EX-99.1 3 dex991.htm REVISED MD&A, CONSOLIDATED FINANCIAL STATEMENTS (AS PREVIOUSLY REPORTED) Revised MD&A, Consolidated Financial Statements (as Previously Reported)

EXHIBIT 99.1

Our discussion and analysis is an integral part of understanding our financial results. Definitions of key terms can be found in the glossary on page 82. Tabular dollars are presented 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 are based on unrounded amounts.

When used in this Form 8-K, the terms “we,” “us,” “our,” “PepsiCo” and the “Company” mean PepsiCo, Inc. and its divisions and subsidiaries.

OUR BUSINESS

Our Operations

We are a leading global snack and beverage company. We manufacture, market and sell a variety of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages and foods in approximately 200 countries, with our largest operations in North America (United States and Canada), Mexico and the United Kingdom. Additional information concerning our divisions and geographic areas is presented in Note 1.

Our commitment to sustainable growth, defined as Performance with Purpose, is focused on generating healthy financial returns while giving back to the communities we serve. This includes meeting consumer needs for a spectrum of convenient foods and beverages, reducing our impact on the environment through water, energy and packaging initiatives, and supporting our employees through a diverse and inclusive culture that recruits and retains world-class talent. In September 2007, we were again included on the Dow Jones Sustainability North America Index and were also added to the Dow Jones Sustainability World Index. These lists are compiled annually.

In the fourth quarter of 2007, we announced a strategic realignment of our organizational structure into three new business units, as follows:

 

  (1) PepsiCo Americas Foods (PAF), which includes Frito-Lay North America (FLNA), Quaker Foods North America (QFNA) and all of our Latin American food and snack businesses (LAF), including our Sabritas and Gamesa businesses in Mexico;

 

  (2) PepsiCo Americas Beverages (PAB), which includes PepsiCo Beverages North America (PBNA) and all of our Latin American beverage businesses; and

 

  (3) PepsiCo International (PI), which includes all PepsiCo businesses in the United Kingdom, Europe, Asia, Middle East and Africa.

 

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Our three business units are comprised of six reportable segments, as follows:

 

   

FLNA,

 

   

QFNA,

 

   

LAF,

 

   

PAB,

 

   

United Kingdom & Europe (UKE), and

 

   

Middle East, Africa & Asia (MEAA).

Frito-Lay North America

FLNA manufactures or uses contract manufacturers, markets, sells and distributes branded snacks. These snacks include Lay’s potato chips, Doritos tortilla chips, Tostitos tortilla chips, Cheetos cheese flavored snacks, branded dips, Fritos corn chips, Ruffles potato chips, Quaker Chewy granola bars, SunChips multigrain snacks, Rold Gold pretzels, Santitas tortilla chips, Grandma’s cookies, Frito-Lay nuts, Munchies snack mix, Gamesa cookies, Funyuns onion flavored rings, Quaker Quakes corn and rice snacks, Miss Vickie’s potato chips, Stacy’s pita chips, Smartfood popcorn, Chester’s fries, branded crackers and Flat Earth crisps. FLNA branded products are sold to independent distributors and retailers.

Quaker Foods North America

QFNA manufactures or uses contract manufacturers, markets and sells cereals, rice, pasta and other branded products. QFNA’s products include Quaker oatmeal, Aunt Jemima mixes and syrups, Life cereal, Cap’n Crunch cereal, Quaker grits, Rice-A-Roni, Pasta Roni and Near East side dishes. These branded products are sold to independent distributors and retailers.

Latin America Foods

LAF manufactures, markets and sells a number of leading salty and sweet snack brands including Gamesa, Doritos, Cheetos, Ruffles, Sabritas and Lay’s. Further, LAF manufactures or uses contract manufacturers, markets and sells many Quaker brand cereals and snacks. These branded products are sold to independent distributors and retailers.

PepsiCo Americas Beverages

PAB manufactures or uses contract manufacturers, markets and sells beverage concentrates, fountain syrups and finished goods, under various beverage brands including Pepsi, Mountain Dew, Gatorade, 7UP (outside the U.S.), Tropicana Pure Premium, Sierra Mist, Mirinda, Propel, Tropicana juice drinks, Dole, SoBe Life Water, Naked juice and Izze. PAB also manufactures or uses contract manufacturers, markets and sells ready-to-drink tea, coffee and water products through joint ventures with Unilever (under the Lipton brand name) and Starbucks. In addition, PAB licenses the Aquafina water brand to its bottlers and markets this brand. PAB sells concentrate and

 

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finished goods for some of these brands to authorized bottlers, and some of these branded products are sold directly by us to independent distributors and retailers. The bottlers sell our brands as finished goods to independent distributors and retailers. PAB’s volume reflects sales to its independent distributors and retailers, as well as the sales of beverages bearing our trademarks that bottlers have reported as sold to independent distributors and retailers. Bottler case sales (BCS) and concentrate shipments and equivalents (CSE) are not necessarily equal during any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our revenues are not based on BCS volume, we believe that BCS is a valuable measure as it measures the sell-through of our products at the consumer level.

United Kingdom & Europe

UKE manufactures, markets and sells through consolidated businesses as well as through noncontrolled affiliates, a number of leading salty and sweet snack brands including Lay’s, Walkers, Cheetos, Doritos and Ruffles. Further, UKE manufactures or uses contract manufacturers, markets and sells many Quaker brand cereals and snacks. UKE also manufactures, markets and sells beverage concentrates, fountain syrups and finished goods, under various beverage brands including Pepsi, 7UP and Tropicana. These brands are sold to authorized bottlers, independent distributors and retailers. However, in certain markets, UKE operates its own bottling plants and distribution facilities. In addition, UKE licenses the Aquafina water brand to certain of its authorized bottlers. UKE also manufactures or uses contract manufacturers, markets and sells ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name).

UKE reports two measures of volume. Snack volume is reported on a system-wide basis, which includes our own sales and the sales by our noncontrolled affiliates of snacks bearing Company-owned or licensed trademarks. Beverage volume reflects Company-owned or authorized bottler sales of beverages bearing Company-owned or licensed trademarks to independent distributors and retailers. BCS and CSE are not necessarily equal during any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our revenues are not based on BCS volume, we believe that BCS is a valuable measure as it measures the sell-through of our products at the consumer level.

Middle East, Africa & Asia

MEAA manufactures, markets and sells through consolidated businesses as well as through noncontrolled affiliates, a number of leading salty and sweet snack brands including Lay’s, Doritos, Cheetos, Smith’s and Ruffles. Further, MEAA manufactures or uses contract manufacturers, markets and sells many Quaker brand cereals and snacks. MEAA also manufactures, markets and sells beverage concentrates, fountain syrups and finished goods, under various beverage brands including Pepsi, Mirinda, 7UP and Mountain Dew. These brands are sold to authorized bottlers, independent distributors and retailers. However, in certain markets, MEAA operates its own bottling plants and distribution facilities. In addition, MEAA licenses the Aquafina water brand to certain of its authorized bottlers. MEAA also manufactures or uses contract manufacturers, markets and sells ready-to-drink tea products through the joint venture with Unilever (see United Kingdom & Europe above). MEAA reports two measures of volume (see United Kingdom & Europe above).

 

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A Perspective from our Chairman and CEO

The questions below reflect those often asked by our shareholders about key areas of our businesses. The answers come from our Chairman and CEO, Indra Nooyi.

In November 2007, PepsiCo announced a new organizational structure. What drove this decision, and how will the restructuring impact financial results?

Given our robust growth in recent years, we felt it was time to manage the Company as three units instead of two — both to allow us to sustain our growth rate and also to develop global senior leadership talent for PepsiCo’s future. We therefore created three operating business units: PAF, PAB and PI.

We are confident this organizational structure will help us deliver strong top-line performance and profit growth for the following reasons:

 

   

Each sector has significant scale and growth potential, operates across multiple geographies, and is comprised of both developed and developing markets;

 

   

This facilitates our ability to leverage both capabilities and innovation between our international and North American businesses;

 

   

With each sector being of significant scale, more executives will have the opportunity to run large operating businesses and gain global operating experience; and

 

   

It enables us to extend the competitive advantages of our very successful Power of One initiatives by making them increasingly global.

Finally, investors will receive more granular international performance data, as we will report volume, revenue and operating profit for six PepsiCo segments, versus four in the previous structure.

How is PepsiCo reacting to the changing global economy, particularly the slowing U.S. economy?

It is likely the world economies outside the emerging countries will slow in 2008 – although our businesses have generally proved pretty resilient in past economic downturns. It’s also clear that inflation in commodity costs has accelerated, particularly as it relates to grains and energy. We will be utilizing all of the tools at our disposal to address rising inflation. From a productivity standpoint, we’re accelerating efforts across the entire business system: product formulations, ingredient sourcing, trade efficiencies, manufacturing, go-to-market and administrative expenses. In addition, we will be looking to gain effective pricing, both through innovative new products as well as through a judicious combination of mix management, product weight-outs, and absolute pricing. As always, our decisions are grounded in the consumer, customer and competitive environments in each market.

 

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Underlying these efforts are the important structural advantages we have across the world. Our brands have highly loyal and engaged consumers; they are affordable treats and healthy eats; and the strength of our go-to-market systems makes them readily available to consumers.

And as a team, we remain committed to managing for the long term, executing with excellence and consistently delivering our annual targets.

How are you responding to the category shift in consumer beverage consumption between carbonated soft drinks (CSD) and non-carbonated beverages (NCB), particularly in the U.S.?

We know that consumers have changing desires, and we are continually transforming our beverage portfolio in response to these changes.

Consumers respond to innovation in the CSD category, and so we continue to invigorate our flagship CSDs: Pepsi, Diet Pepsi and Mountain Dew. Last year, we launched Diet Pepsi Max in the U.S., a no calorie beverage with the energy boost of added caffeine and ginseng; and we launched Mountain Dew Game Fuel, created in conjunction with Microsoft’s Xbox 360 exclusive title, Halo 3, marking the first time a soft drink has been created specifically for video gamers.

