropicana, especially premium innovations like Tropicana Pure, which will help our price realization and also contribute to margins.

In addition, we are exploring longer term supply chain efficiency programs to mitigate the increase in our food input costs.

The second item to impact PBNA's profit performance was Gatorade supply chain costs.

Gatorade supply chain cost increases were largely a function of meeting this summer's increased demand without any additional Company owned manufacturing capacity and instead using more costly third-party manufacturing.

But we also had higher energy and PET costs than we had expected, which pressured Gatorade's margins.

Looking ahead we have two new Gatorade plants under construction.

And once they're up and running they'll lower our manufacturing and supply chain costs relative to using third-party manufacturing.

Our plant in Virginia will be online for the 2007 peak season.

And the Oklahoma plant will be operational for the 2008 season.

And the third key impact on PBNA's profit in the quarter was the targeted increase in marketplace investment that I mentioned earlier.

So to wrap up the PBNA discussion, we are very pleased with the top-line performance at PBNA.

We consider 4% growth very solid in normal circumstances.

And given the 8% growth we are lapping, I'm especially pleased with the performance.

Within CSD's we had positive growth in both trademark Mountain Dew and trademark Sierra Mist and the diets' portfolio also posted positive growth.

The diets performance benefited from our launch of Pepsi Jazz, which is off to a strong start.

It captured 0.7 share in period nine, which was ahead of our expectations.

And noncarbs continued to perform very well with volume up 13%.

Gatorade was up 8% and we had double-digit growth in Aquafina, Propel and Lipton tea, which continued to perform extremely well.

Net, PBNA had very strong top-line performance in the quarter, particularly in light of the difficult comparison.

Costs were higher than we had anticipated, driven primarily by the run-up in FCOJ futures.

But despite the cost pressures, the strength of PepsiCo's business overall enabled us to manage the challenges within the P&L and still deliver a very solid quarter.

Importantly, we have taken actions that will help mitigate the structural cost issues longer term.

Turning now to Frito-Lay North America.

Frito-Lay's performance was right in line with its first-half performance.

Volume was up 3% and operating profit was up 6%.

In salty snacks, top-line growth was led by Lays, Tostitos, Cheetos and Sun Chips.

Sun Chips continued to perform exceedingly well, with volume growth of over 30%.

And we're encouraged by the steady progress of Doritos in the quarter.

Doritos' strength continued the improve and we have a solid marketing plan for Doritos as we head into 2007.

We're also pleased by our consumers' reaction to our use of heart healthy sunflower oil in Lays and Ruffles.

This initiative is a great example of how we are making our core products healthier.

We began converting to sunflower oil earlier this year and we'll have the entire U.S. conversion completed by November as planned.

Other macro snacks have continued broad-based growth with good performance in Quaker branded chewy bars and rice cakes and in our nuts business.

Finally, across our salty snacks and other macro snacks, we continue to see very strong growth in our Smart Spot original product, which posted 28% revenue growth for the quarter.

Turning now to PepsiCo International, we had another very strong quarter.

Snacks volume was up 12% and beverage volume was up 8%.

We were lapping 13% growth in beverages from the third quarter of 2005.

Profits increased 17%, lapping 28% growth from the third quarter of 2005.

CSD's volume grew 6%, with each of our major trademarks registering positive performance.

Mountain Dew continued to gain momentum with 27% growth in the quarter.

In noncarbs, we had over 20% volume growth and each of our major noncarb trademarks had double-digit growth.

Our Tropicana international business in particular continued to perform very well with volume growth of over 20%.

Our snacks business had 12% growth in the quarter, which includes a 3 point contribution from acquisitions and 9% organic growth.

We continued to see very strong growth in the developing markets, and we posted positive performance in both the U.K. and Mexico, our two largest snack markets.

Wrapping up the division review, a few comments on Quaker Foods North America.

Another very strong quarter with double-digit revenue and profit growth.

The performance was broad-based and was led by double-digit volume gains in oatmeal and solid growth in Aunt Jemima and the ready-to-eat cereal business.

ForEx had a very slight positive impact in the quarter, with the upside driven by the pound, the euro, and the Canadian dollar, substantially offset by weakness in the Mexican peso.

For the full year, our expectation is for ForEx to have a very modest favorable impact on both the international line of business and on PepsiCo in total.

Let me now turn the call over to Richard Goodman to comment on the P&L below the division line.

Thanks, Indra.

