24 April 2010

PEP: Income Statement Analysis for the March 2010 Quarter

This post examines PepsiCo's (NYSE: PEP) Income Statement for the 12-week quarter that ended 20 March 2010 and compares the entries on each line to our "look-ahead" estimates

The principal sources for this review were the earnings announcement, the formal 10-Q report, and the conference call with analysts (transcript made available by Seeking Alpha).

In a second article, we will report PepsiCo's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Because PepsiCo's  acquisition of Pepsi Bottling Group and PepsiAmericas occurred during the March 2010 quarter, the financial statements for this period include numerous special items that affect the comparability of the results. 

On a GAAP basis, PepsiCo earned $0.89 per diluted share in the latest quarter.  GAAP earnings were 23 percent above the $0.72 PepsiCo made in the same quarter of 2009.

"Core" earnings is a non-GAAP measure that provides better insight into the company's fundamental financial performance, especially in an unusual quarter such as the last one.   Core earnings exclude the acquisition-related gains and expenses, inventory valuation adjustments, the effect of Venezuela's currency devaluation, and several other special gains and losses.

In the latest quarter, Core earnings increased from $0.71 to $0.76 per share.  Core earnings exceeded the $0.70 per share we had forecast for the EPS.

Let's take a step back before diving into the Income Statement

PepsiCo, Inc., is a leading global purveyor of beverages and snacksThe company's $7.8 billion acquisitions of Pepsi Bottling Group, Inc., and PepsiAmericas, Inc., closed on 26 February 2010.   Additional background information about PepsiCo and the business environment in which it is currently operating can be found in the beginning of the look-ahead.

Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Revenue, on a GAAP basis, grew by 13.4 percent, from $8.263 billion in the first quarter of 2009 to $9.368 billion.  Revenue in the latest period very nearly matched our $9.402 billion estimate.

Pepsi achieved constant-currency Revenue growth, a non-GAAP measure, of 11 percent.

As a result of the bottler acquisitions, Revenue attributable to the PepsiCo Americas Beverage division surged 32 percent to $2.77 billion.  Revenue rises at the Asia, Middle East & Africa division (up 23 percent) and the Latin America Foods unit (up 12 percent) may have more long-term significance.  PepsiCo noted that "volume momentum in China and India" drove the AMEA sales increase.

The Cost of Goods Sold of $4.463 billion in the quarter equaled 47.6 percent of Revenue, which translates into a Gross Margin of 52.4 percent.  The CGS figure was nearly identical to our $4.466-billion target (proof that even a blindfolded dart thrower will hit the bulls-eye if given enough opportunities).

The latest Gross Margin was 230 basis points less lucrative than its year-earlier value of 54.7 percent.

The $4.05 billion PepsiCo spent on Sales, General, and Administrative expenses was 39 percent more than last year's $2.92 billion.  However, the latest amount includes numerous one-time items, including, for example, $282 million in merger and integration costs.  On a "Core" basis, the SG&A expense was a more normal -- although on the high side --  $3.448 billion (36.8 percent of Revenue).

The reported figure for SG&A exceeded our $3.29 billion estimate by 23 percent.  The Core figure was 4.8 percent greater than our target.

The $16 million operating charge for amortization of intangible assets was close to our $15 million estimate.

Subtracting these expenses from Revenue yields Operating Income of $840 million, which was 47 percent less than last year's $1.588 billion.  The situation is clearer if we look at Core Operating Profit, which was $1.72 billion in the latest quarter (11 percent more than in the March 2009 quarter).

Core Operating Profit was 5.5 percent greater than our $1.63 billion estimate for Operating Income.

PepsiCo reported that Core, Constant-Currency Operating Profit increased 9 percent at FLNA, but declined 14 percent at Quaker Foods North America.

We had assumed a relatively light $50 million for Bottling equity income in the first quarter.  So, were surprised that PepsiCo reported equity income of $709 million.  The explanation is that the category includes a on-time, non-taxable gain of $735 million on previously held equity interests in the bottlers.  It also includes $9 million of merger and integration costs.

The Net Interest Expense was $148 million, up substantially from last year's $98 million. The increase was due, in part, to financing used to complete the bottler acquisitions. The interest expense was greater than the $100 million we expected.

The Income Tax Rate was negative 2.4 percent (a net benefit).  This odd result was a byproduct of "the reversal of deferred taxes attributable to our previously held equity interests in PBG and PAS, as well as the favorable resolution of certain tax matters in the quarter."

The core tax rate was 23 percent.  We had modeled 28 percent.

Bottom-line GAAP Net Income, greatly affected by one-time benefits and costs, rose 26 percent to $1.43 billion ($0.89 per diluted share).  Earnings in the year-earlier quarter were $1.135 billion ($0.72 per share).  Net Income exceeded our $1.14 billion estimate by 26 percent.

Core earnings increased 9.5 percent, from $1.114 billion ($0.71 per share) to $1.22 billion ($0.76 per share).

In summary, the two big bottler acquisitions made this a transformation quarter for PepsiCo.  The financial statements contain numerous high-dollar, one-time items that make comparisons with past results difficult.  The company-defined "Core" earnings are easier to grasp and are more insightful.

Full disclosure: Long PEP at time of writing.

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