We have also introduced new carbonated juice drinks like Izze, an all-natural sparkling fruit juice brand that we acquired in 2006; and we have a growing energy drink business with Amp Energy, SoBe Adrenaline Rush and No Fear.

In NCBs, we have made great progress in the nutrition category with the acquisition of Naked Juice and our recent introduction of Tropicana Pure.

We have U.S. category leadership positions with many of our NCB brands, including Aquafina, the number one national PET water brand; Lipton, the number one ready-to-drink tea and the number one ready-to-drink coffee with Starbucks Frappuccino.

PepsiCo defines the performance category with our number one sports drink Gatorade; and with our recent launch of G2 we have added a low-calorie, off-the-field hydration answer for athletes. Rounding out the NCB portfolio are great enhanced water brands including our low-calorie reformulated SoBe Life Water and Propel Fitness Waters.

Across the entire spectrum of categories, our continued focus on R&D and innovation as well as consumer insights enable us to adapt and continually meet consumer needs, while still leveraging the global strength of our flagship CSD beverage portfolio.

What progress has PepsiCo made in its SAP implementation?

PepsiCo’s multi-year technology transformation initiative continues on track. At the end of 2007, we kicked off our third major deployment by successfully implementing new capabilities to PCNA and the Quaker, Tropicana and Gatorade businesses (QTG). These

 

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implementations build on earlier SAP releases, enhancing the order management and demand planning functions for QTG and deliver new capability to PCNA’s fountain equipment service model. They also lay the groundwork to convert all of the financial processes, contracts and projects to SAP technology.

On the international front we went live with SAP financials at Gamesa and Sabritas and launched our first plant in Saltillo, Mexico; successfully integrated our Duyvis acquisition onto our new global platform; and launched China Beverages. We are working toward 2008 implementations in Egypt and Saudi Arabia.

We remain confident in the capabilities and business case that our transformation initiative will deliver.

PepsiCo’s businesses generate a lot of cash, and some people may believe the Company’s balance sheet is conservative. Will investors see any changes in capital structure, acquisition activity or increased share repurchases?

PepsiCo does generate considerable cash, and we are disciplined about how cash is reinvested in the business. Over the past three years, over $6 billion has been reinvested in the businesses through capital expenditures to fuel growth. All cash not reinvested in the business is returned to our shareholders. Since 2005, $16 billion has been returned to shareholders through a combination of dividends and share repurchases; and in 2007, cash returned to shareholders was up 34%. We will generally use our borrowing capacity in order to fund acquisitions – which was the case in 2007, when we spent $1.3 billion in acquisitions to enhance our future growth and create value for our shareholders. Our current capital structure and debt ratings give us ready access to capital markets and keep our cost of borrowing down.

In 2007, you expanded your joint venture agreements with Starbucks and Unilever. Does this represent a new growth model for PepsiCo?

We have great partnerships on ready-to-drink beverages with both Starbucks and Unilever. If what it takes to win in a certain marketplace is to partner with other brands and together make the pie much bigger, then we will apply that model to grow our businesses.

A key factor in these successful partnerships is that PepsiCo is not simply a distributor. The development of these brands is included in the partnerships between our companies on a worldwide scale, and that certainly distinguishes our model.

Growth will also come from the enormous opportunities we see for tuck-in acquisitions. We are also expanding into adjacent categories through our recently announced acquisition of Penelopa nuts and seeds in Bulgaria and our 2006 purchase of the Duyvis nuts business in Europe. Last year, we entered the salty snacks business in New Zealand with the acquisition of Bluebird Foods, and we expanded our snacks business in Brazil with the purchase of Lucky snacks. We also recently announced a joint venture with the Strauss Group to produce and sell Sabra refrigerated dips and spreads in the U.S. and

 

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Canada. In 2007, Sabra was the top-selling and fastest-growing maker of hummus in the U.S. And we expanded our global juice footprint by acquiring U.S.-based Naked Juice, and the Sandora juice business in the Ukraine, which we purchased in a joint venture with PepsiAmericas, Inc. (PAS).

So there are tremendous opportunities for us to continue to grow — through partnerships, as well as organically, and with tuck-in acquisitions.

Our Customers

Our customers include authorized bottlers and independent distributors, including foodservice distributors and retailers. We normally grant our bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide the Company with the right to charge our bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality.

Since we do not sell directly to the consumer, we rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products. For our independent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include coupons, pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually.

Retail consolidation continues to increase the importance of major customers. In 2007, sales to Wal-Mart Stores, Inc. (Wal-Mart), including Sam’s Club (Sam’s) represented approximately 12% of our total net revenue. Our top five retail customers represented approximately 31% of our 2007 North American net revenue, with Wal-Mart (including Sam’s) representing approximately 18%. These percentages include concentrate sales to our bottlers which are used in finished goods sold by them to these retailers. In addition, sales to The Pepsi Bottling Group (PBG) represented approximately 9% of our total net revenue. See “Our Related Party Bottlers” and Note 8 for more information on our anchor bottlers.

Our Related Party Bottlers

We have ownership interests in certain of our bottlers. Our ownership is less than 50%, and since we do not control these bottlers, we do not consolidate their results. We have designated three related party bottlers, PBG, PAS and Pepsi Bottling Ventures LLC (PBV), as our anchor bottlers. We include our share of their net income based on our percentage of economic ownership in

 

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our income statement as bottling equity income. Our anchor bottlers distribute approximately 58% of our North American beverage volume and approximately 18% of our beverage volume outside of North America. Our anchor bottlers participate in the bottler funding programs described above. Approximately 6% of our total 2007 sales incentives are related to these bottlers. See Note 8 for additional information on these related parties and related party commitments and guarantees.

Our Distribution Network

Our products are brought to market through direct-store-delivery (DSD), broker-warehouse and foodservice and vending distribution networks. The distribution system used depends on customer needs, product characteristics and local trade practices.

Direct-Store-Delivery

We, our bottlers and our distributors operate DSD systems that deliver snacks and beverages directly to retail stores where the products are merchandised by our employees or our bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising.

Broker-Warehouse

Some of our products are delivered from our manufacturing plants and warehouses to customer warehouses and retail stores. These less costly systems generally work best for products that are less fragile and perishable, have lower turnover, and are less likely to be impulse purchases.

Foodservice and Vending

Our foodservice and vending sales force distributes snacks, foods and beverages to third-party foodservice and vending distributors and operators. Our foodservice and vending sales force also distributes certain beverages through our bottlers. This distribution system supplies our products to schools, businesses, stadiums, restaurants and similar locations.

Our Competition

Our businesses operate in highly competitive markets. We compete against global, regional, local and private label manufacturers on the basis of price, quality, product variety and distribution. In U.S. measured channels, we have a similar share of CSD consumption and a larger share of liquid refreshment beverages consumption, as compared to our chief beverage competitor, The Coca-Cola Company. However, The Coca-Cola Company has a significant CSD share advantage in many markets outside the U.S. Further, our snack brands hold significant leadership positions in the snack industry worldwide. Our snack brands face local and regional competitors, as well as national and

 

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global snack competitors, and compete on the basis of price, quality, product variety and distribution. Success in this competitive environment is dependent on effective promotion of existing products and the introduction of new products. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allow us to compete effectively.

Other Relationships

Certain members of our Board of Directors also serve on the boards of certain vendors and customers. Those Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of our anchor bottlers and other affiliated companies and do not receive incremental compensation for their Board services.

Our Business Risks

We are subject to risks in the normal course of business. See “Risk Factors” in Item 1A. of our 2007 Form 10-K and “Market Risks” below for more information about these risks.

Risk Management Framework

The achievement of our strategic and operating objectives will necessarily involve taking risks. Our risk management process is intended to ensure that risks are taken knowingly and purposefully. As such, we leverage an integrated risk management framework to identify, assess, prioritize, manage, monitor and communicate risks across the Company. This framework includes:

 

   

The PepsiCo Executive Committee (PEC), comprised of a cross-functional, geographically diverse, senior management group which identifies, assesses, prioritizes and addresses strategic and reputational risks;

 

   

Division Risk Committees (DRCs), comprised of cross-functional senior management teams which meet regularly each year to identify, assess, prioritize and address division-specific operating risks;

 

   

PepsiCo’s Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PEC and the DRCs, identifies and assesses potential risks, and facilitates ongoing communication between the parties, as well as to PepsiCo’s Audit Committee and Board of Directors;

 

   

PepsiCo Corporate Audit, which evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and

 

   

PepsiCo’s Compliance Office, which leads and coordinates our compliance policies and practices.

 

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Market Risks

We are exposed to market risks arising from adverse changes in:

 

   

commodity prices, affecting the cost of our raw materials and energy,

 

   

foreign exchange rates, and

 

   

interest rates.

In the normal course of business, we manage these risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging strategies. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost saving opportunities or efficiencies. Our global purchasing programs include fixed-price purchase orders and pricing agreements. Our hedging strategies include the use of derivatives. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. We do not use derivative instruments for trading or speculative purposes, and we limit our exposure to individual counterparties to manage credit risk. The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 10 for further discussion of these derivatives and our hedging policies. See “Our Critical Accounting Policies” for a discussion of the exposure of our pension plan assets and pension and retiree medical liabilities to risks related to stock prices and discount rates.

Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See “Risk Factors” in Item 1A. of our 2007 Form 10-K for further discussion.

Commodity Prices

Our open commodity derivative contracts that qualify for hedge accounting had a face value of $5 million at December 29, 2007 and $55 million at December 30, 2006. The open derivative contracts that qualify for hedge accounting resulted in net unrealized gains of less than $1 million at December 29, 2007 and December 30, 2006. We estimate that a 10% decline in commodity prices would have had no impact on our net unrealized gains in 2007.

Our open commodity derivative contracts that do not qualify for hedge accounting had a face value of $105 million at December 29, 2007 and $196 million at December 30, 2006. The open derivative contracts that do not qualify for hedge accounting resulted in net gains of $3 million in 2007 and net losses of $28 million in 2006. We estimate that a 10% decline in commodity prices would have had no impact on our net gains in 2007.

We expect to be able to continue to reduce the impact of increases in our raw material and energy costs through our hedging strategies and ongoing productivity initiatives.

