PepsiCo, Inc. is an American beverage and food company headquartered in Purchase, New York. PepsiCo is currently the Coca-Cola Company's biggest competitor.
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
For the quarterly period ended March 20, 2004 (12 weeks)
OR
For the transition period from to
Commission File Number: 1-1183
PEPSICO, INC.
(Exact name of registrant as specified in its charter)
North Carolina
(State or other jurisdiction
of incorporation or organization)
13-1584302
(I.R.S. Employer
Identification No.)
914-253-2000
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Number of shares of Common Stock outstanding as of April 9, 2004: 1,707,025,588
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PEPSICO, INC. AND SUBSIDIARIES
INDEX
Part I Financial Information
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Statement of Income – 12 Weeks Ended March 20, 2004 and March 22, 2003
Condensed Consolidated Statement of Cash Flows – 12 Weeks Ended March 20, 2004 and March 22, 2003
Condensed Consolidated Balance Sheet – March 20, 2004 and December 27, 2003
Condensed Consolidated Statement of Comprehensive Income – 12 Weeks Ended March 20, 2004 and March 22, 2003
Notes to Condensed Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis – Financial Review
Independent Accountants’ Review Report
Item 4. Controls and Procedures
Part II Other Information and Signatures
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PART I—FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(in millions except per share amounts, unaudited)
Net Revenue
Cost of sales
Selling, general and administrative expenses
Amortization of intangible assets
Merger-related costs
Operating Profit
Bottling equity income
Interest expense
Interest income
Income before Income Taxes
Provision for Income Taxes
Net Income
Net Income Per Common Share
Basic
Diluted
Cash Dividends Declared Per Common Share
See accompanyingNotes to the Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(in millions, unaudited)
Operating Activities
Net income
Adjustments
Depreciation and amortization
Stock-based compensation expense
Cash payments for merger-related costs and
restructuring charges
Bottling equity income, net of dividends
Deferred income taxes
Net change in operating working capital
Other, net
Net Cash Provided by Operating Activities
Investing Activities
Capital spending
Sales of property, plant and equipment
Acquisitions and investments in noncontrolled affiliates
Divestitures
Short-term investments, by original maturity
More than three months—purchases
More than three months—maturities
Three months or less, net
Net Cash Used for Investing Activities
Financing Activities
Proceeds from issuances of long-term debt
Payments of long-term debt
Short-term borrowings, by original maturity
More than three months—proceeds
More than three months—payments
Cash dividends paid
Share repurchases—common
Share repurchases—preferred
Proceeds from exercises of stock options
Net Cash Used for Financing Activities
Effect of Exchange Rate Changes
Net Decrease in Cash and Cash Equivalents
Cash and Cash Equivalents—Beginning of year
Cash and Cash Equivalents—End of period
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CONDENSED CONSOLIDATED BALANCE SHEET
(in millions)
Assets
Current Assets
Cash and cash equivalents
Short-term investments, at cost
Accounts and notes receivable, less allowance: 3/04—$104, 12/03—$105
Inventories
Raw materials
Work-in-process
Finished goods
Prepaid expenses and other current assets
Total Current Assets
Property, Plant and Equipment
Accumulated Depreciation
Amortizable Intangibles, net
Goodwill
Other Nonamortizable Intangibles
Investments in Noncontrolled Affiliates
Other Assets
Total Assets
Continued on next page.
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CONDENSED CONSOLIDATED BALANCE SHEET (continued)
(in millions except per share amounts)
Liabilities and Shareholders’ Equity
Current Liabilities
Short-term borrowings obligations
Accounts payable and other current liabilities
Income taxes payable
Total Current Liabilities
Long-term Debt Obligations
Other Liabilities
Deferred Income Taxes
Total Liabilities
Preferred stock, no par value
Repurchased Preferred Stock
Common Shareholders’ Equity
Common stock, par value 1 2/3 cents per share:
Authorized 3,600 shares, issued 3/04 and 12/03—1,782 shares
Capital in excess of par value
Retained earnings
Accumulated other comprehensive loss
Less: Repurchased shares, at cost:
3/04—74 shares, 12/03—77 shares
Total Common Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
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CONDENSED CONSOLIDATED STATEMENT
OF COMPREHENSIVE INCOME
Other Comprehensive Income/(Loss)
Currency translation adjustment, net of related taxes
Cash flow hedges, net of related taxes:
Net derivative gains
Reclassification of losses/(gains) to net income
Other
Comprehensive Income
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Basis of Presentation and Our Divisions
Basis of Prsentation
Our Condensed Consolidated Balance Sheet at March 20, 2004 and the Condensed Consolidated Statements of Income, Cash Flows and Comprehensive Income for the 12 weeks ended March 20, 2004 and March 22, 2003 have not been audited. These statements have been prepared on a basis that is substantially consistent with the accounting principles applied in our Annual Report on Form 10-K for the year ended December 27, 2003. In our opinion, these financial statements include all normal and recurring adjustments necessary for a fair presentation. The results for the 12 weeks are not necessarily indicative of the results expected for the year.
