PepsiCo, Inc.
Q2 2008 Earnings Call Transcript

Published: 23 Jul 2008

[Operator:]

Welcome to PepsiCo's Second Quarter 2008 Earnings Call. Your lines have been placed on listen-only until the question-and-answer session. Today’s call is being recorded and will be archived for 14 days. It is now my pleasure to introduce Ms. Jane Nielsen, Vice President of Investor Relations.

[Jane Nielsen:]

Thank you. 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 statements. 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. 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 10-K and subsequent reports on Form 10-Q and 8-K for a discussion of specific risks that may effect our performance. You should refer to the Investor Section at the 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 house-keeping item, during today's call, our references to EPS growth excludes the current and prior year mark-to-market gains or losses on commodity positions, included in corporate and allocated expenses. This morning's prepared remarks will be made by Indra Nooyi PepsiCo’s Chairman and CEO; John Compton, CEO of PepsiCo Americas Food; Massimo D'Amore, CEO of PepsiCo Americas Beverages and Mike White, PepsiCo's Vice Chairman and CEO of PepsiCo International, who is joining us from Switzerland, and Richard Goodman, PepsiCo's CFO. After our prepared remarks, we'll move to Q&A. Now to Indra.

[Indra Nooyi:]

Thank you. I appreciate the opportunity to discuss PepsiCo's second quarter performance and our outlook for full year 2008. Now as you saw in this morning's release, we delivered strong second quarter results and I am proud of our performance for the first half of 2008. This quarter, with 4% snack and 5% beverage growth, 14% revenue and 11% EPS growth, our portfolio performed well, especially in the context of absorbing higher levels of commodity inflation and implementing pricing actions around the globe, all while driving against an aggressive productivity agenda. I think this demonstrates our ability to successfully manage the challenges of the current environment, through the power of our portfolio, the breadth of our global footprint, but more importantly, the can-do spirit of our associates around the globe. With strong overall results in the first half, we are on track to deliver earnings per share of at least $3.72 in 2008, excluding the net impact of mark-to-market gains and losses. Now, as you are all aware these are interesting times. Inflation has become a part of consumers' daily lives and economies are slowing in many developed markets. And these realities may be raising some key questions in your mind. For example, given the growth outlook for our international markets, can we manage escalating inflation and drive top and bottom line growth, and can our portfolio manage through the current weakness in the U.S. liquid refreshing beverage category. Before I turn it over to John, Massimo, Mike and Richard, let me share a few thoughts on these questions with you. First and foremost, we have confidence in PepsiCo's outlook. Actions speak louder than words so today we are confirming our 2008 guidance and announcing an increase of at least an additional billion dollars in share repurchases over the balance of the year, bringing total repurchases to at least $5.3 billion during the year 2008. Let’s look at the results and trends that are the basis for our confidence and help provide answers to your questions. First of all, our markets outside the United States remain vibrant. PepsiCo International delivered double-digit snack and beverage growth, both in the quarter and for the first half. Our focus on brand recognition and local relevance combined with convenience, quality and outstanding distribution has delivered steady growth, even as we have effectively executed our pricing strategies. Clearly, we are closely monitoring each of our markets for signs of changes in consumer behavior, and trying to separate the impacts of weather and other temporary factors from any longer-term indicators of change. At the same time, we continue to see the fundamental long-term growth opportunities created by low per capita consumption, a growing middle class and share expansion, especially in micro snacks and non-carbs. We are embracing the challenges of successfully navigating amidst inflation and economic uncertainty. We know we won't drive performance to the business as usual attitude, so we've made changes in three key areas and we are very encouraged with the early results. First, we have adjusted our approach to global procurement, to minimize commodity volatility and uncertainty while reducing costs. We are accomplishing this by hedging a higher percentage of our commodities and by taking longer positions. So in addition to having very extensive commodity coverage for the balance of the year, we also have significant positions for 2009. Second, we are leveraging our pricing and revenue management capabilities around the world. In many cases, we are taking a lesson from our international teams who have managed structural inflation currency devaluations for years. Optimizing price pack architectures and trade investments across our product lines is critical in providing a great product at an attractive price point for our broad consumer base. This quarter, our team showed great revenue management expertise, as we worked with customers locally and in --> power of one teams [Author