 

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Foreign Exchange

Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within shareholders’ equity under the caption currency translation adjustment.

Our operations outside of the U.S. generate 44% of our net revenue, with Mexico, the United Kingdom and Canada comprising 19% of our net revenue. As a result, we are exposed to foreign currency risks. During 2007, net favorable foreign currency, primarily due to appreciation in the euro, British pound, Canadian dollar and Brazilian real, contributed 2 percentage points to net revenue growth. Currency declines which are not offset could adversely impact our future results.

Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses in our income statement as incurred. We may enter into derivatives to manage our exposure to foreign currency transaction risk. Our foreign currency derivatives had a total face value of $1.6 billion at December 29, 2007 and $1.0 billion at December 30, 2006. The contracts that qualify for hedge accounting resulted in net unrealized losses of $44 million at December 29, 2007 and $6 million at December 30, 2006. We estimate that an unfavorable 10% change in the exchange rates would have resulted in net unrealized losses of $152 million in 2007. The contracts not meeting the criteria for hedge accounting resulted in a net gain of $15 million in 2007 and a net loss of $10 million in 2006. All losses and gains were offset by changes in the underlying hedged items, resulting in no net material impact on earnings.

Interest Rates

We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We may use interest rate and cross currency interest rate swaps to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. These swaps are entered into concurrently with the issuance of the debt that they are intended to modify. The notional amount, interest payment and maturity date of the swaps match the principal, interest payment and maturity date of the related debt. Our counterparty credit risk is considered low because these swaps are entered into only with strong creditworthy counterparties and are generally settled on a net basis.

Assuming year-end 2007 variable rate debt and investment levels, a 1-percentage-point increase in interest rates would have decreased net interest expense by $1 million in 2007.

 

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OUR CRITICAL ACCOUNTING POLICIES

An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. Other than our accounting for pension plans, our critical accounting policies do not involve the choice between alternative methods of accounting. We applied our critical accounting policies and estimation methods consistently in all material respects, and for all periods presented, and have discussed these policies with our Audit Committee.

Our critical accounting policies arise in conjunction with the following:

 

   

revenue recognition,

 

   

brand and goodwill valuations,

 

   

income tax expense and accruals, and

 

   

pension and retiree medical plans.

Revenue Recognition

Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the U.S., and generally within 30 to 90 days internationally, and may allow discounts for early payment. We recognize revenue upon shipment or delivery to our customers based on written sales terms that do not allow for a right of return. However, our policy for DSD and chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for warehouse-distributed products is to replace damaged and out-of-date products. Based on our historical experience with this practice, we have reserved for anticipated damaged and out-of-date products. Our bottlers have a similar replacement policy and are responsible for the products they distribute.

Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space limiting the quantity of product. For product delivered through our other distribution networks, customer inventory levels are monitored.

As discussed in “Our Customers,” we offer sales incentives and discounts through various programs to customers and consumers. Sales incentives and discounts are accounted for as a reduction of revenue and totaled $11.3 billion in 2007, $10.1 billion in 2006 and $8.9 billion in 2005. Sales incentives include payments to customers for performing merchandising activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and

 

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discounts to promote lower retail prices. A number of our sales incentives, such as bottler funding and customer volume rebates, are based on annual targets, and accruals are established during the year for the expected payout. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. The terms of most of our incentive arrangements do not exceed a year, and therefore do not require highly uncertain long-term estimates. For interim reporting, we estimate total annual sales incentives for most of our programs and record a pro rata share in proportion to revenue. Certain arrangements, such as fountain pouring rights, may extend beyond one year. The costs incurred to obtain incentive arrangements are recognized over the shorter of the economic or contractual life, as a reduction of revenue, and the remaining balances of $287 million at year-end 2007 and $297 million at year-end 2006 are included in current assets and other assets on our balance sheet.

We estimate and reserve for our bad debt exposure based on our experience with past due accounts. Bad debt expense is classified within selling, general and administrative expenses in our income statement.

Brand and Goodwill Valuations

We sell products under a number of brand names, many of which were developed by us. The brand development costs are expensed as incurred. We also purchase brands in acquisitions. Upon acquisition, the purchase price is first allocated to identifiable assets and liabilities, including brands, based on estimated fair value, with any remaining purchase price recorded as goodwill. Determining fair value requires significant estimates and assumptions based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows.

We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance, and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these perpetual brand criteria are not met, brands are amortized over their expected useful lives, which generally range from five to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history and future expansion expectations, as well as the macroeconomic environment of the countries in which the brand is sold.

Perpetual brands and goodwill, including the goodwill that is part of our noncontrolled bottling investment balances, are not amortized. Perpetual brands and goodwill are assessed for impairment at least annually. If the carrying amount of a perpetual brand exceeds its fair value, as determined by its discounted cash flows, an impairment loss is recognized in an amount equal to that excess. Goodwill is evaluated using a two-step impairment test at the reporting unit level. A reporting unit can be a division or business

 

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within a division. The first step compares the book value of a reporting unit, including goodwill, with its fair value, as determined by its discounted cash flows. If the book value of a reporting unit exceeds its fair value, we complete the second step to determine the amount of goodwill impairment loss that we should record. In the second step, we determine an implied fair value of the reporting unit’s goodwill by allocating the fair value of the reporting unit to all of the assets and liabilities other than goodwill (including any unrecognized intangible assets). The amount of impairment loss is equal to the excess of the book value of the goodwill over the implied fair value of that goodwill.

Amortizable brands are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows.

Management judgment is necessary to evaluate the impact of operating and macroeconomic changes and to estimate future cash flows. Assumptions used in our impairment evaluations, such as forecasted growth rates and our cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks discussed in “Risk Factors” in Item 1A. of our 2007 Form 10-K.

We did not recognize any impairment charges for perpetual brands or goodwill in the years presented. As of December 29, 2007, we had $6.4 billion of perpetual brands and goodwill, of which approximately 60% related to Tropicana and Walkers.

Income Tax Expense and Accruals

Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we may not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit.

An estimated effective tax rate for a year is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior year tax matters to be such items.

Tax law requires items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, our annual tax rate reflected in our financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets

 

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generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit in our income statement. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our financial statements.

In 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109, (FIN 48), which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that we recognize in our financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. We adopted the provisions of FIN 48 as of the beginning of our 2007 fiscal year. As a result of our adoption of FIN 48, we recognized a $7 million decrease to reserves for income taxes, with a corresponding increase to opening retained earnings. See Note 5 for additional information regarding our tax reserves and our adoption of FIN 48.

In 2007, our annual tax rate was 25.9% compared to 19.3% in 2006 as discussed in “Other Consolidated Results.” The tax rate in 2007 increased 6.6 percentage points primarily reflecting an unfavorable comparison to the prior year’s non-cash tax benefits. In 2008, our annual tax rate is expected to be 27.5%, primarily reflecting the absence of the non-cash tax benefits recorded in 2007.

Pension and Retiree Medical Plans

Our pension plans cover full-time employees in the U.S. and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts that vary based upon years of service, with retirees contributing the remainder of the cost.

On December 30, 2006, we adopted SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS 158). In connection with our adoption, we recognized the funded status of our pension and retiree medical plans (our Plans) on our balance sheet as of December 30, 2006 with subsequent changes in the funded status recognized in comprehensive income in the years in which they occur. In accordance with SFAS 158, amounts prior to the year of adoption have not been adjusted. SFAS 158 also requires that, no later than 2008, our assumptions used to measure our annual pension and retiree medical expense be determined as of the balance sheet date, and all plan assets and liabilities be reported as of that date. Accordingly, as of the beginning of our 2008 fiscal year, we will change the measurement date for our annual pension and retiree medical expense and all plan assets and liabilities from September 30 to our year-end

 

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balance sheet date. As a result of this change in measurement date, we will record an after-tax $39 million increase to 2008 opening shareholders’ equity which will be reflected in our 2008 first quarter Form 10-Q. For further information regarding the impact of our adoption of SFAS 158, see Note 7.

Our Assumptions

The determination of pension and retiree medical plan obligations and related expenses requires the use of assumptions to estimate the amount of the benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) increase in the liability due to the passage of time (interest cost), and (3) other gains and losses as discussed below, reduced by (4) expected return on plan assets for our funded plans.

Significant assumptions used to measure our annual pension and retiree medical expense include:

 

   

the interest rate used to determine the present value of liabilities (discount rate);

 

   

certain employee-related factors, such as turnover, retirement age and mortality;

 

   

for pension expense, the expected return on assets in our funded plans and the rate of salary increases for plans where benefits are based on earnings; and

 

   

for retiree medical expense, health care cost trend rates.

Our assumptions reflect our historical experience and management’s best judgment regarding future expectations. Due to the significant management judgment involved, our assumptions could have a material impact on the measurement of our pension and retiree medical benefit expenses and obligations.

At each measurement date, the discount rate is based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. In the U.S., we use the Moody’s Aa Corporate Bond Index yield (Moody’s Aa Index) and adjust for differences between the average duration of the bonds in this Index and the average duration of our benefit liabilities, based upon a published index. As of the beginning of our 2008 fiscal year, our discount rate will be determined using the Mercer Pension Discount Yield Curve (Mercer Yield Curve). The Mercer Yield Curve uses a portfolio of high-quality bonds rated Aa or higher by Moody’s. We believe the Mercer Yield Curve includes bonds that provide a better match to the timing and amount of expected benefit payments than the Moody’s Aa Index.

The expected return on pension plan assets is based on our historical experience, our pension plan investment strategy and our expectations for long-term rates of return. Our pension plan investment strategy is reviewed annually and is established based upon plan liabilities, an evaluation of market conditions, tolerance for risk, and cash requirements for benefit payments. As part of our investment strategy, we employ certain equity strategies which, in addition to investing in U.S. and international common and preferred stock, include investing in certain equity- and debt-based securities used collectively to

 

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generate returns in excess of certain equity-based indices. Our investment policy also permits the use of derivative instruments to enhance the overall return of the portfolio. Our expected long-term rate of return on U.S. plan assets is 7.8%, reflecting estimated long-term rates of return of 9.3% from our equity strategies, and 5.8% from our fixed income strategies. Our target investment allocation is 60% for equity strategies and 40% for fixed income strategies. We use a market-related valuation method for recognizing investment gains or losses. For this purpose, investment gains or losses are the difference between the expected and actual return based on the market-related value of assets. This market-related valuation method recognizes investment gains or losses over a five-year period from the year in which they occur, which has the effect of reducing year-to-year volatility. Expense in future periods will be impacted as gains or losses are recognized in the market-related value of assets over the five-year period.

