PEP

PEPSICO INC. 10-Q Summary: 36 Weeks Ended September 9, 2006

Business Context and Reporting Period

This Form 10-Q covers the 36-week period ended September 9, 2006, for PepsiCo, Inc. The company operates through four primary divisions: Frito-Lay North America (FLNA), PepsiCo Beverages North America (PBNA), PepsiCo International (PI), and Quaker Foods North America (QFNA). The financial statements are unaudited and prepared in accordance with U.S. GAAP.

Key Financial Metrics

Margins: Operating profit margin for the 36 weeks was 19.9% (down 0.1 percentage points from 20.0% in the prior year). The effective tax rate was 27.9% (down from 38.6% in the prior year).

Material Changes vs. Prior Period

• Revenue Growth: Net revenue increased 10% year-over-year, driven by a 5% volume increase and over 3% positive effective net pricing. Acquisitions and foreign exchange contributed an additional 1.5 percentage points.
• Profitability: Operating profit rose 10% to $4.9 billion. Growth was partially offset by higher raw material and energy costs across all divisions.
• Net Income Surge: Net income increased 30% to $3.9 billion. This significant jump was primarily due to the absence of a $468 million tax charge recorded in Q3 2005 related to the repatriation of international earnings under the American Jobs Creation Act (AJCA).
• Division Performance: PepsiCo International showed the strongest growth with 14% revenue and 19% operating profit increases. PBNA revenue grew 9%, while operating profit grew 4% despite higher raw material costs.
• Shareholder Returns: The company repurchased $2.2 billion of common stock and paid $1.4 billion in dividends during the 36-week period.

Outlook, Risks, and Unusual Items

• Capital Spending: Management anticipates net capital spending of approximately $2.2 billion for the full year 2006, reflecting investments in the Gatorade business and the Business Process Transformation (BPT) initiative.
• Divestitures and Gains: Bottling equity income included a $167 million pre-tax gain from the sale of Pepsi Bottling Group (PBG) stock. Additionally, a $11 million gain was recorded in Q1 2006 from the revaluation of an asset held for sale.
• Accounting Changes: The company is evaluating the impact of new accounting standards (FIN 48, SAB 108, SFAS 157, and SFAS 158). Adoption of SFAS 158 is estimated to reduce net assets by approximately $2 billion on the year-end balance sheet with no impact on income or cash flows.
• Risks: Approximately 40% of revenue is generated outside the U.S., exposing the company to foreign currency risks. Management expects to mitigate rising raw material and energy costs through hedging and productivity initiatives.

Investor Verification Checklist

• Tax Rate Volatility: Verify the sustainability of the 27.9% effective tax rate, noting it is significantly lower than the prior year due to the one-time absence of the AJCA repatriation tax charge.
• Raw Material Costs: Monitor the impact of rising commodity costs (specifically cooking oil, oranges, and energy) on future operating margins, as these offset revenue growth.
• Share Repurchase Program: Confirm the remaining capacity of the $8.5 billion repurchase program authorized in May 2006, which had approximately $8.2 billion remaining as of September 9, 2006.
• Debt Refinancing: Note the reclassification of $1.5 billion of short-term debt to long-term based on intent to refinance, and review the new $1.5 billion revolving credit facility.
• Volume vs. Pricing: Assess the balance between volume growth (5%) and pricing actions (3%+) to determine if future growth is driven by demand or inflationary pricing.