PepsiCo, Inc. (PEP) Q4 2006 Earnings Report, Transcript and Summary

Good morning and welcome to PepsiCo's fourth 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. Jamie Caulfield: Thank you, operator. 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 included in our Annual Report on Form 10-K for a discussion of specific risks that may affect our performance. You should refer to the investor section of PepsiCo's website at www.pepsico.com under the heading ‘PepsiCo Financial Press Releases’ to find disclosure and a reconciliation of non-GAAP financial measures that may be used by management when discussing PepsiCo's financial results with investors and analysts. This morning's prepared remarks will be made by Indra Nooyi, our President and CEO; and Richard Goodman, PepsiCo's CFO. Indra and Richard are joined today by Mike White, PepsiCo's Vice-Chairman and CEO of PepsiCo International; by John Compton, CEO of PepsiCo North America; and Dawn Hudson, CEO of PepsiCo North America. Following the prepared remarks by Indra and Richard, Mike, John, and Dawn will be glad to take your questions. We have intentionally kept the prepared remarks short this morning to allow more time for Q&A. I would like to call your attention to a few items that affect the comparability of the numbers we have reported this morning. We had net tax benefits in the quarter totaling $0.37 per share, $0.36 of that -- or approximately $600 million -- is made up principally of the tax benefits we announced in October related to the IRS examination of our tax returns for the years 1998 through 2002 and is reflected in the tax provision line. Another $0.01 relates to our share of the tax benefits that PBG announced last week and that amount is reflected in the bottling equity income line. We recorded a charge related to the Frito-Lay manufacturing network consolidation that we also announced in October. That amount is $67 million on a pre-tax basis and $43 million after tax or approximately $0.03 per share. Now in the prior year, there were three items that affect the comparability of the results. There was a $0.27 per share tax charge in the third quarter of 2005 related to our repatriation of $7.5 billion in international cash; there was an extra reporting week in the fourth quarter of 2005; and there was a restructuring charge of $0.03 per share in the fourth quarter; again, of 2005. The net is that our reported EPS for the fourth quarter shows a 63% increase, but excluding the impacts of the items I just mentioned, EPS grew 11%. And for the full year, the comparable EPS growth rate -- again, excluding those items -- is 13%. The tables in the release and attached financial schedules include both the GAAP reported numbers, and the numbers adjusted for the items I just mentioned which we believe are more indicative of our ongoing performance. On today's call, we will refer to the results excluding the items I just mentioned as core results. It is now my pleasure to introduce Indra Nooyi. Indra Nooyi: Thank you, Jamie and good morning to all of you. Thank you for joining us this morning. I appreciate the opportunity to discuss PepsiCo's 2006 performance and our outlook for 2007. As I am sure you saw in this morning's release, we had a very good quarter to complete what has been another very strong year for PepsiCo. We are pleased with how our portfolio of businesses performed in 2006, and I want to take this opportunity to recognize all of our associates around the world who made it all happen. On a core basis, worldwide snacks volume grew 6%, worldwide beverages grew 7%, net revenue was up 9%, division operating profit grew 8%, and as Jamie just mentioned, core EPS grew 13%. Let me spend just a minute recapping the 2006 headlines for each of the divisions. Frito-Lay had a very solid year. It had consistent volume growth, accompanied by accelerating price realization during the course of the year, in part by pricing and in part by managing a positive mix shift in the portfolio. At the same time, Frito continued to drive its productivity agenda to offset the impact of inflation. It had efficiency gains across manufacturing, increasing its manufacturing efficiency by almost 1% for the year. It was a combination of strong volume growth, price realization and systematic productivity programs that drove Frito-Lay North America's strong balanced financial performance. We are particularly pleased with the strong finish they had in Q4 with operating profit growth accelerating. Importantly, the business is in great shape as we head into 2007. Frito has continued to advance its health and wellness agenda. In 2006, that included the move to cook Lay's and Ruffles in 100% sunflower oil which reduced the amount of saturated fat by 50%; and the introduction of more Smart Spot original products like Baked Tostitos Scoops. We are also pleased with the momentum of Doritos; a combination of product news, updated packaging and terrific marketing has really reignited the brand, and SunChips had a spectacular year with strong double-digit growth in every quarter. We broadened Frito's product portfolio with the addition of Stacy's Pita and Bagel Chips which gives us another growth platform and we continue to improve productivity across the value chain, for example, in areas like packaging automation and through the deployment of new technology at the front line. We also are very excited about the innovation we have lined up for 2007, beginning with the introduction this month of Flat Earth, a line of fruit and vegetable-based snacks that are truly unique. We feel very good about Frito-Lay's performance and the momentum of the business as we head into 2007. Turning now to Pepsi Beverages North America. We are pleased with PBNA's top line performance for 2006 with volume growth of 4%. This growth was led by terrific non-comp performance where we had core volume growth of 