Other gains and losses resulting from actual experience differing from our assumptions and from changes in our assumptions are also determined at each measurement date. If this net accumulated gain or loss exceeds 10% of the greater of plan assets or liabilities, a portion of the net gain or loss is included in expense for the following year. The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in earnings on a straight-line basis over the average remaining service period of active plan participants, which is approximately 11 years for pension expense and approximately 13 years for retiree medical expense.

Effective as of the beginning of our 2008 fiscal year, we amended our U.S. hourly pension plan to increase the amount of participant earnings recognized in determining pension benefits. Additional pension plan amendments were also made as of the beginning of our 2008 fiscal year to comply with legislative and regulatory changes.

The health care trend rate used to determine our retiree medical plan’s liability and expense is reviewed annually. Our review is based on our claim experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers.

Weighted-average assumptions for pension and retiree medical expense are as follows:

 

      2008     2007     2006  

Pension

      

Expense discount rate

   6.3 %   5.7 %   5.6 %

Expected rate of return on plan assets

   7.6 %   7.7 %   7.7 %

Expected rate of salary increases

   4.4 %   4.5 %   4.4 %

Retiree medical

      

Expense discount rate

   6.4 %   5.8 %   5.7 %

Current health care cost trend rate

   8.5 %   9.0 %   10.0 %

 

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Sensitivity of Assumptions

A decrease in the discount rate or in the expected rate of return assumptions would increase pension expense. The estimated impact of a 25-basis-point decrease in the discount rate on 2008 pension expense is an increase of approximately $36 million. The estimated impact on 2008 pension expense of a 25-basis-point decrease in the expected rate of return is an increase of approximately $17 million.

See Note 7 regarding the sensitivity of our retiree medical cost assumptions.

Future Funding

We make contributions to pension trusts maintained to provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions, and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently deductible.

Our pension contributions for 2007 were $230 million, of which $92 million was discretionary. In 2008, we expect to make contributions of up to $150 million with up to $75 million expected to be discretionary. Our cash payments for retiree medical are estimated to be approximately $85 million in 2008. As our retiree medical plans are not subject to regulatory funding requirements, we fund these plans on a pay-as-you-go basis. Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns, and changes in tax or other benefit laws. For estimated future benefit payments, including our pay-as-you-go payments as well as those from trusts, see Note 7.

Recent Accounting Pronouncements

In September 2006, the U.S. Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their impact on each of our financial statements and related disclosures. On December 30, 2006, we adopted SAB 108. Our adoption of SAB 108 did not impact our financial statements.

In September 2006, the FASB issued SFAS 157, Fair Value Measurements (SFAS 157), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective as of the beginning of our 2008 fiscal year. However, the FASB deferred the effective date of SFAS 157, until the beginning of our 2009 fiscal year, as it relates to fair value measurement requirements for nonfinancial assets and liabilities that are not remeasured at fair value on a recurring basis. We are currently evaluating the impact of adopting SFAS 157 on our financial statements. We do not expect our adoption to have a material impact on our financial statements.

 

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In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB Statement No. 115 (SFAS 159), which permits entities to choose to measure many financial instruments and certain other items at fair value. The provisions of SFAS 159 are effective as of the beginning of our 2008 fiscal year. Our adoption of SFAS 159 will not impact our financial statements.

In December 2007, the FASB issued SFAS 141 (revised 2007), Business Combinations (SFAS 141R), and SFAS 160, Noncontrolling Interests in Consolidated Financial Statements (SFAS 160), to improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements. The provisions of SFAS 141R and SFAS 160 are effective as of the beginning of our 2009 fiscal year. We are currently evaluating the impact of adopting SFAS 141R and SFAS 160 on our financial statements.

 

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OUR FINANCIAL RESULTS

Items Affecting Comparability

The year-over-year comparisons of our financial results are affected by the following items:

 

      2007     2006  

Operating profit

    

Restructuring and impairment charges

   $ (102 )   $ (67 )

Net income

    

Restructuring and impairment charges

   $ (70 )   $ (43 )

Tax benefits

   $ 129     $ 602  

PepsiCo share of PBG tax settlement

     —       $ 18  

Net income per common share diluted

    

Restructuring and impairment charges

   $  (0.04 )   $  (0.03 )

Tax benefits

   $ 0.08     $ 0.36  

PepsiCo share of PBG tax settlement

     —       $ 0.01  

For the items affecting our 2005 results, see Notes 3 and 5, as well as our 2006 Annual Report.

Restructuring and Impairment Charges

In 2007, we incurred a charge of $102 million in conjunction with restructuring actions primarily to close certain plants and rationalize other production lines.

In 2006, we incurred a charge of $67 million in conjunction with consolidating the manufacturing network at FLNA by closing two plants in the U.S., and rationalizing other assets, to increase manufacturing productivity and supply chain efficiencies.

Tax Benefits

In 2007, we recognized $129 million of non-cash tax benefits related to the favorable resolution of certain foreign tax matters.

In 2006, we recognized non-cash tax benefits of $602 million, substantially all of which related to the Internal Revenue Service’s (IRS) examination of our consolidated tax returns for the years 1998 through 2002.

PepsiCo Share of PBG Tax Settlement

In 2006, the IRS concluded its examination of PBG’s consolidated income tax returns for the years 1999 through 2000 (PBG’s Tax Settlement). Consequently, a non-cash benefit of $21 million was included in bottling equity income as part of recording our share of PBG’s financial results.

 

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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.

Servings

Since our divisions each use different measures of physical unit volume (i.e., kilos, gallons, pounds and case sales), a common servings metric is necessary to reflect our consolidated physical unit volume. Our divisions’ physical volume measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products.

In 2007, total servings increased over 4% compared to 2006, as servings for beverages worldwide grew 4% and servings for snacks worldwide grew 6%. All of our divisions positively contributed to the total servings growth. In 2006, total servings increased 5.5% compared to 2005, as servings for beverages worldwide grew over 6% and servings for snacks worldwide grew 5%.

Net Revenue and Operating Profit

 

                       Change  
     2007     2006     2005     2007     2006  

Total net revenue

   $ 39,474     $ 35,137     $ 32,562     12 %   8 %

Operating profit

          

FLNA

   $ 2,845     $ 2,615     $ 2,529     9 %   3 %

QFNA

     568       554       537     2.5 %   3 %

LAF

     714       655       583     9 %   12 %

PAB

     2,487       2,315       2,247     7 %   3 %

UKE

     774       700       619     11 %   13 %

MEAA

     535       401       249     34 %   61 %

Corporate unallocated

     (753 )     (738 )     (780 )   2 %   (5 )%
                            

Total operating profit

   $ 7,170     $ 6,502     $ 5,984     10 %   9 %
                            

Total operating profit margin

     18.2 %     18.5 %     18.4 %   (0.3 )   0.1  

2007

Net revenue increased 12% primarily reflecting favorable effective net pricing and volume growth. Effective net pricing contributed 4 percentage points and the volume gains contributed 3 percentage points to net revenue growth. The impact of acquisitions contributed 3 percentage points and foreign currency contributed 2 percentage points to net revenue growth.

 

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Total operating profit increased 10% and margin decreased 0.3 percentage points. The operating profit performance reflects leverage from the revenue growth, offset by increased cost of sales, largely due to higher raw material costs. The impact of foreign currency contributed 2 percentage points to operating profit growth. There was no net impact of acquisitions and divestitures on operating profit growth.

2006

Net revenue increased 8% primarily reflecting higher volume and positive effective net pricing across all divisions. The volume gains and the effective net pricing each contributed 3 percentage points to net revenue growth. Acquisitions contributed 1 percentage point and foreign exchange contributed almost 1 percentage point to net revenue growth. The absence of the prior year’s additional week reduced net revenue growth by over 1 percentage point and reduced volume growth by almost 1 percentage point.

Total operating profit increased 9% and margin increased 0.1 percentage points. The operating profit gains reflect the net revenue growth, partially offset by the impact of higher raw material and energy costs across all divisions. The absence of the prior year’s additional week reduced operating profit growth by over 1 percentage point.

Corporate Unallocated Expenses

Corporate unallocated expenses include the costs of our corporate headquarters, centrally managed initiatives, such as our ongoing business transformation initiative in North America, unallocated insurance and benefit programs, foreign exchange transaction gains and losses, and certain commodity derivative gains and losses, as well as profit-in-inventory elimination adjustments for our noncontrolled bottling affiliates and certain other items.

In 2007, corporate unallocated expenses increased 2% primarily reflecting $35 million of increased research and development costs, partially offset by lower pension costs of $18 million. Gains of $19 million from certain mark-to-market derivatives (compared to $18 million of losses in the prior year) were fully offset by the absence of certain other favorable corporate items in the prior year.

In 2006, corporate unallocated expenses decreased $42 million primarily reflecting the absence of a non-recurring charge of $55 million in the prior year to conform our method of accounting across all divisions, primarily for warehouse and freight costs. Higher costs associated with our ongoing business transformation initiative of $35 million, as well as the unfavorable comparison to the prior year’s $25 million gain in connection with the settlement of a class action lawsuit, were offset by the favorable impact of certain other corporate items.