Corporate unallocated costs decreased by $29 million, or 15% in the quarter.

Corporate departmental costs were essentially flat.

And the costs associated with our business process transformation initiative increased by approximately 13 million, but this was more than offset by the net impact of other items, primarily the impact of lapping the accounting conformity charge we recorded in the third quarter of last year.

Bottling equity income reflects the year on year increase of $20 million in the gain on sale of shares in the Pepsi Bottling Group.

The tax rate for the quarter was 27%, bringing our year to date effective rate to approximately 28%.

On last quarter's call, we indicated that we expected our 2006 full-year tax rate to be 28.4%.

However, based primarily on the resolution of state tax audits during the quarter, we revised our full-year assumption downward to 28%.

Coincidentally, our updated guidance of 28% is consistent with the guidance we originally provided at the beginning of this year.

And for the quarter, average diluted shares declined by approximately 90 basis points or 15 million shares, as compared to the third quarter of last year.

Turning to cash flow.

Year to date, we generated $4.3 billion in cash from operating activities.

The cash flow performance reflects an increase in cash tax payments of $535 million, which includes the $420 million tax payment we made in the first quarter related to last year's cash repatriation.

The operating cash performance also reflects working capital investment in inventory and receivables, which are driven by our underlying business growth.

Capital spending is $1.1 billion year to date, an increase from last year, but in-line with our projected full-year increase in capital spending.

Option proceeds for the first three quarters were $1 billion on exercise of 27 million options.

And we have returned approximately $3.5 billion to shareholders through dividends and share repurchases.

Our cash flow outlook for 2006 remains unchanged.

We expect cash from operating activities to exceed $6.2 billion, capital spending of $2.2 billion, and share repurchases of $3 billion for the full year, all consistent with what we shared with you last quarter.

And now, I'll turn the call back over to Indra.

Thank you, Richard.

Let me just close my opening comments with talking about our outlook for the fourth quarter.

In summary, I feel very good about the year we've had so far, and I'm optimistic about the fourth quarter.

So, we've increased our full-year earnings outlook to at least $2.98 per share.

This represents a $0.05 increase to the target we established at the beginning of the year.

So that concludes our prepared remarks and we'd be glad to take your questions now.

Thank you. [OPERATOR INSTRUCTIONS] Our first question is from Kaumil Gajrawala of UBS.

Hi, guys.

Can you talk about how much of international growth is coming from distribution gains?

And also as it relates to international how much -- what the margin expansion is in the underlying business when you take out the acquisitions?

Let me turn this over this Mike White.

Mike?

Yes, Kaumil.

First, in terms of distribution gains and our overall growth rate, on the beverage side, Pepsi is in 200 countries.

And so, it's certainly true that in China -- our growth rate in China would have been buoyed a little bit by that, a little built in India.

But I would have to say, if I look it at kind of our overall growth rate on beverages for the quarter or for the year, I feel pretty comfortable with where we are as being reasonably representative.

If I had -- if you pushed me to the wall and said on beverages, maybe it's 1 point out of the 6 points on CSD's.

On noncarbs, we've had a terrific year, so far, in existing markets.

For instance, Tropicana in France and the U.K. is up over 30% this year, and our profits are well in excess of that, as well, in the U.K. and France.

On the other hand there's certainly some new markets for our noncarb growth rate that you would have to say are new markets.

But certainly, as I look at our overall beverage algorithm, and I'll talk snacks in a second, I certainly don't think we're heavily dependent on either new markets or new territories when I look at the underlying growth rates by business around the world.

On the snack side, as you know, we had a couple of acquisitions to counter in Australia, a low-fat rice-based product.

We also completed the acquisition of Star Foods in Poland, which we're lapping.

And then also the Duyvis nuts business.

So if you look at the overall numbers on the snack side.

The organic numbers, as we've said are quite a bit -- a little bit below what we reported with the double digit.

But even without that, again, I would have to say looking at our snacks components, we'd still have to say we're certainly comfortable in the 6% to 8% range easily.

Again, I wouldn't say there are that many new markets on the snack side.

Snacks are in about 50 countries.

We've opened up our first snacks plant in Pakistan, so that's a tiny little bit.

But to be honest with you, I don't think, other than the acquisitions impact, which we told you about, there was all that much.

So, salty organic still was up 11% for the quarter, which is terrific.

Now, again, I would say maybe there's some strength in that number that we had an extraordinary quarter with Sabritas, Sankiros and a couple of others.