[John Compton:]

Thanks Indra. I'm pleased to take you through PepsiCo's Americas Food strong second quarter results. Our volume was up 2%, revenues were up 16% and operating profit grew 13%. I'm proud of the work the teams have done to successfully grow our top line, while managing through the ongoing commodity headwinds facing our businesses. All three of our businesses contributed to balanced growth. So let me take you through the results of each. Frito-Lay's second quarter results with volume growth of 2% and revenue and operating profit each growing 8% were driven by solid volume growth, effective net pricing, and productivity. [Casually] interest true-up accounted for 1 point of the overall operating profit growth. Now, our volume growth was largely driven by strong increases for our core salty brands, like Cheetos, Ruffles and Fritos, and double-digit growth for our better for you brand like SunChips and Quaker Chewy Granola Bars. Our --> lays[Author

[Massimo d'Amore:]

Thank you. I’ll provide you an overview of PepsiCo Americas Beverage and our forward focus. This quarter was a tale of two cities for our business. First, our Latin American markets performed well and we increased volume in mid-single digits. But in North America, our business was challenged. PB declined about a point versus the prior year and total operating profit decreased 7%. In fact, North American beverages faced a perfect storm. With declining category volumes, rising inflation, are shifting channel mix away from C-Stores and food service and the slowing growth in unflavored water. Let me review now some of these factors. You know that the economic slowdown continues to pressure the LRB category. Consumers seek value and affordability, while the rising inflation requires pricing actions. This quarter, the total LRB category has declined almost four points in measured channels and about two points across old channels. We have not seen these kinds of declines since we started measuring this category. We saw a significant shift away from convenient channels. Indeed, food traffic declined over 10% in Q2. As a result, C&G beverage volume declined and LRB scan data was down more than 5.5 points, about 8 points below its historic growth rate. As you know, food service is also experiencing a consumer pullback. We estimate that convenient channels put about two points of pressure on the overall LRB category, which had some downstream impacts as well. Flavored water, which grew double digits over the last two years, had moderated growth across all channels and was flat this quarter. Consumers are eating more at home and increasing consumption of tap water as they look for ways to economize. So, with that as a bit of context for the market, I'll take you through our results in North America. For CFDs this quarter, we gained volume and value share, although volume was down 2%. This share growth reflects our strong performance in our Mountain Dew and Sierra Mist trademarks. Mountain Dew loyal user base showed their passion by posting over 200,000 online votes to determine the next new flavor. Our customers have fully embraced this Mountain Dew initiative, which is driving awareness, especially in C&G, with engaging point of purchase displays. Our new Sierra Mist line extension and their cover orange is driving consumer interest in trial, especially in the impulse channels. Finally for CFDs, although trademark Pepsi was down mid-single digit, growth in Pepsi Max is very encouraging. Now, turning to non-carbs, Gatorade continued to gain volume and value share. And total, shipments grew slightly in the quarter, despite the weakness of the convenience channels, where Gatorade is highly developed. Importantly, Gatorade scans in the grocery, drug and mass channels with up about 5.5%, in line with our expectations. We also showed progress on our shelf resale’s, adding four additional SKUs in large format and gained about half a share in the C&G cold wars. G2 continues to gain consumer acceptance and broaden the user demographic. As a result, our trail and repeat numbers in G2 continue to be stable. Tiger also continues to grow trial and repeat with its unique formula and the differentiated link to Tiger Woods. Overall, Gatorade grew faster than the category and I expect it to continue to do so as we are investing in marketing and trial on G2 and Tiger and will focus our execution to give the entire Gatorade line-up the space it deserves to continue overall. Also in hydration, our SoBe Life Water brand continued strong growth, with volume up over 50% and very strong repeat rates. With three new flavors and a new very popular commercial, we expect SoBe Life Water to continue growing its user base. Turning now to the energy category, our total energy portfolio was up 18%. Our Amp business is driving a lot of this increase and our association with Dale Earnhardt, Jr. as a result of the Amp Energy more than doubling its business in the quarter. You also know that consumers love tea. Lipton Tea is the undisputed market leader in tea across America. A large number of Lipton Iced Tea users consume it on the go and we will be leveraging our one liter package to offer a great value in [these] channels. You will also see great packaging news on Lipton, a new light weight bottle with 20% less plastic, which will save 20 million pounds of plastic each year. We're also expanding our offerings on Lipton PureLeaf, our best quality tea the gold standard. We have increased the amount of tea we offer in PureLeaf and added new consumer preferred varieties like red and white. Our Tropicana juice business was down mid single digits, partially due to weight-out in our new 89-ounce picture, which is a packaging improvement offering easier pour and the new flip-top lid that feels easier. This is the start of our important efforts to re-engage Tropicana consumers with packaging, innovation and brand marketing to strengthen the health credentials and the naturalness of the Tropicana brand. As Indra said, during these times we need to retool and retain. During this quarter we maintained our focus on affordability despite rising commodity costs and we continue to invest in A&M, IT distribution. Volume and profitability pressured performance in North America below our expectations. Going forward, our focus is on developing priced pack architectures and innovations, to meet the consumer need for affordability, while driving net revenue and profit for us and for our bottling partners Stay tuned for news of our 2009 initiatives, which we'll unveil early in Quarter 4. Now Latin American markets, beverage growth was broad-based, with mid single digit CSD growth and double-digit NCB growth. This growth was led by H20 with rollout across the region and with successful flavor extensions in Argentina and Brazil. Lipton was up over 70%, with excellent growth in Mexico and successful launches in Central America and Venezuela. Finally, Gatorade also performed well, with growth across all key markets and continued strength in Mexico. In total, continued strong results in Latin America. Now over to Mike.