Our significant interim accounting policies include the recognition of marketplace spending during the year incurred, generally in proportion to revenue, and the recognition of income taxes using an effective tax rate. In addition, we now recognize stock-based compensation in division results as division management are held accountable for this expense. Prior year results have been adjusted for comparability.
The following information is unaudited. Tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless noted and are based on unrounded amounts. This report should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended December 27, 2003.
Our Divisions
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12 Weeks Ended
Frito-Lay North America
PepsiCo Beverages North America
PepsiCo International
Quaker Foods North America
Total divisions
Divested businesses (a)
Corporate unallocated
Total
Corporate
Bottling investments
Intangible Assets
Amortizable intangible assets, net
Brands
Other identifiable intangibles
Accumulated amortization
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The change in nonamortizable intangible assets is as follows:
Balance,
12/27/03
3/20/04
Pension intangible
Total goodwill
Total brands
Total pension intangible
Stock-Based Compensation
We account for stock options using the fair value method of accounting. We recognized stock-based compensation expense of $91 million for the 12 weeks in 2004 and $110 million for the 12 weeks in 2003 which is reflected in selling, general and administrative expenses in our condensed consolidated statement of income.
Our weighted average Black-Scholes fair value assumptions are as follows:
Expected life
Risk free interest rate
Expected volatility
Expected dividend yield
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Pension and Retiree Medical Benefits
The components of net periodic benefit cost for pension and retiree medical plans are as follows:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Amortization of experience loss
Special termination benefits
Total expense
The computations of basic and diluted net income per common share are as follows:
Less: preferred dividends
Net income available for common shareholders
Basic net income per common share
Dilutive securities:
Stock options (b)
ESOP convertible preferred stock
Diluted net income per common share
Impairment and Restructuring Charges
In the fourth quarter of 2003, we incurred a charge of $147 million ($100 million after-tax or $0.06 per share) in conjunction with actions taken to streamline our North American divisions and PepsiCo International. The majority of the remaining terminations related to these actions occurred in the first quarter. As of March 20, 2004, $36 million of these costs remain payable and are included in other current liabilities.
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Supplemental Cash Flow Information
Interest paid
Income taxes paid
Acquisitions:
Fair value of assets acquired
Cash paid and debt assumed
Liabilities assumed
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FINANCIAL REVIEW
Our discussion and analysis is an integral part of understanding our financial results. Also refer toBasis of Presentation and Our Divisions in the Notes to the Condensed Consolidated Financial Statements. Tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless noted, and are based on unrounded amounts. Percentage changes and tax rates are based on unrounded amounts.
Our Critical Accounting Policies
In addition to the critical accounting policies disclosed in our Annual Report on Form 10-K for the fiscal year ended December 27, 2003, the following should be considered.
Marketplace Spending
We offer sales incentives through various programs to our customers and to consumers. These incentives are recorded as a reduction of the sales price of our products. Certain sales incentives are recognized at the time of the sale while other incentives, such as bottler funding and customer volume rebates, are recognized during the year incurred, generally in proportion to revenue, based on annual targets. Anticipated payments are estimated based on historical experience with similar programs. In addition, certain marketing costs are also recognized during the year incurred, generally in proportion to revenue.
Effective Tax Rate
In determining our quarterly provision for income taxes, we use an annual effective tax rate which is based on our expected annual income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Our effective tax rate also reflects our best estimate of the ultimate outcome of tax audits. Significant or unusual items are separately recognized in the quarter in which they occur.
