Why did reported earnings fall so sharply in 1996 if sales grew?

Reported net income fell 28% to $1.149 billion because of $822 million in unusual impairment, disposal and other charges, which reduced EPS by $0.45. The largest piece was $576 million in International beverages, including $454 million tied largely to unconsolidated affiliates and concentrate-related assets and $122 million in restructuring. The rest was a $246 million charge to exit non-core U.S. restaurant businesses. Excluding these items, EPS was $1.17, down 6%.

What is the status of the planned restaurant spin-off?

In January 1997 PepsiCo announced plans to spin off its core restaurant businesses (Pizza Hut, Taco Bell and KFC) to shareholders as an independent public company, with completion expected by the end of 1997. The spin-off depends on an IRS ruling that it will be tax-free to shareholders, regulatory approvals, suitable market conditions and final board approval. The company is also exploring a separate sale of PepsiCo Food Systems, its restaurant distribution unit.

What went wrong in International beverages?

The segment swung from a $117 million operating profit in 1995 to an ongoing operating loss of $270 million in 1996. Causes cited include higher advertising and marketing spending, higher-than-normal fourth-quarter balance sheet adjustments, increased losses from unconsolidated affiliates (including a 24% share of BAESA's operating losses), and a volume decline of 41 million cases. The company also lost a Venezuelan bottler in August 1996. Management responded with a restructuring into 10 business units, projected to save about $50 million in 1997 and $80 million annually thereafter.

How is PepsiCo returning cash to shareholders, and can it sustain this?

In 1996 PepsiCo repurchased $1.65 billion of stock (54.2 million shares, about 3.4% of shares outstanding), paid $675 million in dividends, and raised the annual dividend rate to $0.445 per share from $0.39. These payments were funded by $4.2 billion of operating cash flow, $355 million from refranchising, and $323 million from stock option exercises. Free cash flow of $1.544 billion covered the combined dividends and buybacks with room to spare, but the company still ran a $1.2 billion financing deficit for the year, which it funded with reduced short-term investments and debt repayment. Remaining buyback authorization was 51.4 million shares at year-end.

What is the risk of Mexico's accounting change for 1997?

Beginning in 1997, Mexico will be treated as a highly inflationary economy, so the U.S. dollar becomes the functional currency for PepsiCo's Mexican operations. Management expects 1997 reported results for its Sabritas and Gamesa snack businesses to be slightly lower than they would have been under the peso, although the company says this is difficult to estimate. The expectation assumes the peso does not devalue significantly in 1997. Mexico's peso devaluation in 1994–95 had sharply reduced PepsiCo's Mexican sales and profits, so currency remains a material risk.

PEP 10-K FY1996 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 25, 1997. Cited figures are marked; the original filing is the authoritative source.

PepsiCo's 1996 Form 10-K shows a company in transition.

Reported net sales rose 5% to $31.6 billion^a, and volume gains of $592 million were driven by snack foods and North American beverages. However, reported operating profit fell 15% to $2.5 billion and reported net income fell 28% to $1.15 billion ($0.72 per share). The decline reflects $822 million of unusual impairment, disposal and other charges, including $576 million in International beverages and $246 million from disposing of non-core U.S. restaurant businesses.

Excluding these items, ongoing operating profit fell 4% to $3.4 billion^b and ongoing EPS fell 6% to $1.17, so the core business weakened but did not collapse. International beverages swung to an ongoing operating loss of $270 million, driven by higher advertising spending, unconsolidated affiliate losses (notably BAESA) and a Venezuelan bottler loss. Management is restructuring the portfolio.

In January 1997 PepsiCo announced plans to spin off Pizza Hut, Taco Bell and KFC to shareholders, subject to an IRS tax ruling and board approval, with completion targeted for year-end 1997. The company is also exploring a sale of PepsiCo Food Systems. Restaurant refranchising continues to reduce ownership, which generated $355 million^c in cash in 1996.