But really broad-based growth across the portfolio, and it is not something where I'd say there's a huge amount of that growth that's coming from distribution gains.

A small amount, but not a huge amount.

Kaumil, if I can just finish up what Mike said, acquisitions contributed about 3 percentage points to the top-line growth rate but did not contribute any to the profit growth rate because in the first year of the acquisition you're still investing to build the business.

So from a -- yes, from an acquisitions standpoint we're right in line with our plans.

We're integrating Star Foods together with our business in Poland, so there's been some restructuring costs there to complete that integration.

Duyvis is brand-new, doing very well and right in line with our expectations, so nothing to be concerned about.

But as a result there , in the PI number, the 16% revenue number you're looking at, there are about 3 points from acquisitions, which really didn't contribute any material profits in the quarter.

Although, I certainly am well expecting profit growth from those businesses in 2007.

And as I said, that was right in line with our expectation.

On the margin expansion question, again, I'm quite pleased with the productivity that we're driving across the portfolio.

We made a couple of conscious investment decisions in the quarter.

Really kind of as we looked out over our full-year expectations for PI as well as 2007 and what we knew about, we felt we had an opportunity to invest in the launch of baked Walkers in the U.K.

It's off to a terrific start, and I think is a big idea within 70% less saturated fat for that market.

Less than 100 grams packs that are out there and flying off the shelves, as we speak.

So, we did make a plan conscious decision to invest in A&M and get that launch in this year.

And we also made some investments in expanding Pepsi Max in a number of existing and new markets for the quarter as well.

So some of the quarter in the margin was a conscious decision on that part.

We also are lapping some tough numbers with 28% growth last year, in the U.K., for instance.

We had a pension credit and some legal credits that we were lapping.

So, we were right in line with where we expected to be in the U.K. but it was a tough lap from last year with some nonoperating items.

And then we had a bit of flow-through challenge in Mexico.

But I'm quite comfortable with where we are in the portfolio as a whole.

And still am right in line with what I've said before, which is I still see margin expansion potential in PI.

We still have many businesses that are in the double digits, low double-digit range that can improve significantly.

And so, I still expect to see 25 to 50 basis points a year, as I've said before, in continued margin expansion in PI.

Thanks, Mike.

Thanks, Mike.

Just really quickly on that, if I take those 3 percentage points out of the revenue growth on the profit, it looks like despite all of that you still grew margins almost 70 basis points for your businesses before the acquisitions.

Does that sound about right?

Absolutely right.

Thank you.

Thank you.

Your next question is from Bill Pecoriello of Morgan Stanley.

I -- my question is on PBNA.

I wanted to talk about the two areas of profit pressure, which was the raw materials and the spend back.

With the pricing that you're taking in oranges, in orange juice, resident energy coming down, the new Gatorade plants coming on-line, do you think the net impact of the inflation would have peaked in this quarter?

And then can you talk about the nature of the spend back?

You continue to roll out many new products, which require space, also you have been increasing the merchant display activity on the noncarb portfolio.

So, should we see continued bias to reinvest on that type of trade spending in that division?

I'm going to turn it over to John Compton to talk about this, Bill.

And then I'll come back and make some of my own comments.

John?

Good morning, Bill.

This is John.

First of all, I would characterize PBNA as strong volume growth given what we were overlapping from the previous year.

And as Indra outlined in her prepared comments, the spread between volume and revenue we didn't see as much in the third quarter as we saw in the first half, largely due to the impact of the Gatorade mix not being as strong in this quarter.

Gatorade, we're pleased to say, grew 8% in the quarter, lapping the 34% growth from previous year.

So on the volume and revenue side, we're pleased with PBNA overall.

On the profit side, the performance was slightly below expectation and I'm sure yours.

And as you appropriately outlined, it was largely driven by raw materials, which was basically driven by increase in orange costs.

And that was something we had seen in the beginning of the year, but as the orange juice futures market escalated during the summer, that caused us to have to go back and true-up our contract prices.

We also got hit a little bit on resin costs and packaging, but that is something we don't see as long term being permanent.

But the orange costs we have seen as more structural.

And we have taken pricing, as you now know, on the Tropicana business going forward.

The Gatorade capacity, essentially all the growth that we had this year, as you know, last year we were on allocation for almost 120 days, so essentially all of our growth this year on Gatorade came from higher third-party copacking.

We approved manufacturing plants last year, one of which is in Wytheville, Virginia and it's up and running, as we speak.