[Mike White:]

Thanks, Massimo. As you've all seen in our release, PepsiCo International turned in another strong quarter. Our revenues were up 25% and our operating profit up 18%, despite of lapping more than 30% profit growth in 2007. Now to address rise in commodity inflation, we did continue to execute our plan to phase in price increases to optimize consumer acceptance while holding volume growth. This approach has worked very well, as evidenced by our strong, very balanced top line growth. Our performance allowed us to make incremental investments in marketing in China and India, as we continue to build important platforms for growth in those countries. Overall, I'm very pleased with PI's second quarter results two fronts are particularly encouraging. First, we drove growth across our categories and products. Volumes were strong across our snacks products, up 10%. Our carbonated soft drinks were up over 6%, and our non-carb beverages were up strong double digits, led by Tropicana and Lipton. This growth in part reflects our consumer-driven innovation and the broad appeal of our marketing initiatives. Our growth was also geographically broad-based. Our developed markets grew steadily and our emerging markets accelerated our total growth significantly. In fact, PI's 10 largest snack and beverage markets posted organic volume growth of about 9% in the quarter, terrific performance. A brief overview of our innovations and marketing follows, with market and brand performance by division. Our focused innovation in marketing capabilities produced strong growth. On beverages, the juice platform expansion which has been a major area of focus over the past several quarters, continues and is doing very well. Among other juice and juice drink initiatives, we launched a new package in India and we expanded our Tropicana Smoothies product from the UK to parts of Western Europe, with different fruit flavors, such as mango passion and fruit pineapple. In China, we continued with the geographic rollout of Tropicana juice drinks, which is achieving impressive consumer acceptance. Regional rollouts of Pepsi Max and 7UP H2O continued to be strong. During our second quarter we launched Pepsi Max in Vietnam and Pakistan, and H20 in China, Lebanon and a few additional European markets. We've also added new flavors, citrus, apple and tangerine to our 7Up H2O line-up. In China, our Go China chain has been successful in engaging consumers in a unique Pepsi way with the two-thumbs up way to cheer on China's athletes in the games next month. Our base snacks lines are also doing well in both Russia and Spain and we're borrowing a page from my friends in the United States, where consumers take control of their brand's new flavor innovation. For instance in India, we launched a fight for your flavor program where consumers will vote on their favorite lays flavor innovation and each flavor has its own celebrity sponsor. So together, innovation and marketing continue to fuel growth across our categories and our markets. Turning now to our divisions, let me discuss first the UK and Europe and then the Middle East, Asia and Africa markets. In the UK, our developed snacks market grew very well with Walkers setting the pace as they continue to successfully implement pricing while also growing volume mid single digits. Our [British] promotion was a successful way to add consumer value, while --> taking[Author