14%. Gatorade, Aquafina, Lipton, Frappuccino and our energy drink portfolio each had double-digit growth for the full year. We added to our portfolio through the acquisition of Izze sparkling beverages and through the alliance with Ocean Spray that we announced in September, and we just completed the acquisition of Naked Juice last month. But the year was not without its challenges, chief among them the extraordinary inflation on oranges. Given the hand we were dealt, I think our team has done a good job in managing through the situation and I feel reasonably good about the Tropicana business as we head into 2007. We have executed a series of price increases to cover the orange cost inflation, and it appears that the pricing is sticking. Focusing a bit on Gatorade. Gatorade had a very good volume growth for the full year, but the fourth quarter performance was off the full-year trend, so let me provide a little perspective on Gatorade's Q4 performance: First, keep in mind that Gatorade was lapping 30% plus growth from the fourth quarter of 2005, so we were facing very tough comparisons. Second, the weather at the beginning of the fourth quarter was cooler than it was in the prior year, and because of the seasonality of this category, September to October are more important months than November and December. So if you get behind in the beginning of the quarter, it's very difficult to make it up in the back half of the quarter. Third, the allocation situation we had in the third quarter of 2005 had an effect. Retail inventories were abnormally low entering the fourth quarter of 2005, and we believe a bit higher than normal coming into the fourth quarter of 2006, as retailers did not want to be short of product following last year's experience. Now, it may help to normalize the weather impact and the retail inventory situation by looking at Gatorade's average two-year growth rate for Q4, which is an annual growth of about 10%. Needless to say, the Q4 Gatorade volume performance, combined with incremental Gatorade supply chain costs were the key drivers of PBNA's Q4's profit performance. As we head into 2007, we feel pretty good about the PBNA portfolio, and we are excited about the innovations we have lined up. Eric Foss of PBG mentioned a number of new products on the PBG call last week including Aquafina Alive, Sobe Essential Energy, Mountain Dew AMP Overdrive and Pepsi Jazz Caramel Cream. Tropicana's new products include Tropicana Fruit Squeeze and Gatorade just launched Gatorade AM and Propel Lemonade. Finally, I want to emphasize the strength of the partnership with our bottlers. We think they are the best in the business. We continue to have a very productive relationship with them and we are well aligned in our priorities for the coming year. PepsiCo International. Another terrific performance in 2006 from PepsiCo International, the portfolio of PI businesses continues to strengthen. We had another year of very broad based growth. Our larger, more mature markets had solid performance, and we saw a continuation of the smaller, faster growing markets making an increasingly large contribution to PI's overall results. Core snacks volume was up 10%. Beverage volume was up 9% and core operating margins improved nearly 80 basis points to just over 15%. As with the North American businesses, International is also making great progress with its non-carbonated beverage and health and wellness agendas which are becoming increasingly important contributors to the division's overall growth. Let me talk to just a few of the highlights for each of the regions. In Mexico and Latin America, Sabritas had very strong financial and market share performance and made significant progress in its go-to-market transformation projects. Gamesa had a strong year with particularly good volume results in the higher end of the category driving very good net price realization and margin growth. Gatorade across the region was up over 20%, and we launched a number of products to expand the health and wellness portfolio like 7-UP H20 and Twistos in Chile. In the U.K. and Europe, the successful relaunch of the Walker's brand and new product launches like Baked Walker's drove favorable volume share performance and reignited category growth. Tropicana continued its impressive growth trend with volume in the U.K. up more than 25% for the year. We have strong snack growth across Europe behind strong execution and innovation, and we successfully integrated the Duyvis Nuts and Poland Snacks acquisitions. In the Middle East, we had double-digit volume gains in both snacks and beverages, accompanied by very strong market share gains and we advanced our health and wellness agenda by spending on non-carbonated beverage business. In Asia, we had double-digit snacks growth and 9% beverage growth. Our Australia snacks business had one of its best performances ever. Profit margins improved across almost all of our operations. We successfully integrated the Sakata and other acquisitions we made and continued to strengthen our bottling infrastructure throughout the region. Net, a great year for International and strong momentum as we start 2007. Quaker Foods in North America also had a strong year in 2006 with core revenue and profit each up 5%, even as we were lapping revenue growth each of 10% and operating profit growth of 11% on a core basis from the prior year. So overall, we feel very good about the business. The PepsiCo portfolio delivered strong, balanced, top line and bottom line growth. We are making good progress on key initiatives of expanding our product portfolio, driving health and wellness, and strengthening our geographic footprint. Our key management changes have been seamless with no disruption to the businesses. As I mentioned before, we have good momentum as we go into 2007. Now let me hand it over to Richard to cover the 2006 corporate items and the 2007 guidance.