Shareholder returns remain a priority: share repurchases rose to $1.65 billion and dividends were raised to $0.445^d per share, with free cash flow up 41% to $1.54 billion. Leverage is moderate, with a market net debt ratio of 18% and a historical net debt ratio of 48%. Key watch items for investors are the execution of the restaurant spin-off, whether International beverages can return to profitability after its restructuring (expected to save about $50 million in 1997 and $80 million annually thereafter), and the earnings effect of Mexico's move to U.S. dollar functional currency accounting in 1997.

02—Key points

Key Highlights

Net sales rose 5% to $31.6 billion, with net volume gains of $592 million led by worldwide snack foods and North American beverages.
Reported operating profit fell 15% to $2.546 billion and reported EPS fell 28% to $0.72, driven by $822 million in unusual charges ($0.45 per share after-tax).
Ongoing (excluding unusual items) operating profit declined 4% to $3.368 billion and ongoing EPS declined 6% to $1.17.
International beverages posted an ongoing operating loss of $270 million, versus a profit of $117 million in 1995, with $576 million in impairment, disposal and restructuring charges.
PepsiCo plans to spin off Pizza Hut, Taco Bell and KFC to shareholders by year-end 1997, subject to an IRS tax ruling and board approval; PFS may be sold separately.
Free cash flow rose 41% to $1.544 billion, and the company repurchased $1.65 billion of stock (54.2 million shares) while raising the 1996 dividend to $0.445 per share.
Balance sheet remains moderate: total assets of $24.5 billion, shareholders' equity of $6.6 billion, and a market net debt ratio of 18%.

03—Questions

Frequently Asked Questions

Why did reported earnings fall so sharply in 1996 if sales grew?
Reported net income fell 28% to $1.149 billion because of $822 million in unusual impairment, disposal and other charges, which reduced EPS by $0.45. The largest piece was $576 million in International beverages, including $454 million tied largely to unconsolidated affiliates and concentrate-related assets and $122 million in restructuring. The rest was a $246 million charge to exit non-core U.S. restaurant businesses. Excluding these items, EPS was $1.17, down 6%.
What is the status of the planned restaurant spin-off?
In January 1997 PepsiCo announced plans to spin off its core restaurant businesses (Pizza Hut, Taco Bell and KFC) to shareholders as an independent public company, with completion expected by the end of 1997. The spin-off depends on an IRS ruling that it will be tax-free to shareholders, regulatory approvals, suitable market conditions and final board approval. The company is also exploring a separate sale of PepsiCo Food Systems, its restaurant distribution unit.
What went wrong in International beverages?
The segment swung from a $117 million operating profit in 1995 to an ongoing operating loss of $270 million in 1996. Causes cited include higher advertising and marketing spending, higher-than-normal fourth-quarter balance sheet adjustments, increased losses from unconsolidated affiliates (including a 24% share of BAESA's operating losses), and a volume decline of 41 million cases. The company also lost a Venezuelan bottler in August 1996. Management responded with a restructuring into 10 business units, projected to save about $50 million in 1997 and $80 million annually thereafter.
How is PepsiCo returning cash to shareholders, and can it sustain this?
In 1996 PepsiCo repurchased $1.65 billion of stock (54.2 million shares, about 3.4% of shares outstanding), paid $675 million in dividends, and raised the annual dividend rate to $0.445 per share from $0.39. These payments were funded by $4.2 billion of operating cash flow, $355 million from refranchising, and $323 million from stock option exercises. Free cash flow of $1.544 billion covered the combined dividends and buybacks with room to spare, but the company still ran a $1.2 billion financing deficit for the year, which it funded with reduced short-term investments and debt repayment. Remaining buyback authorization was 51.4 million shares at year-end.
What is the risk of Mexico's accounting change for 1997?
Beginning in 1997, Mexico will be treated as a highly inflationary economy, so the U.S. dollar becomes the functional currency for PepsiCo's Mexican operations. Management expects 1997 reported results for its Sabritas and Gamesa snack businesses to be slightly lower than they would have been under the peso, although the company says this is difficult to estimate. The expectation assumes the peso does not devalue significantly in 1997. Mexico's peso devaluation in 1994–95 had sharply reduced PepsiCo's Mexican sales and profits, so currency remains a material risk.

04—Continue

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