[Richard Goodman:]

Thanks, Mike. We are pleased with our overall operating results in Q2, with revenues up 14% and division operating profit up 7%. As you saw in the release, our reported EPS was $1.05 and excluding the net impact of mark-to-market gains in both years, it was up 11% to $1.03. Our below the line leverage reflected mark-to-market gains of $61 million on commodities that do not receive hedge accounting. This mark-to-market gain compares to a $13 million gain in the previous year for a net change of $48 million. So the mark-to-market drove about two points of operating leverage and contributed $0.02 to our per share earnings. Let me remind you that over the duration of our contracts, the mark-to-market impact on corporate costs, nets out to zero with hedges ultimately being reflected in division costs. We will focus our discussion and guidance on EPS and EPS growth, excluding the impact of mark-to-market gains and losses in both the current and prior year. We believe this provides a better perspective on our ongoing business performance. So setting mark-to-market gains aside, lower employee related expenses helped drive other corporate, unallocated costs down $23 million in Q2, offsetting higher interest costs, lower equity income from bottling investments, and continued investments in our business process transformation and in R&D. Developmental costs were slightly down in the quarter. Our tax rate for the quarter was 26.7%, up 20 basis points versus last year. We returned $2 billion to shareholders, $600 million in dividends and $1.4 billion in share repurchases. As a result, our weighted average diluted share count declined by 3.1%. Turning to our balance of the year outlook, we are taking advantage of the current market conditions to repurchase additional shares. As Indra indicated, we will increase our share repurchases to at least $5.3 billion for full year 2008, up by at least $1 billion from our prior guidance of $4.3 billion. Through the end of the second quarter, we spent $2.9 billion on share repurchases. Our outlook is for continued strength in the second half. However, as we manage the company to deliver our performance commitments for the year, we expect stronger performance in Q4 than in Q3. Our commodity overlaps are most challenging in Q3 and as John noted earlier, the floods that damaged our Cedar Rapids facility in June, will impact Quaker Food's performance in Q3. We have insurance coverage, but due to the timing of preparing and approving claims, some of the insurance recovery might not be recognized until Q4. Throughout the balance of the year, we will continue to drive against productivity and expense control. Overall, with our solid results in the second quarter, we are reiterating our EPS guidance for the full year, volume of 3% to 5%, low double-digit revenue growth, including acquisitions of Forex, and EPS, excluding the net impact of mark-to-market gains or losses of at least $3.72. Finally, there is no change to our cash flow or CapEx targets. Back to Indra.