We account for stock options using the fair value method of accounting. We recognized $91 million for the 12 weeks in 2004 and $110 million for the 12 weeks in 2003 which is reflected in selling, general and administrative expenses in our condensed consolidated statement of income. The reduction in our expense is due to the changes in our new executive compensation plan. However, total executive compensation expense, including the new long-term cash bonus award, is not expected to significantly differ from 2003. See our 2003 annual report for more information on our new executive compensation plan. As described in the 2003 annual report, beginning in 2004 our divisions planned for stock-based compensation in division results and senior management will evaluate division performance on that basis. As a result, stock-based compensation expense is allocated to our divisions as an incremental employee benefit cost and prior year division results have been adjusted for comparability. The expense allocated to our divisions excludes the impact of changes in our Black-Scholes assumptions which reflect market conditions over which division
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management has no control. Any variance between the allocated expense and our actual expense is recognized in corporate unallocated expenses. For our 2004 Black-Scholes assumptions, see Stock-Based Compensation in the Notes to Our Condensed Consolidated Financial Statements.
Our Business Risks
We discuss expectations regarding our future performance, such as our business outlook, in our annual and quarterly reports, press releases, and other written and oral statements. These “forward-looking statements” are based on currently available competitive, financial and economic data and our operating plans. They are inherently uncertain, and investors must recognize that events could turn out to be significantly different from our expectations.
Our operations outside of the United States generate about 35% of our net revenue. As a result, we are exposed to foreign currency risks. During the quarter, increases in the euro, the British pound, and the Brazilian real were slightly offset by declines in the Mexican peso contributing to 3 percentage points of net revenue growth. It is unlikely that this level of foreign exchange favorability will remain throughout the year. We expect the impact from the euro and the British pound to moderate while the unfavorable impact from the Mexican peso continues. Continued weakness in the Mexican peso could adversely affect our future results.
While there is continued pricing pressure on commodities, we expect to be able to mitigate this risk for the majority of our commodities through a combination of hedging programs, purchasing commitments and productivity. As a result, we expect our year-over-year costs for our most significant commodities in total to be roughly flat.
Cautionary statements regarding our trends and future results were included in Management’s Discussion and Analysis in our Annual Report on Form 10-K for the fiscal year ended December 27, 2003.
Results of Operations – Consolidated Review
In the discussions of net revenue and operating profit below, effective net pricing reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries.
Items Affecting Comparability
The year-over-year comparisons of our financial results are affected by prior year costs associated with our merger with Quaker of $11 million ($10 million after-tax). In addition, we sold our Quaker Foods North America’s Mission pasta business. The transaction resulted in a net gain of $25 million ($16 million after-tax and $0.01 per share). This gain was included in our divested business results.
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Volume
Since our divisions each use different measures of physical unit volume, a common servings metric is used to reflect our consolidated physical unit volume. For the 12 weeks, total division servings increased 7% reflecting contributions from all our divisions. PepsiCo International contributed more than half of this growth.
Consolidated Results
Total Net Revenue and Operating Profit
Division net revenue
Divested businesses
Total net revenue
Division operating profit
Total operating profit
Division operating profit margin
Total operating profit margin
Net revenue increased 11% primarily due to strong volume gains across all divisions, favorable foreign currency movements and favorable mix, primarily at PBNA and PI. The volume gains contributed 6 percentage points and the favorable foreign currency movements contributed 3 percentage points to the net revenue growth.
Total operating profit increased 10% and margin decreased 0.1 percentage points. Division operating profit increased 16% and margin increased 0.9 percentage points. These gains were driven by the strong volume, favorable mix and favorable foreign currency movements. The foreign currency movements contributed 2 percentage points to the division operating profit growth. Division selling, general and administrative expenses increased 9% reflecting the higher selling and distribution costs at PI and higher advertising and marketing expenses at PBNA. Increased corporate unallocated expenses resulted in total operating profit of 10%.
Corporate unallocated expenses increased 61% primarily due to higher employee-related expenses, primarily pension costs, and continued investment in our Business Process Transformation initiative.
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Other Consolidated Results
Interest expense, net
Tax rate
Net income per common share
Bottling equity income increased primarily due to strong results from The Pepsi Bottling Group and improved international bottler performance reflecting a favorable comparison to prior year losses as a result of the national strike in Venezuela in 2003.
Interest expense, net of interest income, declined 18% primarily reflecting lower average debt levels and higher average investment balances.
