PepsiCo, Inc. — Q1 2010 Form 10-Q
Reporting period: 12 weeks ended March 20, 2010; comparative period ended March 21, 2009. Interim statements are unaudited, and results are not necessarily indicative of the full year. KPMG performed a review, not an audit.
Business context and reporting period
PepsiCo completed its acquisitions of The Pepsi Bottling Group (PBG) and PepsiAmericas (PAS) on February 26, 2010, for a preliminary total purchase price of approximately $12.6 billion, including assumed debt and the fair value of previously held interests. U.S. and Canadian acquired operations are included from the acquisition date; acquired international operations will be included beginning in Q2, consistent with PepsiCo’s reporting calendar. Accordingly, reported year-over-year comparisons are affected by the partial-period consolidation.
PepsiCo reported six divisions: Frito-Lay North America (FLNA), Quaker Foods North America (QFNA), Latin America Foods (LAF), PepsiCo Americas Beverages (PAB), Europe and Asia, Middle East and Africa (AMEA).
Key financial metrics
| Metric | Q1 2010 | Q1 2009 | Change / context |
|---|---|---|---|
| Net revenue | $9.368 billion | $8.263 billion | Up 13%; acquisition timing materially affects comparison |
| Operating profit | $840 million | $1.588 billion | Down 47%; reported margin fell to 9.0% from 19.2% |
| Net income attributable to PepsiCo | $1.430 billion | $1.135 billion | Up 26%, including significant acquisition-related gain and tax effects |
| Diluted EPS | $0.89 | $0.72 | Up 23%; company-reported adjusted EPS, excluding listed comparability items, was $0.76 versus $0.71, up 7% (8% constant currency) |
| Operating cash flow | $241 million | $(266) million | Improved; affected by pension contributions, integration payments, foundation contribution and working capital |
| Cash and cash equivalents | $3.949 billion | $3.943 billion at Dec. 26, 2009 | Balance-sheet date comparison |
| Debt obligations | $21.858 billion | $7.864 billion at Dec. 26, 2009 | Short-term obligations of $1.974 billion and long-term debt of $19.884 billion; increase principally reflects acquisitions and financing |
Capital spending was $274 million; cash flow from operations less capital spending was negative $33 million before $16 million of asset-sale proceeds. Current assets were $15.265 billion and current liabilities $11.654 billion. Total assets rose to $64.144 billion from $39.848 billion, largely reflecting the acquisitions.
Worldwide servings increased slightly: snacks rose 1% and beverages declined 0.5%. Segment revenue and operating profit were mixed: FLNA operating profit rose 10%; Europe rose 16% and AMEA 17%; QFNA and LAF each declined 12%. PAB operating profit fell 83% as reported, but rose 23% excluding listed acquisition-related and other comparability items.
Material changes and unusual items
- Operating profit included $312 million of PBG/PAS merger and integration charges, $281 million of acquired-inventory fair-value costs, a $120 million Venezuela-related charge, a $145 million asset write-off and a $100 million PepsiCo Foundation contribution. Mark-to-market commodity hedge gains were $46 million.
- Net income included a $958 million gain on remeasurement of PepsiCo’s previously held PBG/PAS equity interests, including $735 million recorded in bottling equity income and $223 million from reversal of deferred tax liabilities. The gain contributed $0.60 per diluted share; listed comparability items collectively increased reported EPS by 16 percentage points, according to management.
- Acquisition-related charges had an after-tax impact of $261 million, or $0.16 per share; inventory fair-value adjustments had an after-tax impact of $240 million, or $0.15 per share. These items, together with the Venezuela charge, asset write-off and Foundation contribution, materially complicate comparison of reported earnings.
- Unaudited pro forma results, assuming the acquisitions occurred at the start of each comparative period, showed revenue of $11.112 billion versus $11.083 billion, PepsiCo-attributable net income of $966 million versus $1.200 billion, and diluted EPS of $0.58 versus $0.73. The filing cautions that these figures are not indicative of actual or future results and exclude anticipated ongoing synergies.
