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

Executives

Mike Nathenson - Vice President, Investor Relations
Indra Nooyi - Chairman and Chief Executive Officer
Richard Goodman - Chief Financial Officer
Michael White - Vice Chairman and Chief Executive Officer, PepsiCo International
John Compton - Chief Executive Officer, PepsiCo Americas Foods
Massimo Fasanella d''Amore - Chief Executive Officer, PepsiCo Americas Beverages

Analysts

John Faucher - J.P. Morgan
Kaumil Gajrawala - UBS
Christine Farkas - Merrill Lynch
Bill Pecoriello - Morgan Stanley
Bryan Spillane - Banc of America Securities
Marc Greenberg - Deutsche Bank
Judy Hong - Goldman Sachs
Lauren Torres - HSBC

Presentation

Operator

Good morning and welcome to PepsiCo''s third quarter 2008 earnings conference call. Your lines have been placed on listen-only until the question-and-answer session. (Operator Instructions) In order to ask a question or make a comment please press * followed by the number 1 on your touchtone phone at any time. You may remove yourself from the queue by pressing the pound key. Today’s call is being recorded and will be archived for 14 days. It is now my pleasure to introduce Mike Nathenson, Senior Vice President of Investor Relations. Mr. Nathenson, you may begin.

Mike Nathenson – Senior Vice President of Investor Relations

Thank you, operator and good morning everyone. Thank you, all of you for joining us. Today''s webcast includes a slide presentation that can be accessed at our PepsiCo.com website. Before we begin, please take note of our cautionary statement. This conference call includes forward-looking statements based on currently available information, operating plans and projections about future events and trends. Our actual results could differ materially from those predicted in such forward-looking statements, but we undertake no obligation to update any such statements, whether as a result of new information, future events or otherwise. Please see our filings with the Securities and Exchange Commission including our annual report on Form 10K and subsequent reports on Form 10-Q and 8-K for a discussion of specific risks that may affect our performance. You should refer to the Investor section of PepsiCo''s website at www.PepsiCo.com under the heading PepsiCo Financial Press Releases to find disclosures and reconciliations of non-GAAP financial measures that may be used by management when discussing PepsiCo''s financial results with investors and analysts.

Just one housekeeping item, during today''s call, our references to core EPS growth exclude the one-time tax benefit recorded in the third quarter of last year as well as marked-to-market gains or losses on commodity positions included in corporate unallocated expenses in both this year''s and last year''s third quarter. Also, all references to core EPS guidance exclude any commodity marked-to-market impact as well as Productivity for Growth costs. This morning''s prepared remarks will be made by Indra Nooyi, PepsiCo''s Chairman and CEO, and Richard Goodman, PepsiCo''s CFO. Also, after our prepared remarks, the following executives will be available to answer questions during the Q&A session, John Compton, CEO of PepsiCo Americas Foods, Massimo d''Amore, CEO of PepsiCo Americas Beverages, and Mike White, PepsiCo''s Vice Chairman and CEO of PepsiCo International.

With that I will turn the call over to Indra.

Indra Nooyi – Chairman and CEO

Thank you Mike, and good morning everyone and thank you for joining us. I know that all of you have had a chance to review the press release we issued this morning, and on this call we will be focusing our remarks in five key areas, which should leave ample time for a robust Q&A session. So let me outline the key points and cover each of them in more detail. First, we had solid business results for most of our portfolios. PepsiCo International and PepsiCo Americas Foods performed very well, and they did so in the context of a challenging and volatile macroeconomic environment. As we''d indicated on prior calls, the third quarter represented our most difficult commodity cost comparison versus prior year, and so it is especially encouraging to see solid volume growth in our Snacks businesses around the world, which reflects clearly the strength of our brand, the positive impact of innovation and the successful execution of our price pack strategies. We also saw strong performance across both our Snack and Beverage portfolios in key developing markets.