The second is in Pryor, Oklahoma, and that's going to open in September of '07.

So -- and that obviously is less expensive than third-party manufacturing.

So, the Gatorade capacity issue I think is behind us.

The orange market I think currently we've priced to cover.

And the trade incentives on PBNA were a shift between A&M investments that we made this time last year and the couponing and trade incentives we made this year.

But as I've said, we're pleased with the volume growth.

We're happy now that year to date we have a business that has 5% volume growth in the PBNA line of business.

We have 9% revenue growth in the PBNA line of business.

And our profits are up 4%, despite the impact that oranges, the Gatorade capacity and some of the trade incentives on PBNA.

Bill, just to close off what John said, if I look across all of the raw materials, the one that is probably going to cause us to stop and think hard is the whole oranges cost.

Because that's where the run-up has been significant, and even though we have taken up pricing in Tropicana, we have got to watch and see what the category does next year.

So, we are looking at long-term supply chain initiatives to see how we can mitigate some of those costs.

But as I look at the basket of input costs going into PBNA, orange juice is the one that we need to focus on the most.

And then on the spend-back, on the -- I just wanted to be clear that you have a bias to focus on the top line in the volume there.

So, as you're rolling out all the new noncarb products in the deep portfolio you have there, we should continue to see you spend back and focus more on the top line there than the margin?

As John said, we look sat the whole spending, the push and the pull spending, Bill.

And every quarter, every year, we balance this based on the innovation that's coming out in the market, the nature of the competitive activity, and what we're overlapping from the previous year.

If you look at our performance in Q3 of last year, our A&M was up substantially.

In this quarter, we shifted some of that to couponing activity.

So we move these levels based on innovation, competitive activity, and the marketplace dynamics.

So going forward, our goal is to take this bucket of money we have on push and pull and based on innovation and the calendar, apply it judiciously against couponing and A&M.

So in some quarters you may see the couponing bucket going up, in others you might see the media stuff going up.

So, it's a function of our launch calendar.

Thank you.

Your next question is from Lauren Torres of HSBC.

Good morning.

More or less as a follow-up to Bill's question, if you could give us a sense of the magnitude of this increased marketplace spend in the quarter and just kind of specifically where is it going and where do you see it going for the rest of this year or maybe we could even look into next year?

Lauren, thanks for the question.

I'll give you a top line.

I don't know, John, if you want to add to this.

Let me put this in perspective.

As I look at the PBNA margin story and let me just focus on the difference between what we delivered versus what the sell-side models rolled up to.

The delta is about $60 million in operating profit difference.

The bulk of it was orange juice cost increase, more than half of it.

So, I want to put in that perspective that the single biggest driver was orange juice cost increase.

The next big driver was Gatorade capacity costs, PET costs and energy costs, which were much more than we anticipated, and not forgetting the big overlaps we were facing.

The marketplace investment and the impact to the bottom lain was the smallest bucket of them all.

And though we drew attention to it for full disclosure, that's not something I'd worry about too much because below the line we had A&M cutbacks because we were balancing the push and the pull, Lauren.

So I'd say overall, the marketplace spending and issues arising from that are minimal.

And marketplace spending is applied across all of our PBNA businesses, and this is something we do as a matter of course.

John?

I really don't have too much to add to that.

I think we have to remain competitive in the marketplace and I think you'll see on October 23, when you come to our conference, our innovation for next year looks strong, and that will allow us to sort of rebalance the push and the pull.

Great.

Thanks.

Thank you.

Your next question is from John Faucher of J.P. Morgan.

Two quick questions.

The first is -- and I apologize for harping on this additional spending.

Can you let us know whether this is warehouse oriented spending or DSD oriented spending?

And then secondly, switching gathers, can you talk a little about your shares outstanding number, and can we -- is there going to be a point where we will see a little more leverage below the line from a lower share count through higher buybacks?

Thanks.

John, you want to --?

I'll take the first part of your question, John.

The spend back was largely in DSD.

It was not in warehouse.

And from the shares outstanding, Richard?

On the share buybacks, we usually get about 1 percentage point worth of leverage, and that's -- and we anticipate that on a go forward basis as well.

Thanks.

Your next question is from Marc Greenburg of Deutsche Bank Securities.

Good morning, Indra.

Good morning, Mark.

Congratulations, by the way.

Thank you.

I'd like to talk about how PepsiCo manages -- or I'd like you to talk about how you manage your procurement practices against higher agricultural commodity input costs outside of orange juice.