[Indra Nooyi:]

Thanks, Richard and as I said to you at the top of the call today, I'm really proud of our business results and the strength and resiliency of our portfolio and the outstanding commitment and capability of our people really gives me confidence on the future outlook for our business. Now, before I open it up for your questions, I just want to share something with you. This is Jane Nielsen, our Head of Investor Relations, her last call. And I’d like to thank her for her passion and commitment during her time on the road. Jane is staying in the PepsiCo system, but is moving with her family to the Boston area. Taking Jane's place is Mike Nathanson, who until recently was Head of PepsiCo’s Financial Planning and Analysis team and since joining PepsiCo 13 years ago, Mike has held multiple leadership positions, including being the CFO for our Australian snack business. Mike is an incredible individual. I have great respect for Mike's capabilities and I'm confident he will serve our investors well. Mike, you have big shoes to fill, but I'm sure you'll do a great job. Both Jane and Mike have been working together over the past two months to make this transition seamless and will continue to do so through the summer. So with that, let's open it up for questions.

[Operator:]

Thank you. (Operator Instructions). Our first question is from Bill Pecoriello with Morgan Stanley. Please go ahead.

[Bill Pecoriello:]

Good morning, everybody.

[Indra Nooyi:]

Good morning, Bill.

[Bill Pecoriello:]

My question is, you talked about putting on some coverage for ‘09. Can you give us an idea of what percentage of your input costs are now hedged for ‘09 and then given the lead time you have to think about another year of input cost inflation, can you provide any more color on the types and the magnitude of some of the productivity savings that you might see for ‘09?

[Indra Nooyi:]

Bill, let me touch on the productivity savings and then toss it to Richard, who will give you some color on coverage. As I said in my script, in the end of Q3 or early Q4, we will announce our productivity program. So at this point, we are not ready to share with you the details, but just know that it is going to be meaningful and so with that, let me turn it to Richard.

[Richard Goodman:]

Bill as you know, it is really still a little too early to give an estimate for 2009 and we typically do that on our call later in the year. However, obviously, there have been increases in grains and cooking oil and fuel, so there will be inflation next year. That said, as we have discussed, we really are taking the opportunity to decrease our volatility by expanding the amount of coverage that we take and the duration of the coverage we take. So clearly it is higher going into 2009 than it was going into 2008. However, I really do not want to talk about specific percentages at this point.

[Bill Pecoriello:]

Is it too early also to comment if you will be able to rely less on price into ‘09, given the coverage and the productivity programs?

[Richard Goodman:]

Yes, it is a little too early because we are still formulating the productivity programs that we have and then when we have a very more complete understanding of the inflation environment as well as the productivity, then we will have a better sense of what amount of pricing that we will be need to be taking as well.

[Indra Nooyi:]

Bill, we also talked about price back architecture. What we want to do is to make sure that we balance productivity, affordability, and competitive gaps in prices. We want to make sure we maintain a reasonable gap versus competition and not let that widen too much. So as Richard said, as the year progresses and as we complete all our price back work and look at the inflation trends and look at competitive pricing, we will then implement our pricing actions. Just rest assured that every one of our divisions has a maniacal focus on 2009 and what to do to make sure that we are ahead of the curve in 2009.

[Bill Pecoriello:]

Okay, thank you.

[Operator:]

Thank you. Your next question is from Mark Schwartzburg with Stifel Nicolaus. Please go ahead.

[Mark Schwartzburg:]

Thanks. Good morning, everyone.

[Indra Nooyi:]

Good morning, Mark.

[Mark Schwartzburg:]

Indra, division operating profit in the quarter ex-currency, I believe was up 4%. Can you talk a little bit about how you think that number compares to what is going to happen in the future and perhaps things like we just heard from Richard, the volatility and cost management, the improvements you expect there, might we consider that a trough number, incremental pricing, incremental productivity, for is a lot lower than we have seen historically. How do you think it is going to compare to the upcoming quarters next year?