Thank you, Indra. For both the fourth quarter and the full year earnings benefited from a combination of lower corporate unallocated expenses, gains from the PBG share sale program -- which is in its second year -- a decline in net interest expense, a lower tax rate, and a decline in our diluted shares resulting from our share buyback program. Our reported tax rate for the quarter and full year was impacted by the items Jamie mentioned at the beginning of the call. We provided a reconciliation of the reported rate to our core rate in the attachments to the press release and on the current slide. Adjusting for the non-recurring tax items, our tax rate for the fourth quarter was 28.4% and for the full year was 28%. The full-year rate is consistent both with the guidance we provided at the beginning of 2006 and also with the update we provided on last quarter's call. Moving to cash flow for the year. We are pleased with our cash flow performance for the year. Our operating cash flow -- that is cash from operating activities net of CapEx -- came in at just under $4.1 billion. That was slightly ahead of the target we set at the beginning of the year, primarily because CapEx of $2.1 billion was just a bit lower than our full-year target. That concludes the 2006 discussion. Let's now turn to the outlook for 2007. For the year, consistent with our long-term guidance, we anticipate mid single-digit volume and revenue growth with a positive spread between volume and revenue and EPS growth of at least 10% growing off our 2006 core EPS of $3 a share. Let me comment on our expectations for inflation and forex. For 2007, we expect to see a continued net inflationary environment, but I think it is important to put this in an appropriate context. First, we are not expecting the year-on-year inflation to be any greater than the inflation we experienced in 2006. And as in 2006, we expect it to be driven disproportionately by inflation in the cost of oranges. The balance of our strategic inputs as a basket will be slightly inflationary -- that is, in the low single digits -- and we feel reasonably confident in our forecast for the year. We believe it is unlikely that actual costs will vary to the upside or to the downside by more than $50 million versus our forecast going into the year. It is important to keep in mind that we have a very diverse input cost structure. Our top ten North American inputs are made up of the following six key ingredients: oranges, potatoes, cooking oil, other juices and concentrates, sugar and corn; plus on the packaging side: bottles and closures, corrugated and paperboard, packaging film and labels, and finally, energy. As a basket, these inputs represent less than 50% of our total North America cost of goods sold and no individual item represents more than 10% of total cost of goods sold. Our experience with this diverse basket is that in any given year, you tend to have deflation in some items offsetting inflation in others. So with the exception of oranges, I would characterize the inflation as normal and we will manage the inflation as we always have through a combination of productivity, mix and targeted pricing. As we mentioned in October, oranges have experienced a structural change resulting from shortages in Florida. We've taken pricing to cover the costs and we will continue to explore alternative sourcing arrangements as a longer-term solution. With respect to forex, we expect depreciation in the pound and euro to be offset somewhat by a weaker Mexican peso and Canadian dollar with the net impact, a slight upside for the year. We expect a slight benefit on both the top line and operating profit from tuck-in acquisitions. Below the operating line, we will continue to get leverage from controlling our departmental G&A, we'll continue to invest in our business process transformation initiative in 2007 which is reflected in our corporate unallocated costs. We will continue our PBG share sale program and expect to sell about 9.5 million shares in 2007; and, we will get financial leverage from our share buyback, which we expect to be approximately $3.3 billion. We are forecasting our full-year tax rate at 27.7%, which compares to our 2006 core rate of 28%. The reduced tax rate should provide approximately 50 basis points of earning leverage. We expect continued strong cash flow performance. Our target for 2007 is to generate $7 billion in cash from operating activities and to reinvest $2.6 billion in CapEx, consistent with what we communicated in October and resulting in management operating cash flow of $4.4 billion. Before we open it up to questions, I would also like to offer some points to consider as you model out our quarterly growth for the year: First, be mindful of our overlaps. In general, our performance was stronger in the first half than the second half. Second, we expect input cost inflation to be higher in the first half than in the second half. Third, as we adapt to new FIN 48 income tax accounting pronouncement, the result will be a more variable tax rate from quarter to quarter. Finally in 2007, we will be aligning the accounting periods for our international businesses. We currently have operating units using a combination of months and four-week accounting periods. In 2007, we will transition substantially all of our international businesses to months. This move is being made as part of our SAP implementation. In 2007, we will also begin including the results of our international joint venture bottlers in the PI division results. This will result in approximately $60 million of pre-tax earnings being reclassified from the equity income line to the PI line of business. This change is being made because it is more reflective of how we manage the international business. Neither of these changes will affect the full-year pre-tax income, net income or EPS. Within a few weeks, we will provide on our website a recalendarized and reclassified 2006 to reflect these changes so you can adjust the base year in your models. Now I will hand it back to Indra. Indra Nooyi: Thank you, Richard. A few concluding remarks before we open it up to questions. Our guidance for 2007 is right in line with our long-term target. I want to emphasize that we feel very good about the health of our businesses as we begin 2007. We've talked many times about our portfolio approach to managing PepsiCo. It allows us to invest in some areas while we are realizing the benefits of fast investments in others. It has served us well, and has been a major contributing factor to our consistently strong performance. We will continue to operate under this principle in 2007. Finally, I believe our plans are realistic and balanced and provide appropriate flexibility for investments. So with that, operator, we will now be glad to open the line for questions.