Specifically, what kinds of things do you have in place that would cause your costs to be different than those reflected in the spot markets?

And can you talk a little bit about how your bottlers benefit from these practices as well?

Yes.

Marc, I tell you something, some of these details on our practices are proprietary to PepsiCo, and I'm not sure it's prudent for me to share all the details with you.

But let me do something.

At our analyst meeting on the 23, let's make sure we include a section on procurement practices, so that you all get a better sense for why we think global procurement is a major strategic advantage for us.

But just to give you a top line, clearly crops where we have buying power and we represent a large portion of the output of the crop, we work more carefully with the growers and work all the way back to the seed and work hand in hand with the growers to make sure that we manage the costs down.

Where we are a much smaller part of the output, which is not too many agricultural commodities, we have less flexibility.

But let's make sure, Marc, that when you come to our analyst meeting on the 23 of October, you make sure we cover that and I'll make sure we do, too.

Thank you.

Thank you.

Your next question is from Bill Leach of Neuberger Berman.

I have a question about the PBG gain.

You said the incremental gain was 20 million.

What was the actual total gain after tax?

The gain was $60 million versus about $40 last year.

What is the justification for putting that in operating earnings because it's fairly non-operating and eventually will end?

It's in our -- it's the equity income from the bottlers.

It's below the line, Bill.

Let me speak to that, Bill.

This is something we talked about three years ago when we started the PBG -- or two years ago when we started this sell-down of the PBG shares.

If you go back and look at what we talked about, we had to sell down the shares because we wanted to get back to the pre-IPO levels and make our ownership levels at an acceptable level in PBG> But at the same time we were doing that, we were also embarking on our business process transformation project.

And unlike most companies that undertook some sort of a massive systems transformation, we did not announce a special charge, and we're covering it within the double-digit EPS growth guidance.

So essentially, we're using the PBG share gain to offset this extraordinary investment we're making to upgrade our entire systems.

So I think this is how we manage the P&L and still delivered double-digit earnings per share growth.

But do you expect a comparable gain in the fourth quarter?

The fourth quarter --.

I think we had announced that we would sell 10 million shares overall for the year.

And we've sold -- that we would sell 9 million for the first three quarters.

So we'll have 1 million shares being sold.

And again, the gain is a function of what the PBG share price is at.

And then in the international actual results you referred to a gain which seemed to be about $20 million, a capital gain.

Is that correct?

Yes.

It was a $20 million gain in Q3.

There were some costs against that which will occur in Q4.

And lastly, do you expect PBNA to be up in profits year to year in the fourth quarter, if you adjust for the comparable weeks?

Well, we don't provide guidance by business.

All I'll say to you is that Q4, the business trends are looking good overall for the Company, and that's why we have taken up guidance.

Thank you.

Thank you.

Your next question is from Christine Farkas of Merrill Lynch.

Thank you very much.

A couple of questions.

Firstly, just on the corporate expense after several quarters of climb or rising costs we're seeing the last two quarters now flat to down year-over-year.

And of course the explanation was due to this accounting change in the third quarter.

Going forward, would we expect this trend to kind of continue on a similar path or is that $45 million accounting change really a blip on the year-over-year comp?

The 45 -- Christine, the $45 million is clearly a one-time event, and that it drove it down.

There are a whole bunch of other pluses and minuses in the corporate unallocated but that was the big one.

If you sort of net them, you had a $13 million increase in business transformation costs and a $45 million benefit on the accounting change.

And so that -- and that's why we were down by $29 million.

Otherwise, if you take a look at our basic underlying costs, they were basically flat for the quarter.

If you take a look at sort of normal G&A costs for corporate. they were basically flat.

Which is kind of what we saw in the second quarter.

Right.

So, we wouldn't expect that kind of leverage on a go forward basis.

That's helpful.

And then a question on your European business, or specifically the U.K. business.

Your European, Middle East and Africa numbers showed double-digit growth for both the snacks and beverages.

I'm Just wondering if you could give us a little bit more color on each segment?

Snacks, specifically on the Walker trend relative to the second quarter trends?

And then in beverages, on the back of [Rikbiks] reported quarter saw very good growth in still drinks and weakness in CSD's.

I'm just wondering if you have any more color on that?

And if the trends on the continents are similar?

Thanks, Christine.

Mike?

Sure, Christine, In fact, I just got back in last night from the U.K., so that's a great question.