 

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Other Consolidated Results

 

                        Change  
     2007     2006     2005     2007     2006  

Bottling equity income

   $ 560     $ 553     $ 495       1 %     12 %

Interest expense, net

   $ (99 )   $ (66 )   $ (97 )   $ (33 )   $ 31  

Annual tax rate

     25.9 %     19.3 %     36.1 %    

Net income

   $ 5,658     $ 5,642     $ 4,078       —         38 %

Net income per common share – diluted

   $ 3.41     $ 3.34     $ 2.39       2 %     40 %

Bottling equity income includes our share of the net income or loss of our anchor bottlers as described in “Our Customers.” Our interest in these bottling investments may change from time to time. Any gains or losses from these changes, as well as other transactions related to our bottling investments, are also included on a pre-tax basis. During 2007, we continued to sell shares of PBG stock to reduce our economic ownership to the level at the time of PBG’s initial public offering, since our ownership has increased as a result of PBG’s share repurchase program. We sold 9.5 million and 10.0 million shares of PBG stock in 2007 and 2006, respectively. The resulting lower ownership percentage reduces the equity income from PBG that we recognize. In November 2007, our Board of Directors approved the sale of additional PBG stock to an economic ownership level of 35%, as well as the sale of PAS stock to the ownership level at the time of the merger with Whitman Corporation in 2000 of about 37%.

2007

Bottling equity income increased 1% reflecting higher earnings from our anchor bottlers, partially offset by the impact of our reduced ownership level in 2007 and lower pre-tax gains on our sale of PBG stock.

Net interest expense increased $33 million primarily reflecting the impact of lower investment balances and higher average rates on our debt, partially offset by higher average interest rates on our investments and lower average debt balances.

The tax rate increased 6.6 percentage points compared to the prior year primarily reflecting an unfavorable comparison to the prior year’s non-cash tax benefits.

Net income remained flat and the related net income per share increased 2%. Our solid operating profit growth was offset by unfavorable comparisons to the non-cash tax benefits and restructuring and impairment charges in the prior year. Additionally, net income per share was favorably impacted by our share repurchases.

 

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2006

Bottling equity income increased 12% primarily reflecting a $186 million pre-tax gain on our sale of PBG stock, which compared favorably to a $126 million pre-tax gain in the prior year. The non-cash gain of $21 million from our share of PBG’s Tax Settlement was fully offset by lower equity income from our anchor bottlers in the current year, primarily resulting from the impact of their respective adoptions of SFAS 123R in 2006.

Net interest expense decreased $31 million primarily reflecting higher average rates on our investments and lower debt balances, partially offset by lower investment balances and the impact of higher average rates on our borrowings.

The tax rate decreased 16.8 percentage points compared to prior year primarily reflecting the non-cash tax benefits recorded in 2006, the absence of the 2005 tax charge related to the American Jobs Creation Act of 2004 (AJCA) and the resolution of certain state income tax audits in the current year.

Net income increased 38% and the related net income per share increased 40%. These increases primarily reflect the non-cash tax benefits recorded in 2006, the absence of the AJCA tax charge and our solid operating profit growth.

 

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Results of Operations – Division Review

The results and discussions below are based on how our Chief Executive Officer monitors the performance of our divisions. For additional information on these items and our divisions, see Note 1.

 

     FLNA     QFNA     LAF     PAB     UKE     MEAA     Total  

Net Revenue, 2007

   $ 11,586     $ 1,860     $ 4,872     $ 11,090     $ 5,492     $ 4,574     $ 39,474  

Net Revenue, 2006

   $ 10,844     $ 1,769     $ 3,972     $ 10,362     $ 4,750     $ 3,440     $ 35,137  

% Impact of:

              

Volume(a)

     3 %     2 %     5 %     (1 )%     4 %     12 %     3 %

Effective net pricing(b)

     4       3       5       5       3       5       4  

Foreign exchange

     0.5       1       2       0.5       9       5.5       2  

Acquisitions/divestitures

     —         —         11       2       —         11       3  
                                                        

% Change(c)

     7 %     5 %     23 %     7 %     16 %     33 %     12 %
                                                        

 

     FLNA     QFNA     LAF     PAB     UKE     MEAA     Total  

Net Revenue, 2006

   $ 10,844     $ 1,769     $ 3,972     $ 10,362     $ 4,750     $ 3,440     $ 35,137  

Net Revenue, 2005

   $ 10,322     $ 1,718     $ 3,719     $ 9,849     $ 4,176     $ 2,778     $ 32,562  

% Impact of:

              

Volume(a)

     1 %     1 %     1 %     3 %     7 %     13 %     3 %

Effective net pricing(b)

     3       2       4       2       1       7       3  

Foreign exchange

     0.5       1       2       —         1       (1 )     1  

Acquisitions/divestitures

     0.5       —         —         —         4       4.5       1  
                                                        

% Change(c)

     5 %     3 %     7 %     5 %     14 %     24 %     8 %
                                                        

 

(a) Excludes the impact of acquisitions and divestitures. In certain instances, volume growth varies from the amounts disclosed in the following divisional discussions due to non-consolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE. Our net revenue excludes non-consolidated joint venture volume, and, for our beverage businesses, is based on CSE.
(b) Includes 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.
(c) Amounts may not sum due to rounding.

 

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Frito-Lay North America

 

                    % Change
     2007    2006    2005    2007    2006

Net revenue

   $ 11,586    $ 10,844    $ 10,322    7    5

Operating profit

   $ 2,845    $ 2,615    $ 2,529    9    3

2007

Net revenue grew 7% reflecting volume growth of 3% and positive effective net pricing due to pricing actions and favorable mix. Pound volume grew primarily due to high-single-digit growth in trademark Doritos and double-digit growth in dips, SunChips and multipack. These volume gains were partially offset by a mid-single-digit decline in trademark Lay’s.

Operating profit grew 9% primarily reflecting the net revenue growth, as well as a favorable casualty insurance actuarial adjustment reflecting improved safety performance. This growth was partially offset by higher commodity costs, as well as increased advertising and marketing expenses. Operating profit benefited almost 2 percentage points from the impact of lower restructuring and impairment charges in the current year related to the continued consolidation of the manufacturing network.

Smart Spot eligible products represented approximately 16% of net revenue. These products experienced double-digit revenue growth, while the balance of the portfolio had mid-single-digit revenue growth.

2006

Net revenue grew 5% reflecting volume growth of 1% and positive effective net pricing due to salty snack pricing actions and favorable mix. Pound volume grew primarily due to double-digit growth in SunChips, Multipack and Quaker Rice Cakes. These volume gains were partially offset by low-single-digit declines in trademark Lay’s and Doritos. The Stacy’s Pita Chip Company acquisition contributed approximately 0.5 percentage points to both revenue and volume growth. The absence of the prior year’s additional week reduced volume and net revenue growth by 2 percentage points.

Operating profit grew 3% reflecting the net revenue growth. This growth was partially offset by higher commodity costs, primarily cooking oil and energy. Operating profit was also negatively impacted by almost 3 percentage points as a result of a fourth quarter charge for the consolidation of the manufacturing network, including the closure of two plants and rationalization of other manufacturing assets. The absence of the prior year’s additional week, which reduced operating profit growth by 2 percentage points, was largely offset by the impact of restructuring charges in the prior year to reduce costs in our operations, principally through headcount reductions.

 

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Smart Spot eligible products represented approximately 15% of net revenue. These products experienced double-digit revenue growth, while the balance of the portfolio had low-single-digit revenue growth.

Quaker Foods North America

 

                    % Change
     2007    2006    2005    2007    2006

Net revenue

   $ 1,860    $ 1,769    $ 1,718    5    3

Operating profit

   $ 568    $ 554    $ 537    2.5    3

2007

Net revenue increased 5% and volume increased 2%. The volume increase reflects mid-single-digit growth in Oatmeal and Life cereal, as well as low-single-digit growth in Cap’n Crunch cereal. These increases were partially offset by a double-digit decline in Rice-A-Roni. The increase in net revenue primarily reflects price increases taken earlier in the year, as well as the volume growth. Favorable Canadian exchange rates contributed nearly 1 percentage point to net revenue growth.

Operating profit increased 2.5% primarily reflecting the net revenue growth partially offset by increased raw material costs.

Smart Spot eligible products represented over half of net revenue and experienced mid-single-digit net revenue growth. The balance of the portfolio also grew in the mid-single-digit range.

2006

Net revenue grew 3% and volume increased 1%. The volume increase reflects mid-single-digit growth in Oatmeal, high-single-digit growth in Life cereal and low-single-digit growth in Cap’n Crunch cereal. These increases were partially offset by a low-single-digit decline in Aunt Jemima syrup and mix and a mid-single-digit decline in Rice-A-Roni. Net revenue growth was also driven by favorable effective net pricing, which contributed almost 2 percentage points to net revenue growth, and favorable Canadian foreign exchange rates which contributed almost 1 percentage point. The absence of the prior year’s additional week reduced both net revenue and volume growth by approximately 2 percentage points.

Operating profit increased 3% primarily reflecting the net revenue growth. Increased cost of sales, primarily driven by higher raw material and energy costs, were largely offset by lower advertising and marketing expenses. The absence of the prior year’s additional week reduced operating profit growth by approximately 2 percentage points.

Smart Spot eligible products represented approximately 55% of net revenue and had mid-single-digit net revenue growth. The balance of the portfolio experienced a low-single-digit decline. The absence of the prior year’s additional week negatively impacted these results.

 

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Latin America Foods

 

                    % Change
     2007    2006    2005    2007    2006

Net revenue

   $ 4,872    $ 3,972    $ 3,719    23    7

Operating profit

   $ 714    $ 655    $ 583    9    12

2007

Snacks volume grew 6% reflecting double-digit growth at Gamesa in Mexico and in Argentina and high-single-digit growth in Brazil, partially offset by a low-single-digit decline at Sabritas in Mexico. An acquisition in Brazil in the third quarter of 2007 contributed 0.5 percentage points to the reported volume growth rate.

Net revenue grew 23% reflecting favorable effective net pricing and volume growth. Acquisitions contributed 11 percentage points to the net revenue growth. Foreign currency contributed 2 percentage points of growth primarily reflecting the favorable Brazilian real.

Operating profit grew 9% driven by the favorable effective net pricing and volume growth, partially offset by increased raw material costs. Acquisitions contributed 3 percentage points to the operating profit growth. Foreign currency contributed 2 percentage points of growth primarily reflecting the favorable Brazilian real. The impact of restructuring actions taken in the fourth quarter to reduce costs in our operations, rationalize capacity and realign our organizational structure reduced operating profit growth by 6 percentage points.