The tax rate decreased 1.5 percentage points compared to prior year primarily reflecting the increased benefit from our concentrate operations and changes arising from agreements reached with the Internal Revenue Service in the fourth quarter of last year.
Net income and the related net income per share increased 15%. These increases primarily reflect the strong operating profit growth. The increased bottling equity income and the lower effective tax rate also contributed to this growth.
Results of Operations – Division Review
The results and discussions below are based on how our Chief Executive Officer manages the performance of our divisions. Prior year amounts exclude the results of divested businesses. For additional information on our divisions, see Our Divisions in the Notes to our Condensed Consolidated Financial Statements.
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Net revenue
Operating profit
Net revenue growth of 6% reflects volume growth of 4% and positive effective net pricing. Pound volume grew primarily due to new products, strong single-digit growth in Lay’s Classic potato chips, strong double-digit growth in Munchies snack mix and Quaker Chewy granola bars, single-digit growth in Cheetos and variety pack packaging innovation. Lay’s Stax and Doritos Rollitos led the new product growth. These gains were partially offset by low single-digit declines in Doritos and Fritos. Modest pricing actions on certain salty snacks and favorable mix led the positive net pricing, partially offset by trade spending on product innovation.
Operating profit growth of 8% reflects the increased volume and pricing actions. Cost leverage generated from ongoing productivity initiatives offset higher manufacturing costs from unfavorable product mix and corn oil costs.
Net revenue increased 11% and volume increased 5%. The volume increase reflects non-carbonated beverage growth of 13% and carbonated beverage growth of 2%. The non-carbonated growth was fueled by the introduction of the new line of bottler-distributed Tropicana juice drinks and continued double-digit growth in Gatorade, Aquafina and Propel. Tropicana Pure Premium grew slightly for the quarter. The carbonated beverage performance reflects double-digit growth in the Diet Pepsi trademark. Growth in Pepsi Vanilla, introduced nationally in the third quarter of 2003, and mid single-digit growth in trademark Mountain Dew offset declines in regular trademark Pepsi, excluding Pepsi Vanilla, and in Sierra Mist, due to the overlap of the national launch of Sierra Mist in the first quarter 2003. Higher effective net pricing contributed 4 percentage points and favorable Canadian foreign exchange contributed 1 percentage point to the net revenue increase. The higher effective net pricing primarily reflects product mix shift to non-carbonated beverages.
Operating profit increased 20% reflecting the net revenue growth and benefits from purchasing efficiencies, partially offset by increased advertising and marketing costs. Total selling, general and administrative expenses grew at a slower rate than net revenue contributing to the operating profit margin improvement.
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International snacks volume grew 10%, comprised of 8% in our Latin America region, 10% in our Europe, Middle East and Africa region and 26% in our Asia region. These gains were driven by double-digit snack growth at Sabritas, in Mexico, and Brazil in large part from successful Yu-Gi-Oh promotions. Other contributors to snack growth were double-digit advances in India and Turkey and mid single-digit growth from Walkers in the United Kingdom. Growth at Gamesa in Mexico was flat due to the comparison to prior year double-digit growth.
Beverage volume grew 13%, comprised of 15% in our Europe, Middle East and Africa region, 14% in our Asia region and 11% in our Latin America region. Broad-based increases were led by strong double-digit growth in China and the Middle East, strong single-digit growth in Mexico and strong double-digit growth in Venezuela. Favorable comparisons to the 2003 national strike drove the growth in Venezuela.
Net revenue grew 19% driven by the volume growth in most markets. Favorable foreign currency contributed 7.5 percentage points of growth driven by the euro, British pound, Brazilian real and Australian dollar, slightly offset by the unfavorable Mexican peso.
Operating profit grew 34% driven largely by broad-based volume increases and favorable mix. Favorable foreign currency contributed 9 percentage points of growth driven by the British pound, euro and Brazilian real, partially offset by the unfavorable Mexican peso. Selling and distribution costs increased in line with the volume growth.
Net revenue and volume increased 2% primarily due to growth in Oatmeal. Growth in Oatmeal To Go in Canada also contributed to the overall volume performance. These gains were partially offset by Rice-A-Roni declines. The impact of favorable Canadian foreign exchange rates and favorable mix shift to higher priced Oatmeal products offset increased promotional spending.
Operating profit improved 4% reflecting favorable selling, general and administrative expense comparisons.