We had a terrific quarter in Europe in particular.

Russia was very strong.

Let me talk snacks first and then beverages.

So on the snacks side, to your question on the U.K., we were up over a year ago in the U.K.

Not quite as strong as we were in the second quarter but that was because we were lapping some very deep deals, buy-one-get-one-free last summer, which we chose not to repeat this summer.

And kind of just as we looked at our overall trade strategy for the year.

So, it was a conscious decision but our base volume is still very solid.

The baked Walkers launch looks like it's off to a great start.

And so I'm quite pleased with the progress we're making there in that huge business.

In the rest of Europe on snacks, and as you know snacks is a big, big part of our Europe business, we really had some great performance.

Spain was up mid-single digits.

We've got a new product there that's a French fry product called [Alplato] doing very well.

Turkey was very strong, up 27%.

Holland was flattish, again, on a promotional overlap.

Russia and Eastern Europe are just flying for us.

Russia was up nearly 50%.

And even Romania was up 27%.

Poland doing very well also on the snack side.

So overall, I would say Europe snacks has add terrific year and continues to be very strong in the results that we're seeing.

On the beverage side, again, I would say the story was probably Russia and Eastern Europe primarily.

The U.K. was up modestly and we're pleased with that.

That's an improvement on where soft drinks had been earlier in the year.

As I mentioned, our Tropicana, France and U.K. business is absolutely on fire.

Russia was up mid-teens.

Trademark Pepsi was up 17%, which I was delighted with in the quarter.

And that was in the face of some challenges on supply that we had in the month of August, so really strong growth in Russia as well.

So, Eastern Europe in general had a pretty good quarter in beverages.

So overall, I would say kind of, again, lots of things that have been working well in our Europe portfolio as a whole, and both snacks and beverages equally contributing.

Okay.

That's terrific.

Thanks so much.

Thank you.

Your next question is from Bonnie Herzog of Citigroup.

Good morning, Bonnie.

Indra, actually I just had a comment going back to beverages in specifically North America.

I would like it if you could comment on your innovation pipeline for 2007, just maybe highlight in terms of, will we see more new products and packages relative -- next year relative to what has been introduced this year?

Also, I'm curious how you think about beverage innovation in terms of the balance between CSD's?

And then just finally, the strategy becoming more aggressive for beverage innovation if -- [Inaudible]

Bonnie, you're breaking up.

I'm so sorry.

We lost you when you said "more aggressive."

Yes, just more aggressive in terms of breaking into new categories in a big way, whether that's through partnerships, joint ventures, technology?

Bonnie, I wish you had asked me this question about snacks, because I could tell you more.

On beverages, given the competitive nature of the marketplace we have to share information very, very carefully.

But again, I'm not trying to make October 23 a teaser for all of you, but October 23 is the day we're going to not just share with you our plans but also share with you some of the innovation that we've already announced and coming into the marketplace in the first couple of quarters.

So, on October 23, when you hear the PBNA presentation, walk through our trade show featuring the innovation, come back and talk to me and we can address it it in Q&A at the general session, as to whether you think we've had enough new packaging, new products, new need states that we're going after.

I believe we are but I'll let you be the judge on the 23, which is less than two weeks away.

Well, then can I change my question?

Say what you were going to say.

Let's change it into, since everyone is focusing certainly on the beverage business, let's move into the salty snack segment and what's going on there, and sort of the same question is applicable.

Let me turn to the John because it's a good story in salty snacks, as it is in beverages.

But let's talk about salty snacks.

Hi, Bonnie, this is John.

As you saw in the quarter, continued very solid performance from Frito-Lay.

I had a chance to go down about 10 days ago and reacquaint myself with the team and see how well they're doing.

In the quarter, we had very balanced growth.

The Fun For You products grew 5%.

Our Smart Spot products grew 28%, which as you know are 15% of our total revenues at Frito-Lay.

Sun Chips was a big driver in the quarter for the total business.

At a trademark level, very balanced.

The Lays trademark was up 4%, driven by Baked Lays and Lays Kettle.

Tostitos was up double digits, driven by continued growth in Tostitos Scoops and our organic business.

Cheetos was up 6%, driven by Baked Cheetos, the Smart Spot Baked Cheetos and the organic Cheetos.

And our convenience foods business at Frito-Lay, was up double digit, driven between a balance between Gamesa and our Quaker light snacks business.

Introducing right now in the marketplace is Tostitos Baked Scoops.

We've always had Scoops on the regular platform.