2006

Snacks volume grew 2.5% reflecting mid-single-digit growth at Sabritas in Mexico and double-digit growth in Colombia and Venezuela. Additionally, Gamesa in Mexico grew at a low-single-digit rate.

Net revenue grew 7% reflecting favorable effective net pricing and volume growth. Foreign currency contributed 2 percentage points of growth primarily reflecting the favorable Brazilian real.

Operating profit grew 12% driven largely by the favorable effective net pricing and volume growth, partially offset by increased raw material costs. Foreign currency contributed 1 percentage point of growth primarily reflecting the favorable Brazilian real.

 

28


PepsiCo Americas Beverages

 

                    % Change
     2007    2006    2005    2007    2006

Net revenue

   $ 11,090    $ 10,362    $ 9,849    7    5

Operating profit

   $ 2,487    $ 2,315    $ 2,247    7    3

2007

BCS volume grew 1%, driven by a 4% increase in our Latin America businesses. BCS volume was flat at PBNA.

At PBNA, BCS volume was flat due to a 3% decline in CSDs, entirely offset by a 5% increase in non-carbonated beverages. The decline in the CSD portfolio reflects a mid-single-digit decline in trademark Pepsi offset slightly by a low-single-digit increase in trademark Sierra Mist. Trademark Mountain Dew volume was flat. Across the brands, regular CSDs experienced a mid-single-digit decline and diet CSDs experienced a low-single-digit decline. The non-carbonated portfolio performance was driven by double-digit growth in Lipton ready-to-drink teas, double-digit growth in waters and enhanced waters under the Aquafina, Propel and SoBe Life Water trademarks and low-single-digit growth in Gatorade, partially offset by a mid-single-digit decline in our juice and juice drinks portfolio as a result of previous price increases.

In our Latin America businesses, volume growth reflected double-digit increases in Brazil, Argentina and Venezuela, partially offset by a low-single-digit decline in Mexico. Both CSDs and non-carbonated beverages grew at mid-single-digit rates.

Net revenue grew 7% driven by effective net pricing, primarily reflecting price increases on Tropicana Pure Premium and CSD concentrate and growth in finished goods beverages. Acquisitions contributed 2 percentage points to net revenue growth.

Operating profit increased 7% reflecting the net revenue growth, partially offset by higher cost of sales, mainly due to increased fruit costs, as well as higher general and administrative costs. The impact of restructuring actions taken in the fourth quarter was fully offset by the favorable impact of foreign exchange rates during the year. Operating profit was also positively impacted by the absence of amortization expense related to a prior acquisition, partially offset by the absence of a $29 million favorable insurance settlement, both recorded in 2006. The impact of acquisitions reduced operating profit by less than 1 percentage point.

Smart Spot eligible products in the U.S. and Canada represented over 70% of PBNA’s net revenue. These products experienced mid-single-digit net revenue growth, while the balance of the portfolio grew in the high-single-digit range.

2006

BCS volume grew 4.5%, driven by a 4% increase at PBNA and a 7% increase in our Latin America businesses.

 

29


At PBNA, the volume increase was driven by a 14% increase in non-carbonated beverages, partially offset by a 2% decline in CSDs. The non-carbonated portfolio performance was driven by double-digit growth in trademark Aquafina, Gatorade, Lipton ready-to-drink teas, Tropicana juice drinks and Propel. Tropicana Pure Premium experienced a low-single-digit decline in volume. The decline in CSDs reflects a low-single-digit decline in trademark Pepsi, partially offset by a mid-single-digit increase in trademark Sierra Mist and a low-single-digit increase in trademark Mountain Dew. Across the brands, regular CSDs experienced a low-single-digit decline and diet CSDs declined slightly.

In our Latin America businesses, volume growth reflected double-digit increases in Argentina, Venezuela and Honduras, partially offset by a high-single-digit decline in Guatemala. Additionally, Mexico grew at a low-single-digit rate. CSDs grew at a mid-single-digit rate while non-carbonated beverages grew at a double-digit rate.

The additional week in 2005 had no significant impact on volume growth as bottler volume is reported based on a calendar month.

Net revenue grew 5% primarily reflecting volume growth. Positive effective net pricing also contributed to the net revenue growth, reflecting the strength of non-carbonated beverages across the Americas. Price increases taken in 2006, primarily on concentrate, Tropicana Pure Premium and fountain, were offset by overall higher trade spending. The absence of the prior year’s additional week reduced net revenue growth by 1 percentage point.

Operating profit increased 3% primarily reflecting the net revenue growth and lower advertising and marketing expenses. Higher raw material costs, primarily oranges, increased supply chain costs in Gatorade and higher energy costs partially offset the operating profit increase. Total marketplace spending for the year increased, reflecting a shift from advertising and marketing spending to trade spending. Additionally, the impact of more-favorable settlements of trade spending accruals in 2005 was mostly offset by a favorable insurance settlement of $29 million in 2006. The absence of the prior year’s additional week, which reduced operating profit growth by 1 percentage point, was fully offset by the impact of charges taken in the fourth quarter of 2005 to reduce costs in our operations at PBNA, principally through headcount reductions.

Smart Spot eligible products in the U.S. and Canada experienced high-single-digit revenue growth and represented over 70% of PBNA’s net revenue. The balance of PBNA’s portfolio declined in the low-single-digit range.

 

30


United Kingdom & Europe

 

                    % Change
     2007    2006    2005    2007    2006

Net revenue

   $ 5,492    $ 4,750    $ 4,176    16    14

Operating profit

   $ 774    $ 700    $ 619    11    13

2007

Snacks volume grew 6% reflecting broad-based increases led by double-digit growth in Russia and Romania, partially offset by low-single-digit declines at Walkers in the United Kingdom and in France. The acquisition of a business in Europe in the third quarter of 2006 contributed nearly 2 percentage points to the reported volume growth rate.

Beverage volume grew 8% reflecting broad-based increases led by double-digit growth in Russia and Poland, partially offset by a high-single-digit decline in Spain. The acquisition of a noncontrolling interest in a business in the Ukraine in the fourth quarter of 2007 contributed 3 percentage points to the reported volume growth rate. CSDs grew at a low-single-digit rate while non-carbonated beverages grew at a double-digit rate.

Net revenue grew 16% primarily reflecting volume growth and favorable effective net pricing. Foreign currency contributed 9 percentage points to net revenue growth primarily reflecting the favorable euro and British pound. The net impact of acquisitions and divestitures reduced net revenue growth slightly.

Operating profit grew 11% driven by the net revenue growth, partially offset by increased raw material costs and less-favorable settlements of promotional spending accruals in 2007. Foreign currency contributed 10 percentage points of growth primarily reflecting the favorable British pound and euro. The net impact of acquisitions and divestitures reduced operating profit growth by 4 percentage points.

2006

Snacks volume grew 15% reflecting broad-based increases led by double-digit growth in Russia and Romania. Additionally, Walkers in the United Kingdom grew at a low-single-digit rate and Spain and the Netherlands each grew at mid-single-digit rates. Acquisitions of two businesses in Europe in 2006 contributed 8 percentage points to the reported volume growth rate. The absence of the prior year’s additional week reduced the growth rate by 1 percentage point.

Beverage volume grew 8% reflecting broad-based increases led by double-digit growth in Romania and Russia. Additionally, the United Kingdom, Germany and Spain grew at low-single-digit rates. Acquisitions contributed 1 percentage point to the reported volume growth rate. CSDs grew at a mid-single-digit rate while non-carbonated beverages grew at a double-digit rate.

 

31


Net revenue grew 14% primarily reflecting volume growth. The net impact of acquisitions and divestitures contributed 4 percentage points to net revenue growth. Foreign currency contributed 1 percentage point of growth primarily reflecting the favorable British pound and euro. The absence of the prior year’s additional week reduced net revenue growth by nearly 1 percentage point.

Operating profit grew 13% driven primarily by volume growth. Increased raw material and energy costs were partially offset by the favorable settlement of trade spending accruals during the year. Foreign currency contributed 2 percentage points of growth primarily reflecting the favorable British pound and euro. The net impact of acquisitions and divestitures contributed 2 percentage points of operating profit growth. The absence of the prior year’s additional week reduced operating profit growth slightly.

Middle East, Africa & Asia

 

                    % Change
     2007    2006    2005    2007    2006

Net revenue

   $ 4,574    $ 3,440    $ 2,778    33    24

Operating profit

   $ 535    $ 401    $ 249    34    61

2007

Snacks volume grew 19% reflecting broad-based growth. The Middle East, Turkey, India, South Africa and China all grew at double-digit rates, and Australia grew at a high-single-digit rate. Acquisitions contributed 4 percentage points to volume growth.

Beverage volume grew 11% reflecting broad-based growth led by double-digit growth in the Middle East, Pakistan and China, partially offset by a high-single-digit decline in Thailand and a low-single-digit-decline in Turkey. Acquisitions had no impact on the growth rates. Both CSDs and non-carbonated beverages grew at double-digit rates.

Net revenue grew 33%, reflecting volume growth and favorable effective net pricing. Foreign currency contributed 5.5 percentage points to net revenue growth. Acquisitions contributed 11 percentage points to net revenue growth.

 

32


Operating profit grew 34% driven by volume growth and favorable effective net pricing, partially offset by increased raw material costs. Foreign currency contributed 7 percentage points to operating profit growth. Acquisitions contributed 1 percentage point to the operating profit growth rate. The absence of amortization expense recorded in 2006 related to prior acquisitions contributed 11 percentage points to operating profit growth. The impact of restructuring actions taken in the fourth quarter of 2007 to reduce costs in our operations, rationalize capacity and realign our organizational structure reduced operating profit growth by 3.5 percentage points.

2006

Snacks volume grew 17% reflecting broad-based double-digit growth in Turkey and the Middle East. Additionally, India grew at a double-digit rate, Australia grew at a high-single-digit rate and China grew at a mid-single-digit rate. The acquisition of a business in Australia contributed nearly 1 percentage point to volume growth.