The second point I''d like to make to you is that our North American Beverage business was soft, reflecting in large measure category challenges. Regaining growth is a major priority for us, and I''ll be talking in a few minutes about the actions we are taking. Third, no news to you but the macroeconomic climate is turbulent and there are uncertainties and volatility in every part of the environment. The constants, however, are the basic strength of our business model, our terrific management teams, and our ability to execute at the field level. We will be agile in our planning and in our operations. Fourth, we are implementing a Productivity for Growth initiative which we expect will produce $1.2 billion in pre-tax savings over the next three years. This will enable us to invest in our businesses, to further improve our competitiveness and to give us breathing room to respond to changes in the marketplace, and fifth and most importantly, we continue to have robust free cash flow, which provides a sound financial base for us at a time when the financial markets are uncertain.

So let me go into detail on each one, turning first to Q3. PepsiCo International delivered solid performance in Q3, while lapping 20% revenue growth in the prior year period. PI''s diverse brand portfolio continued to benefit from growing demand across most markets outside the Americas, despite significant pricing actions to offset the impact of commodity cost increases. Revenue increased 20% and operating profit increased 18%. Growth across the Middle East, Africa, Asia segment was broad based, with revenue up 22% and operating profit up 18%. Snack volume increased 9%, led by high teens growth in the Middle East and double-digit growth in China and India. On the beverages side, volume increased 10%, driven by a combination of mid-teens growth in China, double-digit growth in the Middle East, and high single-digit growth in India. In the U.K.-Europe segment, PI performed well despite increased inflation, macroeconomic challenges, and unseasonably cool weather during the summer months which particularly impacted Beverage results. Revenue and operating profit each grew 17%, benefiting in part from the weaker dollar.

The soft spot in Q3 was beverages. The U.K.-Europe volume growth of 13% entirely reflects the benefit of two acquisitions, Sandora, a Ukrainian juice business, and the expansion of the Pepsi-Lipton joint venture in Europe. Excluding M&A activity, volume was down slightly, with a mid single-digit increase in the U.K. entirely offset by category softness across the continent and Russia, in part related to poor summer weather. Note however that in September we saw an improvement in volume as volume in the U.K.-Europe segment was up high single digits on an organic basis. Snack volume in Q3 was largely in line with expectations and reflected visual pricing and rate hours across the category to address inflationary pressures. Snack volume grew 4% on an apples-to-apples basis, excluding a calendar reporting change in Iberia that excluded about three weeks of performance versus the year ago period. Russia led the segment, with high teens growth.

Overall, Q3 was a good quarter for PI and at the end of the quarter PI closed with its Marbo Snack acquisition in Serbia and it''s Lebedyansky juice acquisition in Russia. We will report the financial performance of these two businesses in Q4. Let me now turn to PepsiCo Americas Foods, where revenue was up 12% and profits were up 9%. Frito-Lay North America Snack brand grew volume 1.5% even as we realized net price increases from rate hours and visual pricing to offset inflation. Revenue growth of 9% was broad based. In addition to growing across all major brands, Frito-Lay North America sales also increased across all retail channels and gained dollar market share in major channels in the savory snack category. We are pleased with the brand equity and pricing power of our brands, with consumer response to our pricing coming in about where we expected. In Q3 we fully realized our 2008 pricing initiatives for the year and, as is customary, we plan to implement another round of judicious pricing in Q4 as we prepare for 2009.

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

Latin America Foods reported revenue growth of 23% and profit growth of 22%. Organic revenue growth was driven by net price realization, both in the form of rate hours and visual pricing across all of our businesses. Let me now turn to Pepsi Americas Beverages. It''s clear that this business is not performing where we would like it to be, in large part because the economic slowdown continues to pressure the North American Liquid Refreshment Beverage category. In major channels category volume was down 3% and overall category revenues were flat, in part as a result of significant discounting in unflavored water. The CNG channel remains soft, with consumer shopping and items purchased per trip both down and beverages have been particularly hard hit. In this environment, CAB volumes declined 2.5%, reflecting a 4% decrease in North America, partially offset by an increase in Latin American beverages. Net revenue was flat for the quarter and operating profit declined 11% largely due to a combination of higher input costs, particularly higher fuel costs, de-leverage from the soft volume, and expenses related to the implementation of SAP.