(Operator Instructions) Your first question comes from Kaumil Gujjarwal - UBS. Kaumil Gujjarwal - UBS : Thank you. Would you mind talking about how much of the profitability decline in PBNA was related to investments in the new Gatorade plant versus some of the year-over-year issues that you talked about in your prepared remarks?

I would be happy to discuss that. I had a hunch there might be a few questions about Gatorade today. If I could, let me build on Indra's comments around the characterization of the business. We felt like 2006 was a strong year for the Gatorade business overall. Our volume was up north of double-digits and that is consistent with where that business has been performing in the past. As you know, last year when the business grew north of 20%, we went on allocation for about four months during the course of the year and we were building new capacity to get ready so we could serve the business going forward. That new capacity did come online, to the basis of your question, in September of this year when we did incur one-time expenses in starting up the Whitfield, Virginia plant. It started up on time. The efficiencies that we are generating from that plant are ahead of our expectations to date and we have four new lines up and running. So the combination of both the shipments on Gatorade being below year ago and the one-time start-up expenses in the Whitfield, Virginia plant were a part of the PBNA profit shortfall in the fourth quarter. Indra Nooyi: We are not providing detail down to the individual product line basis, Kaumil, but it certainly did have a factor in the PBNA profit profile for 2006 Q4. Kaumil Gujjarwal - UBS : Got it. Just to make sure this one-time expense for firing up the plant is not something that continues.

Also as you know, we are building a new facility in Pryor, Oklahoma as we sit here and it is scheduled to open in the fourth quarter of this year.

Just to clarify in 2007 what we will see is a balance. We have new facility opening as John mentioned, but also we will be getting the productivity from this facility and the additional lines that we put it 2006. We will see a greater balance between the investment costs on the one hand and the productivity on the other in 2007 versus what we have seen in 2006. Kaumil Gujjarwal - UBS : Okay. Great, thanks, everyone.

Your next question comes from Bill Pecoriello - Morgan Stanley. Bill Pecoriello - Morgan Stanley: Good morning, everybody. Question again on PBNA. When you look out to '07, I know you don't like to guide by division, but could profit growth be down in the first half of the year or the full year? If you can't comment on that, some of the things we have to think about was the Gatorade costs you were just referring to. You are taking a concentrate price increase close to 4% to spend back on trade promo and coupons. The volume weakness maybe on the CSD side as the bottlers raise 4%. Also the Tropicana pricing, it sounds like that's covering the inflation and the volume decline. With all those puts and takes what should we look at for that division?

Bill, you know we don't like to provide guidance by business, but roughly speaking, I'd say the first half, as I mentioned in my prepared remarks, there is more inflation that will flow through the P&L in the first half, the plant start-ups and the fact we have extraordinary overlaps from the first half of 2006. So I think as you calendarize the year, the second half starts looking a lot better than the first half, but overall we're still looking for a good year from PBNA.

Your next question comes from Bonnie Herzog - Citigroup. Bonnie Herzog - Citigroup: Thank you. I actually have a question regarding something I learned, which is it is my understanding across your Frito-Lay products in North America that you have extended your shelf life date by one week or, I guess, use by date by one week. I was hoping you could comment on that. Obviously, talking about the implications, the potential cost savings of that, and how you are really facilitating that? John Compton: Yes, Bonnie, I am glad you picked up on that. We have gone to an every other week code dating in Frito-Lay North America. We have just implemented that. It is not really an extension of the code date as much as it is we are putting the bellmark and the code date on the bag every other week. That helps our sales person at the store level in the amount of time they're going to be spending on rotation of our product on the store shelves. That's a key part of Frito-Lay's productivity agenda they have in place this year and we have just implemented this change. Bonnie Herzog - Citigroup: It is my understanding that from the salesperson's perspective, a Frito-Lay salesperson's perspective, it might save them -- is it possible -- one to two hours every day, because to your point is does certainly take a lot of time to replace the products that have expired, if you will. John Compton: Your point is well taken. Frito-Lay has consistently been working on ways to take time out the system and give back to our salespeople so they can be more effective in selling, and every other week code dating is a good example of that. Bonnie Herzog - Citigroup: You can't quantify it in terms of savings for me or us? John Compton: I wouldn't put a number on it, Bonnie, because what we want them to do is to use that time to sell more product. Bonnie Herzog - Citigroup: All right. Sounds good. Thank you. Operator: Our next question is coming from Judy Hong - Goldman Sachs.

Good morning, everyone. In PBNA in the fourth quarter, we again follow a shift toward higher trade spending and lower A&M spending. Can you just talk about the rationale and also whether you are pleased with the impact that you saw on the volume as that happens? John Compton: On the PBNA side, as you know, it's a combination of the carbonated soft drink business, the water business, the chilled juice business. We are in multiple categories in which we compete, and we want to remain competitive and we certainly have been able to do that both on a full year basis and within the quarter we were able to hold and grow our total LRB share. At any given time we balance the mix of how much push we put into the marketplace with pull that we put into the marketplace, and I think on the full year and both in the quarter, we were pleased with how that was worked through the system. I don't know, Dawn, if you wanted to comment on the PCNA business particularly, but overall we were happy with it. Dawn Hudson: I would just respond again, emphasizing that it is about marketplace investment which takes the form of trade support and A&M, and we use both in combination and flex different levels year to year to result in good growth for all of our brands. John Compton: Let's just remember last year that we had a big increase in A&M in Q4. What we are seeing here instead of a balancing back again of the two with slightly lower A&M and slightly higher trade spending, but more as a response to what we saw last year.