Beverage volume grew 12% reflecting broad-based growth led by double-digit growth in China and the Middle East, partially offset by a low-single-digit decline in India. Additionally, Thailand grew at a mid-single-digit rate. Acquisitions had no impact on the growth rates. Both CSDs and non-carbonated beverages grew at double-digit rates.

Net revenue grew 24%, reflecting volume growth and favorable effective net pricing. Foreign currency reduced the growth rate by 1 percentage point. Acquisitions contributed 4.5 percentage points to net revenue growth.

Operating profit grew 61% driven by volume growth, favorable effective net pricing and leverage from lower growth in selling, general and administrative costs. This increase was partially offset by increased raw material costs. Foreign currency reduced the growth rate by 0.5 percentage points. Acquisitions contributed 1 percentage point to the operating profit growth rate.

Our Liquidity and Capital Resources

Our strong cash-generating capability and financial condition give us ready access to capital markets throughout the world. Our principal source of liquidity is our operating cash flow. This cash-generating capability is one of our fundamental strengths and provides us with substantial financial flexibility in meeting operating, investing and financing needs. In addition, we have revolving credit facilities that are further discussed in Note 9. Our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns, and generally lowest in the first quarter.

 

33


Operating Activities

In 2007, our operations provided $6.9 billion of cash, compared to $6.1 billion in the prior year, primarily reflecting our solid business results. Our operating cash flow in 2006 also reflects a tax payment of $420 million related to our repatriation of international cash in connection with the AJCA.

Investing Activities

In 2007, we used $3.7 billion for our investing activities primarily reflecting capital spending of $2.4 billion and acquisitions of $1.3 billion. Acquisitions primarily included the remaining interest in a snacks joint venture in Latin America, Naked Juice Company and Bluebird Foods, and the acquisition of a minority interest in a juice company in the Ukraine through a joint venture with PAS. Proceeds from our sale of PBG stock of $315 million were offset by net purchases of short-term investments of $383 million. In 2006, capital spending of $2.1 billion and acquisitions of $522 million were mostly offset by net sales of short-term investments of $2.0 billion and proceeds from our sale of PBG stock of $318 million.

We anticipate net capital spending of approximately $2.7 billion in 2008, which is expected to be within our net capital spending target of approximately 5% to 7% of net revenue. Planned capital spending in 2008 includes investments to increase capacity in our snack and beverage businesses to support growth in developing and emerging markets, investments in North America to support growth in key trademarks, and investments in our ongoing business transformation initiative. New capital projects are evaluated on a case-by-case basis and must meet certain payback and internal rate of return targets.

Financing Activities

In 2007, we used $4.0 billion for our financing activities, primarily reflecting the return of operating cash flow to our shareholders through common share repurchases of $4.3 billion and dividend payments of $2.2 billion, as well as net repayments of short-term borrowings of $395 million. The use of cash was partially offset by stock option proceeds of $1.1 billion and net proceeds from issuances of long-term debt of $1.6 billion. In 2006, we used $6.0 billion for our financing activities, primarily reflecting the return of operating cash flow to our shareholders through common share repurchases of $3.0 billion and dividend payments of $1.9 billion. Net repayments of short-term borrowings of $2.3 billion were partially offset by stock option proceeds of $1.2 billion.

We annually review our capital structure with our Board, including our dividend policy and share repurchase activity. In the second quarter of 2007, our Board of Directors approved an increase in our targeted dividend payout rate from 45% to 50% of prior year’s earnings, excluding certain items. The Board of Directors also authorized stock repurchases of up to an additional $8 billion through June 30, 2010, once the current share repurchase authorization is complete. The current $8.5 billion authorization began in 2006 and has approximately $3.1 billion remaining. We have historically repurchased significantly more shares each year than we have issued under our stock-based compensation plans, with average net annual repurchases of 1.4% of outstanding shares for the last five years.

 

34


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 U.S. Since net 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 the net cash provided by operating activities, as reflected in our cash flow statement, to our management operating cash flow.

 

     2007     2006     2005  

Net cash provided by operating activities

   $ 6,934     $ 6,084     $ 5,852  

Capital spending

     (2,430 )     (2,068 )     (1,736 )

Sales of property, plant and equipment

     47       49       88  
                        

Management operating cash flow

   $ 4,551     $ 4,065     $ 4,204  
                        

Management operating cash flow was used primarily to repurchase shares and pay dividends. We expect to continue to return approximately all of our management operating cash flow to our shareholders through dividends and share repurchases. However, see “Risk Factors” in Item 1A. of our 2007 Form 10-K and “Our Business Risks” for certain factors that may impact our operating cash flows.

Credit Ratings

Our debt ratings of Aa2 from Moody’s and A+ from Standard & Poor’s contribute to our ability to access global capital markets. We have maintained strong investment grade ratings for over a decade. Each rating is considered strong investment grade and is in the first quartile of their respective ranking systems. These ratings also reflect the impact of our anchor bottlers’ cash flows and debt.

Credit Facilities and Long-Term Contractual Commitments

See Note 9 for a description of our credit facilities and long-term contractual commitments.

Off-Balance-Sheet Arrangements

It is not our business practice to enter into off-balance-sheet arrangements, other than in the normal course of business. However, certain guarantees were necessary to facilitate the separation of our bottling and restaurant operations from us. At year-end 2007, we believe it is remote that these guarantees would require any cash payment. We do not enter into off-balance-sheet transactions specifically structured to provide income or tax benefits or to avoid recognizing or disclosing assets or liabilities. See Note 9 for a description of our off-balance-sheet arrangements.

 

35


Consolidated Statement of Income

PepsiCo, Inc. and Subsidiaries

Fiscal years ended December 29, 2007, December 30, 2006 and December 31, 2005

(in millions except per share amounts)

 

     2007     2006     2005  

Net Revenue

   $ 39,474     $ 35,137     $ 32,562  

Cost of sales

     18,038       15,762       14,176  

Selling, general and administrative expenses

     14,208       12,711       12,252  

Amortization of intangible assets

     58       162       150  
                        

Operating Profit

     7,170       6,502       5,984  

Bottling equity income

     560       553       495  

Interest expense

     (224 )     (239 )     (256 )

Interest income

     125       173       159  
                        

Income before Income Taxes

     7,631       6,989       6,382  

Provision for Income Taxes

     1,973       1,347       2,304  
                        

Net Income

   $ 5,658     $ 5,642     $ 4,078  
                        

Net Income per Common Share

      

Basic

   $ 3.48     $ 3.42     $ 2.43  

Diluted

   $ 3.41     $ 3.34     $ 2.39  

See accompanying notes to consolidated financial statements.

 

36


Consolidated Statement of Cash Flows

PepsiCo, Inc. and Subsidiaries

Fiscal years ended December 29, 2007, December 30, 2006 and December 31, 2005

(in millions)

 

     2007     2006     2005  

Operating Activities

      

Net income

   $ 5,658     $ 5,642     $ 4,078  

Depreciation and amortization

     1,426       1,406       1,308  

Stock-based compensation expense

     260       270       311  

Excess tax benefits from share-based payment arrangements

     (208 )     (134 )     —    

Cash payments for merger-related costs and restructuring charges

     —         —         (22 )

Pension and retiree medical plan contributions

     (310 )     (131 )     (877 )

Pension and retiree medical plan expenses

     535       544       464  

Bottling equity income, net of dividends

     (441 )     (442 )     (414 )

Deferred income taxes and other tax charges and credits

     118       (510 )     440  

Change in accounts and notes receivable

     (405 )     (330 )     (272 )

Change in inventories

     (204 )     (186 )     (132 )

Change in prepaid expenses and other current assets

     (16 )     (37 )     (56 )

Change in accounts payable and other current liabilities

     500       223       188  

Change in income taxes payable

     128       (295 )     609  

Other, net

     (107 )     64       227  
                        

Net Cash Provided by Operating Activities

     6,934       6,084       5,852  
                        

Investing Activities

      

Capital spending

     (2,430 )     (2,068 )     (1,736 )

Sales of property, plant and equipment

     47       49       88  

Proceeds from (Investment in) finance assets

     27       (25 )     —    

Acquisitions and investments in noncontrolled affiliates

     (1,320 )     (522 )     (1,095 )

Cash proceeds from sale of PBG stock

     315       318       214  

Divestitures

     —         37       3  

Short-term investments, by original maturity

      

More than three months – purchases

     (83 )     (29 )     (83 )

More than three months – maturities

     113       25       84  

Three months or less, net

     (413 )     2,021       (992 )
                        

Net Cash Used for Investing Activities

     (3,744 )     (194 )     (3,517 )
                        

(Continued on following page)

 

37


Consolidated Statement of Cash Flows (continued)

PepsiCo, Inc. and Subsidiaries

Fiscal years ended December 29, 2007, December 30, 2006 and December 31, 2005

(in millions)

 

     2007     2006     2005  

Financing Activities

      

Proceeds from issuances of long-term debt

   $ 2,168     $ 51     $ 25  

Payments of long-term debt

     (579 )     (157 )     (177 )

Short-term borrowings, by original maturity

      

More than three months – proceeds

     83       185       332  

More than three months – payments

     (133 )     (358 )     (85 )

Three months or less, net

     (345 )     (2,168 )     1,601  

Cash dividends paid

     (2,204 )     (1,854 )     (1,642 )

Share repurchases – common

     (4,300 )     (3,000 )     (3,012 )

Share repurchases – preferred

     (12 )     (10 )     (19 )

Proceeds from exercises of stock options

     1,108       1,194       1,099  

Excess tax benefits from share-based payment arrangements

     208       134       —    
                        

Net Cash Used for Financing Activities

     (4,006 )     (5,983 )     (1,878 )
                        

Effect of exchange rate changes on cash and cash equivalents

     75       28       (21 )
                        

Net (Decrease)/Increase in Cash and Cash Equivalents

     (741 )     (65 )     436  

Cash and Cash Equivalents, Beginning of Year

     1,651       1,716       1,280  
                        

Cash and Cash Equivalents, End of Year

   $ 910     $ 1,651     $ 1,716  
                        

See accompanying notes to consolidated financial statements.