Liquidity, debt and capital allocation
PepsiCo issued $4.25 billion of fixed- and floating-rate notes during Q1, partly to finance the acquisitions. It also assumed substantial PBG/PAS debt; acquired anchor-bottler debt had approximately $7.5 billion face value, $8.4 billion fair value, a 5.7% weighted-average stated rate and 7.5-year weighted-average remaining maturity. Total long-term contractual commitments were $31.8 billion, up $18.1 billion from year-end, primarily due to acquired and newly issued debt and related interest.
Financing activities provided $3.921 billion, including $4.216 billion of long-term debt proceeds; investing activities used $4.011 billion, including $2.833 billion net cash paid for PBG/PAS and $900 million for Dr Pepper Snapple Group manufacturing and distribution rights. Dividends paid were $712 million and common share repurchases were $735 million. The board raised the annual dividend 7%, from $1.80 to $1.92 per share, and authorized up to $15 billion of repurchases through June 30, 2013.
Management expected 2010 operating cash flow of approximately $8.3 billion and net capital spending of approximately $3.6 billion, and said cash generation, credit facilities and debt financing should meet operating, investing and financing needs. The company noted that volatile credit markets could impair access to financing on acceptable terms.
Outlook, management commentary and risks
- Moody’s lowered PepsiCo’s long-term ratings to Aa3 from Aa2; S&P lowered its corporate rating to A from A+ and senior unsecured debt rating to A- from A+. Both cited increased leverage or credit measures following the acquisitions; short-term ratings and outlooks were confirmed as stable.
- Foreign currency contributed 3 percentage points to reported revenue growth. PepsiCo reported Venezuela’s transition to hyperinflationary accounting and the bolivar’s official-rate devaluation; the resulting one-time charge was $120 million. Venezuela generated less than 1% of Q1 revenue, but represented 5% of cash and cash equivalents, and currency restrictions affected dividend remittances.
- Key exposures include foreign exchange, commodities and interest rates. Management estimated that a 1-percentage-point rise in interest rates would increase full-year net interest expense by $47 million, based on Q1-end variable-rate debt and investment levels. The company uses derivatives for hedging and stated it does not use them for speculative trading.
- PepsiCo expected a one-time tax charge of approximately $40 million in Q2 2010 from the new health-care law’s treatment of retiree drug subsidies, and was evaluating longer-term effects.
- Other identified items include $312 million of merger and integration charges, with substantially all related cash payments expected by the end of 2011, and a $145 million SAP-program asset write-off following a change in implementation scope. Management stated the SAP implementation would continue.
- Management reported disclosure controls were effective; internal control processes were being enhanced during the SAP transition. The filing disclosed no material change to previously reported risk factors. Two environmental matters were settled for fines of $123,500 and $147,000; management did not expect other ordinary-course proceedings to have a material adverse effect.
Important facts for investors to verify
- How the final PBG/PAS purchase-price allocation, acquired debt and preliminary fair values compare with the estimates in this filing; the allocation was expected to be finalized by year-end 2010.
- Whether post-acquisition integration costs, inventory fair-value effects and operating synergies develop as expected, especially in PAB and the newly integrated distribution system.
- Whether the $8.3 billion operating-cash-flow and $3.6 billion net-capital-spending expectations were achieved, and how acquisition-related debt affects liquidity, interest expense and credit ratings.
- Whether the reported earnings increase is supported by ongoing operating performance, given the $958 million remeasurement gain and other significant comparability items.
- Developments in Venezuela’s exchange controls, currency rates and remittance restrictions, and the effects of foreign-exchange, commodity-price and interest-rate movements.
- Final treatment and longer-term implications of the expected Q2 tax charge, as well as any material changes in legal, environmental or other contingencies.