Thank you. Operator: Our next question is coming from Mark Swartzberg - Stifel Nicolaus. Mark Swartzberg - Stifel Nicolaus: Can you all hear me?

Yes, good morning, Mark. Mark Swartzberg - Stifel Nicolaus: Good morning. Indra, two questions. First, I wonder if you could share with us a little of the board's thinking in having you be Chairman and CEO imminently here which is a very well-established traditional PepsiCo, but, of course, we have seen some companies decide to split those roles and it seems like structurally you had that opportunity here but you chose not to do that. Secondly, if you will answer a second question, just for either John or Dawn, can you give us a better sense of what the extra dollars are going for? What I mean by that, with this 4% increase that the bottlers are seeing in terms of concentrate and what sounds like they are describing at least as a net pressure item for them, that means you are getting a little more money. Can you give us a better sense of how those incremental dollars are flowing?

Mark, let me just take the first question. I think it is better asked to our board as opposed to me. All I can say is I am delighted. I think though, you should talk to the chairman of the board committees that made that decision. Mark Swartzberg - Stifel Nicolaus: But Indra, you were there. I was just kind of wondering…

No, when the decisions are made, it is made by the independent Board of Directors without my involvement. Mark Swartzberg - Stifel Nicolaus: Did they explain their thinking at all?

No. Let me now toss it to Dawn to answer the second part of the question, Mark. Mark Swartzberg - Stifel Nicolaus: Great, thank you. Dawn Hudson: Let me talk about the concentrate price increase and why we took a higher than average increase. First of all, our business has cost of goods in it, and we are experiencing higher than traditionally seen increases which we needed to cover. As well as, it is important for us to maintain the right level of investment against both short and long-term innovation and we felt that was appropriate number to ensure that we can keep driving the business on behalf of the system. I would comment that while it is above average, it is not the highest concentrate price we have taken. Mark Swartzberg - Stifel Nicolaus: Thank you. Operator: Our next question is coming from Christine Farkas - Merrill Lynch. Christine Farkas - Merrill Lynch: Thank you very much. A two-part question on costs, if I could. Firstly, just to confirm the top ten basket of commodities I am assuming were in no particular order, but on that front within Frito-Lay, very strong profit growth of 8%. Can you talk about the reduction in A&M spend versus the high level a year ago versus perhaps the commodity or the input cost? Should we be looking at that as a two-year average there for Frito-Lay? As a follow-up question on corporate expenses how much of the lowered expenses is costs being cut versus programs being delayed?