Now, it's coming on the baked lines.

There will be new salsas and accompaniment dips to go with that.

And I think you're going to be very pleasantly pleased when you see the new innovation pipeline on the 23 from Frito-Lay overall.

And we saw a turnaround in the quarter on the Doritos business, which I know all of us were looking for, and the Doritos trademark started to improve in the third quarter.

And we're very optimistic about Doritos in the fourth quarter right now.

And Dawn, you might want to talk about what is happening right now in the marketplace in beverages and what to expect in the near term on beverages.

Well Bonnie, without going into total detail, I would tell you we see a strong innovation calendar for 2007, and it's important for us to balance that between CSD's and noncarbs.

CSD's because despite the softness in the category it still is more than 50% of beverage occasions and highly desirous by consumers.

And when you talk about new categories and new opportunities, I would answer it in two ways.

The opportunity in beverages broadly is consumers.

Both young consumers and old consumers want more specific benefits directed at them.

There are opportunities to create new areas of growth, many of which can be margin accretive for the division.

And so we're going to be putting the right balance between scaling some of our big noncarbonated businesses in particular and also entering new segments.

And some of those examples that we have talked about or you have seen in the press recently would be our alliance with Ocean Spray, Ethos, Premium Water, and Izze sparkling juice beverages.

And then one area that I'm hoping we're going to hear more about is dairy.

Yes, we'll talk about some of our launches in dairy.

All right.

Thank you.

Your next question is from Mark Swartzberg of Stifel Nicolaus.

Thanks, operator.

Good morning, everyone.

Indra, question for you on capital spending.

In the past, you have said that you see returning to your long-term target of 5% to 5.5% of sales in '07.

Of course, this year it's meaningfully above that.

Do you continue to have that view?

Well, again, Mark, in the next year or two, as we've indicated in our earlier call, capital spending does go up because our top-line growth is pretty spectacular at this point.

We're entering the snacks business internationally, as it grows we have to add more capacity.

Gatorade bringing the capacity in-house is going to require us to build more new plants.

And the fact that our hot food beverages are growing faster than the cold food beverages means that hot food capacity needs to come up.

Again, this is one of the topics we've highlighted specifically for our investor conference.

Because I think you need to get a rich understanding of where the capacity is going, what's the nature of the growth that it's going to generate.

And we're going to devote some time at the conference to talk about it.

So, I look forward to seeing you there, Mark.

So, that actually sounds like a change.

Like this year I think it it's about 6.3% or so.

Can you give us an idea for '07?

The return to the 5% to 5.5% is going take a couple of years.

Sorry?

The return to the 5.5% CapEx is going to be two years out.

Can you give us any idea of what level for '07?

We will give you an answer on the 23 of October, but not today.

Okay, great.

Thank you.

We're just finalizing the plans.

Fair.

Thank you.

Thank you.

Your next question is from Alec Patterson of RCM.

Yes, good morning.

One quick one on the PBG sell-down.

How many more shares do you have to go?

Richard?

We now -- we started at the -- in 2005 we were at sort of 45% economic interest.

We're now at 42, and we were planning on getting down to 40.

So, I think we were anticipating selling another 10 million shares next year.

Alec, the thing to be careful about is we target getting to a pre-IPO ownership level.

So, that's where we want to get.

And so the IPO ownership level, if PBG keeps buying back shares, that level keeps going up.

So, we have to buy back down to that level.

So, it's a function of what we have as a number and then PBG's share buyback program.

Understood.

And then just a broader question, Indra, on Frito-Lay and the -- sort of the sales versus costs and margin algorithm over time.

If the numbers I have are right, which is always a question mark, it looks like margins have been essentially flat in Frito-Lay for the past few years, and we clearly do have some more head winds on the food ingredient side in front of us.

Any thoughts as to how we should be looking at that algorithm of sales and costs in Frito-Lay North American over time versus where we've been?

We don't provide division-specific guidance but let me turn to John to just give you some top-line comments on Frito-Lay North America.

I think, Alec, as you've seen in the quarter and year to date, the revenues are growing slightly faster than the profits.

And in each quarter there's been investments that we've made into the business.

Q3 is an example, we launched the sunflower oil conversion on to both Lays and Ruffles.

That's not dissimilar from the trans fat conversion we did three or four years ago.

And in the quarter we didn't take pricing to cover that.

We rolled those products into the marketplace.

So, I think our expectations on Frito-Lay are pretty consistent with what we've been delivering year to date this year.

