20 July 2010

PEP: Income Statement Analysis for the June 2010 Quarter

PepsiCo (NYSE: PEP) earned $0.98 per diluted share on a GAAP basis in the fiscal 2010's 12-week second quarter, which ended on 12 June.  The reported EPS amount was 7 percent lower than the $1.06 PepsiCo made in the same quarter of 2009.

Core earnings increased from $1.02 to $1.10 per share in the second quarter.  Core earnings exclude acquisition-related gains and expenses, inventory valuation adjustments, and other unusual gains and losses.  (The exclusions from the GAAP figures are intended to provide better insight into the company's fundamental financial performance.)

This post examines PepsiCo's Income Statement for the quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings were $0.11 less than the $1.09 we had forecast for the second quarter, but core earnings were a mere $0.01 more than our target.

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

A challenge when working with PepsiCo's latest financial data is that comparisons of current and historic results are complicated by two large acquisitions earlier this year.

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.

Before getting into the details, we will take one step back to introduce the subject of today's analysis.

PepsiCo, Inc., is a leading global purveyor of beverages and snacks.  The company is well regarded for good management, steady growth, and significant international exposure.  The company's $7.8 billion acquisitions of Pepsi Bottling Group, Inc., and PepsiAmericas, Inc., made PepsiCo one of largest consumer staple firms in the U.S.  Additional background information about PepsiCo and the business environment in which it is currently operating can be found in 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 in the June quarter rose 39.7 percent, from $10.6 billion last year to $14.8 billion in the last three months.  Excluding currency exchange rate fluctuations (i.e., constant currency), the Revenue growth rate was 37 percent.

Revenue in the latest quarter fell 1.3 percent, a minor amount, short of our $15.0 billion target.  We had estimated a 4 percent increase over estimated pro forma Revenue, and the actual rise was about 3.5 percent.

The following table lists PepsiCo Revenue growth by division.

Revenue ($M)2Q 20102Q-2009% change
Frito-Lay North America $3195$31381.8%
Quaker Foods North America 379396-4.3%
Latin American Food 1538137811.6%
PepsiCo Americas Beverages 55482618111.9%
PepsiCo Europe 2416164247.1%
PepsiCo Asia, Middle East and Africa 1725142021.5%

The surge in PepsiCo Americas Beverage revenue was primarily due to the bottler acquisitions.  The 100+ percent gain is not a pro forma comparison.

The Cost of Goods Sold
in the quarter was of $6.75 billion, or 45.6 percent of Revenue.  This ratio translates into a Gross Margin of 54.4 percent, which is 50 basis points more profitable than the 53.9 percent Gross Margin in last year's second quarter.

The Gross Margin surpassed our 53.6-percent target for the second quarter by 80 basis points. 

PepsiCo spent $5.56 billion on Sales, General, and Administrative expenses, which was 37.6 percent of Revenue.  The latest amount includes $155 million for PBG/PAS merger and integration costs.  On a "Core" basis, the SG&A expense was $5.40 billion (36.5 percent of Revenue).

PepsiCo stated that the merger and integration costs will "help create a more fully integrated supply chain and go-to-market business model, to improve the effectiveness and efficiency of the distribution of our brands and to enhance our revenue growth."

The reported figure for SG&A exceeded our $5.44 billion estimate by 2.3 percent.  Core SG&A nearly matched our target.

The $32 million operating charge for amortization of intangible assets was a little less than our $40 million estimate.

Subtracting the various GAAP operating expenses from Revenue yields Operating Income of $2.46 billion.  Operating Income increased 12.4 percent when compared to last year's second quarter.  If not for PBG/PAS merger and integration costs, Operating Income would have slightly exceeded our $2.56 billion target for the second quarter.

Another perspective is gained by looking at non-GAAP Core Operating Profit, which increased from $2.101 billion in the June 2009 period to $2.696 billion in the latest quarter.

Core Operating Profit ($M)2Q 20102Q-2009% change
Frito-Lay North America $845$7837.9%
Quaker Foods North America 114132-13.6%
Latin America Foods 233240-2.9%
PepsiCo Americas Beverages 109162175.7%
PepsiCo Europe 33425531.0%
PepsiCo Asia, Middle East and Africa 27724712.1%

The recent acquisitions have made Bottling equity income a relatively insignificant item, as anticipated.  Income declined from $119 million to $9 million for this non-operating item.

The Net Interest Expense was $170 million, up substantially from last year's $73 million.  The $170 million figure includes $30 million for certain merger and integration costs.  The remained of the increase was due to higher debt balances required to complete the bottler acquisitions. The interest expense was marginally greater than the $160 million we budgeted.

The quarter's effective income tax rate of 30 percent was more burdensome than the 25 percent rate we had used for our estimates.  PepsiCo continues to expect a full-year reported tax rate of 23 to 24 percent.

Net Income was $1.6 billion ($0.98 per share), compared to $1.66 billion ($1.06 per share) in last year's second quarter.  Our estimate for the latest quarter was $1.8 billion ($1.09 per share).

Core earnings of $1.793 billion ($1.09 per share) nearly matched our estimate. Core earnings rose 12 percent, from $1.605 billion ($1.02 per share).

Full disclosure: Long PEP at time of writing.

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