Richard, do you want to talk about the top ten? Richard Goodman: On the top ten it was in no special order. I just did the ingredients and then the packaging and then the energy, but as I said, no single one of them is more than 10% of cost of goods sold. I'll switch to John on the Frito-Lay question, but on the corporate, it really is just making sure that we are just extremely efficient from a corporate standpoint. We are not cutting programs. We are just being very vigilant in how we operate. John Compton: On the Frito-Lay question our A&M as a percent of sales has continued to stay the same year-over-year, 2006 compared to 2005. The business, as you know, did extremely well for the year and very strong on the quarter as those investments back into the brands have performed very well, particularly on the Doritos business which had struggled the first part of the year and was probably one of the key stars in the Frito-Lay business in the fourth quarter. So I am extremely pleased with how Frito-Lay is performing. The innovation pipeline they have going into the first part of this year is very strong and we are optimistic about that business going forward. Christine Farkas - Merrill Lynch: Thank you very much. Operator: Thank you. Our next question is coming from Lauren Torres with HSBC. Lauren Torres - HSBC: At your October meeting, you spoke about greater spend behind expansion efforts this year. Now can you give us a sense of how we should think about this anticipated cap spend of $2.6 billion this year? Where you are directing that spend, and how much of it will be maintenance spend? Richard Goodman: As we talked about in the October meeting, all of the increase in spending relates to expansion of capacity, either for innovation or simply for volume growth. The majority of that is where we are growing, primarily in PI. So a lot of the growth as you saw both on the top line and the bottom line over the last couple of years has been PI, and we expect that to continue on a go-forward basis. The other part of that, the other big piece of the increase is in Gatorade because we are simply out of Gatorade capacity and the business continues to grow. Lauren Torres - HSBC: Maybe if I can just follow quickly to -- and maybe Mike could help out with expectations regarding PepsiCo International -- seeing several quarters of strong growth here. What are your expectations, where are the best opportunities for you and how we should think about the International business? Michael White: Thanks, Lauren. Nice to get a question on International. We are quite pleased with the performance that we had in the fourth quarter. As you know going into the quarter I felt that you would see an improvement, particularly in Sabritas, which we did, and overall finished, I think, a very strong year. We don't provide guidance by division so I don't want to get into that level of specificity but it is consistent with what I've said before, both at the October analyst meeting and at the CAGNY meeting last year. There really is no change in terms of the algorithm for PI. In any portfolio as complex as our International portfolio, there are some businesses that are performing well and others that run into challenges every now and then and we have got a couple of businesses that have had fantastic fourth quarters and some challenges in a couple of markets; but net-net, the portfolio is working. I think we have increased flexibility in the portfolio and balance, as I said at the October meeting. Overall, I still expect to see solid top line in both beverages and snacks, but the emerging markets continue to be the critical growth driver for us and I expect will be so this year, as well. Lauren Torres - HSBC: Thank you. Operator: Our next question is coming from Christine Farkas - Merrill Lynch. Christine Farkas - Merrill Lynch: I must have gotten back into queue. Thank you for taking the question. I will just have a brief question on China. I am noticing a little bit of slower growth in beverages. I was wondering, Mike, if you can address if there is something structural going on there? Michael White: Thanks, Christine. On China, actually we did see a little bit of a slowdown primarily in and around Shanghai. In the balance of the country we continue to see very, very strong growth. We have some programming in place. I also think we have sharpened up our competitiveness as well in the balance of the latter part of the quarter and so I feel pretty good about going into this year. We have got a very, very strong Chinese New Year initiative that will be broader than Pepsi last year. We did Chinese New Year just on Brand Pepsi. This year we have packaging and promotion around Pepsi, Mirinda and 7-UP. So I feel pretty good about our ability to lap what was an unbelievable first quarter last year for China. We have a tough lap. The business is strong. I would say there has probably been some strength in non-carbs in Shanghai that we have seen. The other thing I will say is Gatorade is doing well in China, and we have also got some juice drinks and the soy product we'll be launching to build our non-carb presence there this year. Christine Farkas - Merrill Lynch: Thank you. Operator: Our next question is coming from John Faucher - JP Morgan. John Faucher - JP Morgan: You talked a little bit about the COGS inflation outlook relative to '07 versus '06. Can you give us an outlook from a pricing standpoint? Should we expect pricing to be roughly similar? In particular, the COGS outlook on Frito-Lay where you have seen a lot of pressure there. It sounds as though that is the one where you might get a nice delta in your favor year-over-year in terms of the rate of COGS inflation which could potentially help the gross margin. Is that the right way to look at it?

John, let's go back. A couple of quarters ago we talked about pricing and we said we will take pricing in North America, in particular, if we believe the inflation is structural. As the year progressed in 2006, we realized that the orange juice cost increase was structural, some of the energy cost increase was structural, so the beginning Q4 2006 and going to 2007 we started to take some pricing. So the pricing actions, you are beginning to see the impact of pricing actions in Q1 and Q2 of this year. It's in Frito-Lay, it's definitely in Tropicana beginning Q4 2006 and you will start to seeing some pricing action in Gatorade also. Across the board there is pricing action to cover the inflation. Let me toss it over to Richard to talk more about this. Richard Goodman: As I said in the prepared remarks, the level of inflation versus 2006 is really very similar and our response to that will be similar. If you exclude the Tropicana piece, then the rest of the inflation is sort of low single-digits. As Indra said we are responding appropriately with a balance of pricing, productivity and innovation in order to be able to drive appropriate revenue gains. John Faucher - JP Morgan: Great, thanks. Operator: Our next question is coming from Alex Paterson - RPM. Alex Paterson - RPM: Indra, I am curious, I presume your guidance for '07 should read with the new tax rate at least 10.5% growth?

I think I was very clear in my guidance, the new tax rate is at least 10% growth. Alex Paterson - RPM: The Frito-Lay North American margins, flattish again. Obviously, you've had a lot of headwinds to deal with on the cost of goods front, but I am wondering to what degree the revenue mix, the product portfolio is impacting the ability of that business to begin rate margin advance? John Compton: I will go back and double-check the numbers. I thought the Frito-Lay margins in the quarter were --

Actually went up. John Compton: Actually did go up. Alex Paterson - RPM: I am talking about the year-over-year, the multiyear trend? John Compton: Yes. As you know it is a high margin business to begin with, and we are focused on making sure we have a strong top line going forward, and the mix of new products that we bring in tend to be at the same margin level as our current portfolio. So, again, we are happy with the performance overall.

Alex, the thing to also be careful about if we go back to 2005/2006, we made some major changes at Frito-Lay. The move to sunflower oil was a big change we made because we thought it was the right thing to do and we didn't pass through a lot of pricing with that, so there was an additional cost which didn't offset with pricing. Now as the year has gone on and going into 2007, we have, as Richard just talked about, we have new products coming in with higher pricing. We have productivity programs kicking in covering some of the inflation, and we've got the overlapping effects from all of the cost increases we had in 2006. So I think 2007, you are starting to see the benefits from all of that and you actually started seeing it in Q4 of 2006. Alex Paterson - RPM: I guess the answer to my question is that the new products which tend to have a positive revenue mix don't necessarily generate a negative margin mix, sort of like what Gatorade does to PBNA?

