PepsiCo, Inc. — Q2 2016 Form 10-Q
Reporting period: The second quarter comprised 12 weeks ended June 11, 2016; year-to-date (YTD) results cover 24 weeks. Amounts are in millions of dollars except per-share data. Interim statements are unaudited.
Financial performance
| Metric | 12 weeks ended June 11, 2016 | Change vs. prior year | 24 weeks ended June 11, 2016 | Change vs. prior year |
|---|---|---|---|---|
| Net revenue | $15,395 | (3%) | $27,257 | (3%) |
| Gross profit | $8,565 | (1%) | $15,276 | (1%) |
| Operating profit | $2,964 | +2% | $4,583 | (2%) |
| Operating margin | 19.2% | +1.0 percentage point | 16.8% | +0.1 percentage point |
| Net income attributable to PepsiCo | $2,005 | +1% | $2,936 | (8%) |
| Diluted EPS | $1.38 | +4% | $2.01 | (6%) |
| Net interest expense | $233 | Up $30 | $465 | Up $66 |
| Effective tax rate | 26.3% | 26.1% prior year | 28.2% | 25.0% prior year |
Gross margin was approximately 55.6% for the quarter and 56.0% YTD, compared with approximately 54.5% and 54.7%, respectively, in the comparable periods. PepsiCo reported 2% servings growth in both periods. Excluding foreign exchange and structural changes, including the Venezuela deconsolidation, organic revenue grew 3% in both periods. Foreign exchange reduced reported revenue growth by 4 percentage points.
Cash flow and liquidity: YTD cash from operations was $2,921, up from $2,761. Capital spending was $919; reported free cash flow, as defined by the company, was $2,049 versus $1,955. Cash and equivalents were $9,646 and short-term investments $3,733 at June 11, 2016. Current assets were $25,878 against current liabilities of $18,459.
Debt and capital returns: Short-term obligations were $4,774 and long-term debt $30,847, totaling $35,621, versus $33,284 at December 26, 2015. PepsiCo had $3.6 billion of commercial paper outstanding and no borrowings under its revolving credit facilities. YTD dividends paid were $2,060 and common share repurchases were $1,329. The declared quarterly dividend was $0.7525 per share.
Material changes and segment performance
- Reported revenue declined principally because of unfavorable currency effects and the absence of Venezuelan operations from the comparison following their 2015 deconsolidation. YTD organic growth was 3%, while reported revenue was down 3%.
- Quarterly operating profit growth reflected volume, effective pricing and cost reductions, partly offset by higher advertising and operating costs and unfavorable foreign exchange. YTD operating profit declined 2%; management cited cost increases, advertising, currency and Venezuela, partly offset by pricing, volume, savings and favorable commodity deflation.
- North American segments generally improved: Q2 operating profit rose 8% at Frito-Lay North America, 11% at Quaker Foods North America and 6% at North America Beverages. North America Beverages had a 1% decline in quarterly carbonated soft-drink volume, partly offset by non-carbonated growth.
- Latin America reported revenue fell 23% in Q2 and 24% YTD; operating profit fell 32% and 27%, respectively. Venezuela deconsolidation, currency weakness and higher input costs were significant factors. Europe Sub-Saharan Africa revenue fell 5% in Q2 and 7% YTD, with foreign exchange a major drag. Asia, Middle East and North Africa reported YTD operating profit fell 61%, largely due to the impairment described below.
Outlook, management commentary, risks and unusual items
- Management expected 2016 net capital spending of approximately $3 billion and planned to return approximately $7 billion to shareholders in 2016: about $3 billion in repurchases and $4 billion in dividends. The filing does not provide a clear full-year revenue or EPS guidance figure in the supplied text.
- A $373 million pre- and after-tax impairment charge ($0.26 per share) was recorded in Q1 to write down PepsiCo’s 5% indirect investment in Tingyi-Asahi Beverages to estimated fair value. The remaining carrying value was $166 million at June 11; management said it would continue monitoring the investment.
- PepsiCo’s 2014 productivity plan generated $79 million of YTD restructuring charges. The company expected approximately $990 million of total pre-tax charges over the plan, with most remaining charges anticipated through 2019. It also expected a $125 million full-year 2016 pre-tax reduction in pension and retiree medical expense from a revised cost-estimation method; this method reduced YTD expense by $57 million pre-tax.
- Key risks include foreign-exchange and commodity-price volatility, emerging-market economic and political instability, regulation and potential product taxes, changing consumer demand, competition, supply disruption, water and climate risks, cyber incidents, litigation, and access to capital markets. Venezuela remained subject to currency restrictions; the company had deconsolidated its local businesses and received no U.S.-dollar cash from them in 2016.
- The company said it believed liquidity and financing sources were adequate, while cautioning that capital-market volatility or credit-rating downgrades could raise borrowing costs or limit access. Management reported disclosure controls were effective; financial systems migration was ongoing. The auditor’s interim review identified no material modifications required, but was not an audit opinion. Management said there were no material changes to previously disclosed risk factors, and ordinary-course legal matters were not expected to have a material adverse effect.
Important facts for investors to verify
- How much of underlying growth and margin improvement persists after separating currency effects, Venezuela’s deconsolidation, commodity movements and other comparability items.
- Whether North American volume and pricing can offset weakness in carbonated drinks and pressure in Latin America and Europe.
- Potential further valuation changes in the Tingyi investment and the continued impact of market conditions in China.
- Execution, cash costs and realized savings from the productivity plans, as well as the pension-cost estimate change.
- Debt maturities, commercial-paper funding, planned shareholder returns and the company’s ability to maintain access to capital markets.
- Progress and control implications of the ongoing financial-systems migration, alongside currency, regulatory, supply and geopolitical risks.