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OUR LIQUIDITY AND CAPITAL RESOURCES
During the quarter, our operations provided $712 million of cash reflecting our strong business results and continued focus on working capital. For the 12 weeks in 2003, net cash provided by operating activities of $422 million reflected our business results, partially offset by the impact of the timing of payments. Seasonal increases contributed to the use of cash in operating working capital accounts in both 12 week periods. In the second quarter of 2004, we will make a tax payment of approximately $760 million as a result of our settlement with the IRS in the fourth quarter of 2003. A portion of this payment represents deductible interest, which will lower our estimated tax payments during the second half of 2004 by a total of approximately $150 million.
During the quarter, we used $134 million, primarily reflecting capital spending of $182 million offset by net proceeds from short-term investments of $52 million. Capital spending during the quarter was lower than in the prior year due to spending in 2003 for Lay’s Stax production capacity and our new concentrate plant. We continue to expect full year capital spending to approximate $1.5 billion.
During the quarter, we used $623 million primarily for common share repurchases at a cost of $574 million, dividend payments of $274 million and net debt repayments of $196 million, partially offset by stock option proceeds of $431 million.
Subsequent to the quarter, we completed the repurchase program authorized by our Board of Directors in 2002. On March 29, 2004, our Board of Directors authorized a new share repurchase program of up to $7 billion over the next three years and an increase in our annual dividend from $0.64 to $0.92 per share commencing with our next dividend declaration. For the full year, we expect to spend at least $2.5 billion on share repurchases. Due to the anticipated tax payment and maturing debt, we expect to issue medium term debt of approximately $500 million in May of 2004.
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Management Operating Cash Flow
We focus on management operating cash flow as a key element in achieving maximum shareholder value and it is the primary measure we use to monitor cash flow performance. However, it is not a measure provided by accounting principles generally accepted in the United States. Since capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. The table below reconciles net cash provided by operating activities as reflected in our Condensed Consolidated Statement of Cash Flows to our management operating cash flow.
Net cash provided by operating activities
Management operating cash flow
Management operating cash flow was driven by our strong results and lower capital spending and was used primarily to repurchase shares, pay dividends and repay debt. We expect management operating cash flow for the full year to grow driven by our underlying business growth. We currently expect to continue to return approximately all our management operating cash flows to our shareholders through dividends and share repurchases. See Our Business Risk for certain factors that may impact our operating cash flows.
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The Board of Directors
PepsiCo, Inc.
We have reviewed the accompanying Condensed Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries as of March 20, 2004 and the related Condensed Consolidated Statements of Income, Comprehensive Income and Cash Flows for the twelve weeks ended March 20, 2004 and March 22, 2003. These condensed consolidated financial statements are the responsibility of PepsiCo, Inc.’s management.
We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries as of December 27, 2003, and the related Consolidated Statements of Income, Common Shareholders’ Equity and Cash Flows for the year then ended not presented herein; and in our report dated February 9, 2004, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying Condensed Consolidated Balance Sheet as of December 27, 2003, is fairly presented, in all material respects, in relation to the Consolidated Balance Sheet from which it has been derived.
KPMG LLP
New York, New York
April 15, 2004
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ITEM 4. Controls and Procedures
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-14 of the Exchange Act. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in alerting them on a timely basis to material information required to be included in our periodic filings with the SEC.
In addition, there were no significant changes in our internal control over financial reporting or in other factors that have materially affected or are reasonably likely to materially affect these internal controls over financial reporting as of the end of the period covered by this report.
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PART II OTHER INFORMATION AND SIGNATAURES
A summary of our repurchases (in millions) during the quarter under the $5 billion repurchase program authorized by our Board of Directors in 2002 and publicly announced on July 19, 2002, are as follows:
Shares
Repurchased
Average Price
Per Share
12/28/03—1/24/04
1/25/04—2/21/04
2/22/04—3/20/04
Subsequent to the quarter we completed the 2002 repurchase program. On March 29, 2004, our Board of Directors authorized and publicly announced a new share repurchase program of up to $7 billion over the next three years.
ITEM 6. Exhibits and Reports on Form 8-K
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned.
Peter A. Bridgman
Senior Vice President and
Controller
April 22, 2004
Robert E. Cox
Vice President, Associate General
Counsel and Assistant Secretary
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INDEX TO EXHIBITS
ITEM 6 (a)
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