No. Alex Paterson - RPM: I just want to be clear on that. It sounds like you were saying that the sunflower oil impact should start to lap itself maybe by the middle of the year?

As the year progresses. It is already beginning and that's why you saw the 8% profit growth at Frito-Lay and we are feeling good about the Frito-Lay North America performance at this point. Alex Paterson - RPM: Lastly there has been some talk about third-party warehouse distributors that are looking to increase their fee per case in the beverage area. Could you speak to how you see that playing out and your strategy?

Absolutely. John, would you like to address that? John Compton: Sure. We have multiple customers on the Gatorade business, as you know, that are part of our distributor network, and we don't want to get into specific negotiations or tactics that we have with any. Just rest assured that the Gatorade supply chain and go to market system is something we value, we consider it to be an advantage and we're going to work going forward to ensure we have that. Alex Paterson - RPM: So what does the prospect of an increased fee per case that is fairly substantial mean for the business? John Compton: I really don't want to get into those specific discussions other than to say we feel confident that the Gatorade go to market system will continue to be an advantage to us in the marketplace. Richard Goodman: We like you are obviously aware of the situation, and we have indicated what our guidance is for the year, reflecting that.

Yes, Alex, in any year there is a series of puts and takes and our challenge and the reason you have this management team is we manage through all those puts and takes. This distribution cost increase is an issue we have to address. We will figure out how to offset it but our guidance factors all of that in. Alex Paterson - RPM: Fair enough. Thank you. Operator: Our next question is coming from Matthew Riley - Morningstar. Matthew Riley - Morningstar: Good morning. I will go ahead and ask a question I think you might have been alluding to earlier about Gatorade. With so much great innovation behind you and such strong volume growth, have we reached a point where a new phase of growth has been entered where volume expectations year-over-year should be tempered and flattened out?

Matt, that is a great question. Let me give you some top line comments and then toss it over to John. The Gatorade business has been a phenomenal performer for PepsiCo since we acquired it. The first couple of years, two, three years after we acquired it, Gatorade growth rate was from the high single-digits to low double-digits. 2005, because of a series of events which included a very hot summer, a few hurricanes that caused people to stock up, the Gatorade volume went through the roof and we had growth rates in the 20%, 30%, and some of it carried over into 2006 because people expected that growth rate to continue in the first half, which it did; but then the second half, it moderated somewhat, so the growth rate for the full year was more in the low double-digits. Going forward, our expectation is that the underlying growth rate for Gatorade is somewhere between the high single-digits and the low double-digits. That is what that Gatorade business is all about. The 2005 blip, you know we liked that blip, but that's not really a sustainable growth rate for the Gatorade business. So that's my take on the top line growth. Is it structurally different? No, I think the 2005 growth rate was structurally different. This business is being sized for high single-digit, low double-digit growth. With that let me turn it to John. Do you want to add anything? John Compton: No, I completely agree with that. I come back to watching the scan volume takeaway on this business and it consistently has remained strong even in the fourth quarter of 2006. We scanned out the front door in the measured channels right around 5% lapping 23% scanned growth from the previous year. So on any basis on a two-year look, on our shipments and on a two-year look on scanned volume, we continue to see good strong growth. I agree with Indra, 2005 was nice to have, but we don't long-term ever build into our business expectation that this business was going to be 20% plus going forward. Matthew Riley - Morningstar: Great, thank you. Operator: Our next question is coming from Bryan Spillane - Banc of America. Bryan Spillane - Banc of America Securities: Hey, good morning. Just a couple of questions, follow-up on inflation. Thinking more beyond 2007, if you can talk a little bit about first, productivity. I think my impression coming out of Analyst Day was that productivity in 2007 may be a little bit less of a contributor to the offset of inflation than it was in '06, or has been the last few years and the prospects for that improving '08 and beyond. Second, in terms of cooking oil, there's seemingly more competition for that relative to fuel, bio diesel, that sort of thing. So what contingency have you made, or have you made one yet for the prospects that maybe you start competing with the energy industry for raw material inputs, especially on cooking oil? Richard Goodman: Bryan, on the productivity side, we have exactly the same amount of productivity in 2007 that we had in 2006. Those were productivity efforts have been stimulated in part by the increased inflation, and we have programs both domestically and internationally to do that. You saw in 2006, the manufacturing efficiencies in Frito-Lay gained almost a percentage point, and that was as high as it has been over the last couple of years and we have plans in place to make sure that continues, and it is the same thing internationally. Our businesses are always going after productivity and we have both CapEx for productivity as well as supply chain and other initiatives to make that happen. So there is no diminishment there at all. Bryan Spillane - Banc of America Securities: In that pipeline your outlook in terms of continuing productivity beyond this year is still pretty good? Richard Goodman: Yes, it is a continuing part of our business. It is the way we are able to deliver value to the customer and make sure our cost structures are phenomenally competitive. So it is a very, very key part of where we are, and it really is what we need to do to balance out the entire equation. On cooking oil, obviously, everybody has been taken aback by the huge increase in the ethanol usage of corn and we are sensitive to that. That has raised prices in anybody who is using corn. We are making sure that we have adequate supplies both for 2007 and on a go-forward basis and we are working actively with all of our suppliers in order to make sure that is the case, both to guarantee supply and to make sure that the pricing of that is appropriate. Bryan Spillane - Banc of America Securities: Is that the case also with things sunflower oil, soybean oil? I am thinking more in terms of bio diesel.