[Indra Nooyi:]

Mark, the first two quarters and going into the third quarter is when we have the extraordinary inflation hitting us and as we said in our Q1 call, the Frito-Lay pricing started going into effect in Q2. In fact, we did not have the benefit of the pricing the entire Q2. On top of that, as Massimo discussed on North American beverages, we were all balancing affordability and beverages and not taking up the pricing too much, when traffic was slowing down, especially in C stores for beverages and making sure we were driving some volume growth. The good news is we had four as tail winds that allowed us to reinvest in some pricing, keep our investments in A&M up at a fairly high level and keep investing in R&D and IT. So as we managed the portfolio and looked at the overall EPS numbers, we felt like driving the top line revenue growth and getting the pricing in initially was more important than focusing then directly on line of business operating profits. So the portfolio in fact worked. Going forward, Q3 is going to be an interesting quarter because the full impact of the commodity inflation hits us in Q3, but we will also get a full quarter of Frito-Lay pricing. I think the portfolio is still going to work well in the second half. I think sequentially as you go through the year, into Q4, our line of business operating profit improved and as you go into 2009, as we take all the pricing actions earlier, you start seeing sequential improvement. Richard, did you want to add anything on that?

[Richard Goodman:]

Yes, I think we do manage, we manage it as a portfolio and as Indra said, it is really rather than looking at a specific line item expert or we trying to be able to balance all the things that we need to achieve over both the quarters and the year, and so I think, you know, part of the Forex impact was also seen in our cost of goods sold because inflation, part of the inflation was driven by the poor dollar. So it really is the ability to have the broad portfolio that allows us to achieve this sort of consistent results.

[Indra Nooyi:]

Mark, given the tail winds on the Forex, we made a conscious decision to keep investing in A&M, R&D, IT. We said we are not backing off any of those expenses, because we really have an eye towards the long-term future of the company. So feel good about the top line. Feel good about revenue. Feel very good about overall EPS in returns.

[Mark Schwartzburg:]

Great. Thank you.

[Operator:]

Thank you. Your next question is from Jonathan Feeney with Wachovia. Please go ahead.

[Jonathan Feeney:]

Good morning, thank you.

[Indra Nooyi:]

Hi, Jonathan.

[Jonathan Feeney:]

Just one clarification. John told us about how convenience stores held up actually quite well with, on the Frito-Lay side, but in North America, but Massimo told us that it cost beverages 2 points of pressure. Why do you think the desperate performance inconvenient stores between the Frito-Lay portfolio and beverages, is there something specific to the beverage portfolio in that channel that you could elaborate on?

[Indra Nooyi:]

John, do you want to take this?

[John Compton:]

Jonathan, its John. Two things, one on the Frito-Lay side, the pricing that we took in that channel was largely through the weight-out. Some of our visual price points has been and remains at 0.99 cent package. That is largely what consumers see when they walk into the store. As we said in our comments, we also had a very deliberate execution focus against specific multicultural type products, flaming hot Cheetos, flaming hot Funyuns, new Doritos flavors to serve that segment. The second part is, as the snack business is different from the beverage business and it is not as penetrated as beverages are. So beverages, if one business was going to slow down before the other, beverages would, because it is almost twice the size in convenience stores than salty snacks are.

[Indra Nooyi:]

Tracks more closely to food traffic.

[John Compton:]

Yes.

[Indra Nooyi:]

However, I think there were more alternatives for beverages, as Massimo mentioned when unflavored water slowed down, people switched to tap water and, you know, applied their discretionary dollars against Frito-Lay salty snacks.

[Jonathan Feeney:]

Okay. Well, thanks very much.

[Operator:]

Thank you. You next question is from Judy Hong with Goldman Sachs. Please go ahead.

[Judy Hong:]

Good morning, everyone.

[Indra Nooyi:]

Hi, Judy.

[Judy Hong:]

Just looking at North America beverages and recognizing that you have managed the business as a portfolio, but margin was pretty weak in the second quarter. I wanted to just walk through some of the key drivers of margin decline and then more broadly speaking, some of the new price pack architecture initiatives that you are talking about, if you could give us a little bit more details and the timing of when you can introduce these initiatives and how quickly can these initiatives really restore profitability in North America beverages?

[Indra Nooyi:]

Massimo, do you want to take that?