And Alec, the thing to focus on, as I mentioned it in my opening comments, but let me reiterate it, think of PepsiCo as a portfolio.

And each piece of the business we manage individually to make the overall portfolio work.

There are times we will allow investments to continue in certain businesses, not let the pricing go up.

Other times we will take pricing based on how the overall portfolio works and the consumer dynamics work.

So, Frito-Lay has had a couple of years of major investments and inflation and we didn't price up to cover all of it because that was a conscious decision we made.

And as long as the portfolio works we'll keep driving share by doing those sorts of activities.

So, can I try and rephrase that last comment, Indra?

As the past few years have been investment periods for Frito-Lay, such that going forward this type of sales growth should be leverageable?

Let's just say, why don't you talk about it as PepsiCo overall?

And say that PepsiCo overall portfolio seems to be working.

Okay.

All right.

Thanks, Indra.

Thank you.

Your next question is from Ann Gurkin of Davenport.

Good morning.

I have two things.

One, in doing some store checks in the Mid-Atlantic, it appears that Sun Chips have been out of stock in some instances due to production issues.

So, I was just wondering if you could touch on that and the status of that production?

And then secondly, with the recent acquisition of Izze and the recent agreement regarding snacks and schools, I wonder if you could just review the approach to that segment, that school market?

John, Sun Chips?

Well, Sun Chips we're very pleased with the growth overall, it's north of 30%.

We've had to add capacity to keep one growth.

And there, I'm sure, have been isolated pockets when we have been out of stock.

That's both a good problem and a bad problem to have.

Fortunately, we've got strong growth in the business.

We are very pleased on the agreement we have with the Clinton and the American Heart Association Alliance.

We're the only CPG Company to enter into that agreement both on foods and beverages.

And we think it's an opportunity for our Company because we have an advantaged portfolio in the noncarb arena in beverages.

And we have an advantaged portfolio in the snack side to be on the healthier snacks.

So, we see it as an opportunity to continue our growth in that segment.

Many of our products are already in those schools today, and I'll turn it over to Dawn to take the Izze part of your question.

Hi, Ann.

Yes, Izze for us is even broader than schools.

It's a great play, and an emerging category that we look at it as sparkling.

And bringing the fun of sparkling beverages to juice with all the nutritional value of juice.

And it will be part of our portfolio for schools.

Thank you.

Thank you.

Your next question is from Robert van Brugge of Sanford Bernstein.

Just a quick question for Mike.

Was there any negative impact on the Indian beverage business from all the contamination allegations during the quarter?

Mike?

Yes, Robert, certainly, from a volume standpoint there was.

In August, in particular, we had a disappointing volume trend.

It has improved a little bit in September.

We have been on-air trying to be as clear as we can about the safety of our products and about the testing, the quality testing and all of the procedures that we go through to treat the water and the sugar with filtration systems in the plant that we have in all of our plants in India.

We are working closely with the government and with our competitor to try and ensure that we get clarity on regulatory standards in the country.

And I'm optimistic that we will see an improvement both in the business and clarity in that regard over the next couple of months.

So we're making, I think, progress.

We're doing the right thing but there was certainly an impact in the quarter on volume.

And it certainly impacted revenue and profits for the business relative to what we had expected going into the quarter.

But it's not material from a total PI standpoint, frankly, when I look at the size of that business as a part of the total international business.

Okay.

Great.

Thanks.

Thank you.

Your final question is from Bryan Spillane of Bank of America Securities.

Just quickly, was Frito-Lay advertising up in the third quarter?

Yes, it was.

And it's up year to date as well?

Yes.

Okay.

Thank you.

Thank you.

I would like to hand the floor back to Jamie Caulfield for any closing remarks.

Jamie, if it's okay with you, I'll take the closing remarks.

Thank you all for joining us this morning.

We appreciate your interest in PepsiCo.

As I said in my opening comments, the business trends look good.

We have taken up guidance and across the portfolio all of our businesses are seeing strong top-line growth.

As we look at our Q4 performance, you will see that we will continue to invest in the beverage business but the overall PepsiCo portfolio seems to be working quite well.

I look forward to seeing many of you at our investor meeting on October 23 in Manhattan and answering all the questions you may have about our business.

And for those who cannot attend in person I certainly hope you will join us for the Webcast.

Have a great day and thanks for your time.

Thank you.

This concludes PepsiCo's conference call.

You may now disconnect.