The answer is yes, Bryan. Bryan Spillane - Banc of America Securities: Thank you. Operator: Our next question is coming from Carlos Laboy - Bear Stearns. Carlos Laboy - Bear Stearns: Good morning. Indra, do some of these 50/50 JVs that are being set up by your competitor for non-carbs outside the U.S. cause you to rethink your non-carb business model options at PI, or the opportunity for maybe participating differently in juices throughout emerging markets? Michael White: Not really. We see non-carbs as a significant opportunity, and we will look at arrangements with our bottlers as we have, for instance, in Russia, as well as whether a wholly-owned U.S. Tropicana-type strategy makes sense. I think a lot of it depends on the business model and whether it is chilled or not chilled. You know we look at the entire range and I think one of our advantages is we are comfortable playing any which way. If it makes sense to do a joint venture as we have, for instance, with Unilever on Lipton -- which by the way had a fantastic year in International last year -- we'll do it. I think it is situation-specific Carlos. We will look at each market and we do look at each market and I do think that, as I said in October, you will see us continue to be more aggressive in our non-carb rollout internationally. We had a very good year in International on non-carbs. Gatorade was up 20, Tropicana up 20ish. Very strong in the U.K. and France, in particular, and we continue as part of our innovation plans to have a very, very big emphasis on non-carbs. We have had a range of strategies. In some parts of the world it makes sense for us to own the manufacturing and leverage the bottlers' distribution. In other business models it may make sense to go 100% as an operating business and in other cases it may be a franchise relationship. We look at all of those alternatives and are quite comfortable and I think it is one of our advantages, frankly. Carlos Laboy - Bear Stearns: Thanks, Mike. Operator: Our next question is coming from Ravi Pamnani - GE Asset Management. Ravi Pamnani - GE Asset Management: I just wanted to know why you are not going to be more aggressive on share buybacks given your excellent balance sheet and, obviously, the cash flow looks wonderful. Thanks.

Let me toss that over to my CFO. Go ahead. Richard Goodman: As you saw, we are increasing the share buybacks from $3 billion in 2006 to a targeted $3.3 billion in 2007. As we have discussed, we feel very comfortable with the capital structure that we have which provides us and our bottlers with the flexibility that we need going forward to do acquisitions or to look at multiple small acquisitions at any given time. I think also as we discussed, everybody needs to recognize that as the rating agencies and others look at us, they look at us as a combined basis with our bottlers. While we have a pretty clean balance sheet, the combination including the debt from the bottlers makes that a little bit different. Ravi Pamnani - GE Asset Management: I am just curious in terms of would you be able, for example, if you bought back double the amount of stock that you are saying you are going to buy next year. Let's say instead of $3 billion it was $6 billion. Would that really affect, the ratings? You guys could still do bolt-on deals and I can't imagine given your financial position that would be something that would be of that much concern to you. I am not saying do a leveraged recapitalization, I am saying I don't understand why the buyback can't be potentially double what it is today without affecting any of these issues that you've talked about? Thank you.

Ravi, your comments are taken into consideration. Ravi Pamnani - GE Asset Management: Thank you, Indra. Bye-bye.

Bye-bye. Operator: Thank you. Our final question is coming from Mark Swartzberg - Stifel Nicolaus. Please go ahead. Mark Swartzberg - Stifel Nicolaus: Thanks again. The Gatorade business, looking out and looking particularly at that ROA outlook, I know there are understandably limits to what you are going to tell us here, but I wonder if, whether it is Richard or John -- I don't know if Chuck is on the line -- if you can paint a picture for us about how that metric trends over the next few years given the capacity expansion? I am going to suspect that it continues to grow it's just that the rate of growth is slower than what we've seen over the last few years. Or, does it dip down and start to recover two years from now? I'm just trying to understand how these expansions are affecting the ROA trend for the business over the next few years.

Mark, the key thing is PepsiCo, we focus on the portfolio that we have and the return on invested capital across the company. At any point in time, based on investments we make in certain businesses, the ROA may see a dip and come back. That is why the portfolio seems to work very well because as a company the ROIC has improved very, very nicely over the years. I think in 2006 the ROIC is north of 26%. We feel very, very good about where the company's return on invested capital is and I think year over year, or over a two-year basis you might see investments in certain businesses impacting the ROIC. I think that is to be expected. But overall I'd say the long-term prospects for Gatorade look very good. Mark Swartzberg - Stifel Nicolaus: Thank you, Indra.

Since there are no more questions, let me just say a big thank you to all of you for your time and attention today. We appreciate your interest in PepsiCo and look forward to speaking with you soon. Thank you.