[Massimo D’Amore:]

Yes. So first of all, as we said, throughout the quarter we have continued to make sure our product remained affordable while investing in A&M, IT, and distribution capabilities. So the key reason for the margin decline is the increased cost of commodities in this environment. However, more importantly Judy, Indra said it very clearly that we are really working on unprecedented price pack architecture across all of our beverage brands and we are building on a lot of expertise available within the company, especially outside of North America, where we have been living with inflation for many years. We are really striking the right balance, I believe, between price points driving affordability and revenue management growth through these price pack architectures. So it would be put in place in the second half of the year and you will see its full impact really as of 2009. Because our objective here is to really lay the right foundations for 2009.

[Judy Hong:]

Massimo, if I can just follow up on the non-carb trend, beyond the economic pressure that we are seeing in North America, do you think the growth of non-carbs could go back to the growth that we had seen historically.

[Indra Nooyi:]

Judy, I tell you something, that is a big mystery and we do not have the answers yet. As Massimo said, ever since we started tracking this category, yesterday we are joking about it saying going back 100 years, but really the last 30 years if we have tracked this category, the category has never been in such a decline as it is now. In the last 10 or 15 years, we haven’t had an economic slowdown of the kind we are seeing now. If you believe standard for capita measures and penetration into tap water and population growth and growth in GDP, you would expect the growth in the LRB category should come back to the 1% to 2% range. That is our long-term expectation for volume, 1% to 2% volume growth, but you know what, predicting the trough is always wrong. We have to wait and see what happens as the economy slowly recovers and then we can all look and see if the fundaments of the category are still there. At this point we feel optimistic about the category.

[Judy Hong:]

Okay. Thank you.

[Operator:]

Thank you. Your next question is from Bryan Spillane with Banc of America. Please go ahead.

[Bryan Spillane:]

Hi good morning.

[Indra Nooyi:]

Good morning Bryan. Just a question on working capital, it was up pretty significantly in the quarter, so want just some of the drivers behind that and then the second question related, just as you hedge out or contract out raw materials further out than you have done in the past, will that also have an impact on working capital, will it cost you more to hold some of that raw material for a longer period of time and will that have an impact on free cash flow going forward?

[Richard Goodman:]

So just on the first question, on working capital, and actually if you look at the fundamental cash conversion cycle that was actually, we were absolutely on track, I mean some of the numbers are higher because our revenue base was higher, but they were absolutely on track and some of the things that drove slightly worse working capital were one-time things, one-time timing things like BAT and stuff, so I feel, we feel very good about being on track from our working capital standpoint. On the contracting, yes, we do not actually make payments on things that we are contracting out in the future, so the amount of goods that we actually will store going forward is extremely, is extremely small and very and would be very localized, almost all of it is simply just locking in prices with suppliers going forward and then when those goods are delivered, that is when we are paying for it. So that it will not impact our working capital on a go-forward basis.

[Bryan Spillane:]

Okay, great. Thanks.

[Richard Goodman:]

Thanks.

[Operator:]

Thank you. Your next question is from Ann Gurkin with Davenport. Please go ahead.

[Ann Gurkin:]

Good morning.

[Indra Nooyi:]

Hi, Ann.

[Ann Gurkin:]

If I could just get some more detail on your outlook for the U.S. liquid refreshment beverage volume at this year and if you could break that down into CSD and non-CSD and how are you going to step up your pace of innovation in domestic beverages in the back half of ‘08 into ‘09? Then if I could pick up more detail on Gatorade reset, how much did that contribute to volume in the quarter and then Lay’s in the U.S., the decline, what was that decline? How much was due to allocation versus just the weight-out impact?

[Indra Nooyi:]

That a lot hard, but Massimo do you want to take some part of that question, go ahead.

[Massimo D’Amore:]

So, first of all, as we said, the performance of the category is equivalent and we would expect to see the category to decline.

[Indra Nooyi:]

Massimo, I am sorry. You are far away.

[Massimo D’Amore:]

Sorry. So as we said earlier, the decline in the category that we are seeing this year is really unprecedented, and we would expect the category to decline one to two points for the year, for 2008. However, going to next year, as Indra said, we will see how strong the economic recovery is going to be and we should see a better performance going forward. Having said this, we are being very aggressive on developing the right innovation for 2009. We are going to disclose it during quarter four, but let me assure you that it is really focused on each one of our key brands and more importantly, we are really innovating, keeping in mind the needs and the trends of each one of the key channels. So you will see innovation that will be just tailored for the convenience channel versus innovation tailored for mass, for drag, or for the club channel. So we are really focusing on the consumer needs within the context of the economic context we are in and the dynamics of each channel. Now, as far as Gatorade is concerned, and what we are seeing is just a slowdown of the Gatorade performance in the convenience channel, but this is a category issue. It is not a brand issue, because that is where the brand is gaining both volume and value share, and the reason why it is impacting Gatorade is because, as we said, it is well developed in the convenience channel. Having said this, the innovation we have in place this year is right on G2 and Tiger are both performing very well, and let me assure you that we have a lot more innovation going forward into 2009. Therefore, Gatorade, we have continued to grow and we are investing at the same time on new marketing initiatives, as well as distribution plans.

[Indra Nooyi:]

John, do you want to talk on Lays.

[John Compton:]

On Lays, as I have said in my comments. Lays is the most price sensitive of the salty brands that we have, but most of the volume impact in the quarter was related to the shortage on the crop, because we lost the big part in the Missouri part of the country, where our potatoes were due to come out. It is the same storm that had the effect in Cedar Rapids on the flooding. So the majority of this was just shifting out of potato into our corn-based products as we prepared for the upcoming July 4th holiday.

[Ann Gurkin:]

How much was the Lays volume down in the quarter?

[John Compton:]

It was down around 7%, I believe, in the quarter.

[Ann Gurkin:]

Okay, great.

[John Compton:]

Again largely, that was just shifting our trade calendars from potato to corn.

[Ann Gurkin:]

All right. Thank you, all.

[Indra Nooyi:]

The only thing I will tell you is that you asked for innovations balance of the year and going into 2009. We are already into July and so really should not be talking about any big new innovation balance of year. I have had the privilege of looking at the early 2009 innovation calendar and in Pepsi Beverages North America, what Massimo and the team have done, is probably among the strongest innovation that we have ever seen coming out of North American Beverages and it is very exciting, I must say. We are going to be unveiling a lot of that at the Morgan Stanley conference in November. So I think it is going to be quite exciting. Thank you, very good.

[Ann Gurkin:]

All right. Thank you.

[Operator:]

Thank you. Your next question is from Alec Patterson of RCM. Please go ahead.

[Alec Patterson:]

Yes, thank you. Two questions, one, Massimo, I may be a connoisseur to be obvious here, but what I am hearing about price pack architecture and the sensitivity to the value equation for consumers, especially in C&G, sounds a bit of a wait-out strategy on beverages. We have obviously heard about smaller bottle sizes and what have you, but in that context, is that an apt description of the pricing initiative that is going on?

[Massimo D’Amore:]

Not exactly, Alec. Let me explain. What we really mean by price pack is that we want to have the right offering to heed the right price point from an un-affordability standpoint as well as the right value for manning for larger packs. So, whenever we look at resizing our offering, is keeping always in mind these two factors. So, if we think of downsizing at the same to heed a certain price point, at the same time we upsize, to maintain better value for money. So it is really acting on both fronts of the value equation.

[Alec Patterson:]

Okay.

[Indra Nooyi:]

So, that is our last question and I want to thank everybody for coming on to our call today and look forward to continuing this dialogue with you through the rest of the quarter. Thank you.

[Operator:]

Thank you. This does conclude today’s PepsiCo second quarter 2008 earnings conference call. You may now disconnect your lines and have a wonderful day.