 

38


Consolidated Balance Sheet

PepsiCo, Inc. and Subsidiaries

December 29, 2007 and December 30, 2006

(in millions except per share amounts)

 

     2007     2006  

ASSETS

    

Current Assets

    

Cash and cash equivalents

   $ 910     $ 1,651  

Short-term investments

     1,571       1,171  

Accounts and notes receivable, net

     4,389       3,725  

Inventories

     2,290       1,926  

Prepaid expenses and other current assets

     991       657  
                

Total Current Assets

     10,151       9,130  

Property, Plant and Equipment, net

     11,228       9,687  

Amortizable Intangible Assets, net

     796       637  

Goodwill

     5,169       4,594  

Other nonamortizable intangible assets

     1,248       1,212  
                

Nonamortizable Intangible Assets

     6,417       5,806  

Investments in Noncontrolled Affiliates

     4,354       3,690  

Other Assets

     1,682       980  
                

Total Assets

   $ 34,628     $ 29,930  
                

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Current Liabilities

    

Short-term obligations

   $ —       $ 274  

Accounts payable and other current liabilities

     7,602       6,496  

Income taxes payable

     151       90  
                

Total Current Liabilities

     7,753       6,860  

Long-Term Debt Obligations

     4,203       2,550  

Other Liabilities

     4,792       4,624  

Deferred Income Taxes

     646       528  
                

Total Liabilities

     17,394       14,562  

Commitments and Contingencies

    

Preferred Stock, no par value

     41       41  

Repurchased Preferred Stock

     (132 )     (120 )

Common Shareholders’ Equity

    

Common stock, par value 12/3¢ per share (authorized 3,600 shares, issued 1,782 shares)

     30       30  

Capital in excess of par value

     450       584  

Retained earnings

     28,184       24,837  

Accumulated other comprehensive loss

     (952 )     (2,246 )
                
     27,712       23,205  

Less: repurchased common stock, at cost (177 and 144 shares, respectively)

     (10,387 )     (7,758 )
                

Total Common Shareholders’ Equity

     17,325       15,447  
                

Total Liabilities and Shareholders’ Equity

   $ 34,628     $ 29,930  
                

See accompanying notes to consolidated financial statements.

 

39


Consolidated Statement of Common Shareholders’ Equity

PepsiCo, Inc. and Subsidiaries

Fiscal years ended December 29, 2007, December 30, 2006 and December 31, 2005

(in millions)

 

     2007     2006     2005  
     Shares     Amount     Shares     Amount     Shares     Amount  

Common Stock

   1,782     $ 30     1,782     $ 30     1,782     $ 30  
                                          

Capital in Excess of Par Value

            

Balance, beginning of year

       584         614         618  

Stock-based compensation expense

       260         270         311  

Stock option exercises/RSUs converted(a)

       (347 )       (300 )       (315 )

Withholding tax on RSUs converted

       (47 )       —           —    
                              

Balance, end of year

       450         584         614  
                              

Retained Earnings

            

Balance, beginning of year

       24,837         21,116         18,730  

Adoption of FIN 48

       7         —           —    
                  

Adjusted balance, beginning of year

       24,844         —           —    

Net income

       5,658         5,642         4,078  

Cash dividends declared – common

       (2,306 )       (1,912 )       (1,684 )

Cash dividends declared – preferred

       (2 )       (1 )       (3 )

Cash dividends declared – RSUs

       (10 )       (8 )       (5 )
                              

Balance, end of year

       28,184         24,837         21,116  
                              

Accumulated Other Comprehensive Loss

            

Balance, beginning of year

       (2,246 )       (1,053 )       (886 )

Currency translation adjustment

       719         465         (251 )

Cash flow hedges, net of tax:

            

Net derivative (losses)/gains

       (60 )       (18 )       54  

Reclassification of losses/(gains) to net income

       21         (5 )       (8 )

Adoption of SFAS 158

       —           (1,782 )       —    

Pension and retiree medical, net of tax:

            

Net pension and retiree medical gains

       464         —           —    

Reclassification of net losses to net income

       135         —           —    

Minimum pension liability adjustment, net of tax

       —           138         16  

Unrealized gain on securities, net of tax

       9         9         24  

Other

       6         —           (2 )
                              

Balance, end of year

       (952 )       (2,246 )       (1,053 )
                              

Repurchased Common Stock

            

Balance, beginning of year

   (144 )     (7,758 )   (126 )     (6,387 )   (103 )     (4,920 )

Share repurchases

   (64 )     (4,300 )   (49 )     (3,000 )   (54 )     (2,995 )

Stock option exercises

   28       1,582     31       1,619     31       1,523  

Other, primarily RSUs converted

   3       89     —         10     —         5  
                                          

Balance, end of year

   (177 )     (10,387 )   (144 )     (7,758 )   (126 )     (6,387 )
                                          

Total Common Shareholders’ Equity

     $ 17,325       $ 15,447       $ 14,320  
                              
           2007           2006           2005  

Comprehensive Income

            

Net income

     $ 5,658       $ 5,642       $ 4,078  

Currency translation adjustment

       719         465         (251 )

Cash flow hedges, net of tax

       (39 )       (23 )       46  

Minimum pension liability adjustment, net of tax

       —           5         16  

Pension and retiree medical, net of tax

            

Net prior service cost

       (105 )       —           —    

Net gains

       704         —           —    

Unrealized gain on securities, net of tax

       9         9         24  

Other

       6         —           (2 )
                              

Total Comprehensive Income

     $ 6,952       $ 6,098       $ 3,911  
                              

 

(a) Includes total tax benefits of $216 million in 2007, $130 million in 2006 and $125 million in 2005.

See accompanying notes to consolidated financial statements.

 

40


Notes to Consolidated Financial Statements

Note 1 — Basis of Presentation and Our Divisions

Basis of Presentation

Our financial statements include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates based on our economic ownership interest. We do not control these other affiliates, as our ownership in these other affiliates is generally less than 50%. Equity income or loss from our anchor bottlers is recorded as bottling equity income in our income statement. Bottling equity income also includes any changes in our ownership interests of these affiliates. Bottling equity income includes $174 million, $186 million and $126 million of pre-tax gains on our sales of PBG stock in 2007, 2006 and 2005, respectively. See Note 8 for additional information on our significant noncontrolled bottling affiliates. Income or loss from other noncontrolled affiliates is recorded as a component of selling, general and administrative expenses. Intercompany balances and transactions are eliminated. In 2005, we had an additional week of results (53rd week). Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years.

Beginning in the first quarter of 2007, income for certain non-consolidated international bottling interests was reclassified from bottling equity income and corporate unallocated results to division operating results, to be consistent with PepsiCo’s internal management accountability. Prior period amounts have been adjusted to reflect this reclassification.

Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw material handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product are included in selling, general and administrative expenses.

The preparation of our consolidated financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, stock-based compensation, pension and retiree medical accruals, useful lives for intangible assets, and future cash flows associated with impairment testing for perpetual brands, goodwill and other long-lived assets. Actual results could differ from these estimates.

See “Our Divisions” below and for additional unaudited information on items affecting the comparability of our consolidated results, see “Items Affecting Comparability” in Management’s Discussion and Analysis.

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. Certain reclassifications were made to prior years’ amounts to conform to the 2007 presentation.

 

41


Our Divisions

We manufacture or use contract manufacturers, market and sell a variety of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages, and foods in approximately 200 countries with our largest operations in North America (United States and Canada), Mexico and the United Kingdom. Division results are based on how our Chief Executive Officer assesses the performance of and allocates resources to our divisions. For additional unaudited information on our divisions, see “Our Operations” in Management’s Discussion and Analysis. The accounting policies for the divisions are the same as those described in Note 2, except for the following certain allocation methodologies:

 

   

stock-based compensation expense,

 

   

pension and retiree medical expense, and

 

   

derivatives.

Stock-Based Compensation Expense

Our divisions are held accountable for stock-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of stock-based compensation expense in 2007 was approximately 29% to FLNA, 4% to QFNA, 5% to LAF, 22% to PAB, 12% to UKE, 12% to MEAA and 16% to corporate unallocated expenses. We had similar allocations of stock-based compensation expense to our divisions in 2006 and 2005. The expense allocated to our divisions excludes any impact of changes in our Black-Scholes assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses.

Pension and Retiree Medical Expense

Pension and retiree medical service costs measured at a fixed discount rate, as well as amortization of gains and losses due to demographics, including salary experience, are reflected in division results for North American employees. Division results also include interest costs, measured at a fixed discount rate, for retiree medical plans. Interest costs for the pension plans, pension asset returns and the impact of pension funding, and gains and losses other than those due to demographics, are all reflected in corporate unallocated expenses. In addition, corporate unallocated expenses include the difference between the service costs measured at a fixed discount rate (included in division results as noted above) and the total service costs determined using the Plans’ discount rates as disclosed in Note 7.

Derivatives

Beginning in the fourth quarter of 2005, we began centrally managing commodity derivatives on behalf of our divisions. Certain of the commodity derivatives, primarily those related to the purchase of energy for use by our divisions, do not qualify for hedge

 

42


accounting treatment. These derivatives hedge underlying commodity price risk and were not entered into for speculative purposes. Such derivatives are marked to market with the resulting gains and losses recognized in corporate unallocated expenses. These gains and losses are subsequently reflected in division results when the divisions take delivery of the underlying commodity. Therefore, division results reflect the contract purchase price of the energy or other commodities.

In the second quarter of 2007, we expanded our commodity hedging program to include derivative contracts used to mitigate our exposure to price changes associated with our purchases of fruit. Similar to our energy contracts, these contracts do not qualify for hedge accounting treatment and are marked to market with the resulting gains and losses recognized in corporate unallocated expenses. These gains and losses are then subsequently reflected in divisional results.

New Organizational Structure

In the fourth quarter of 2007, we announced a strategic realignment of our organizational structure. For additional unaudited information on our new organizational structure, see “Our Operations” in Management’s Discussion and Analysis.

LOGO

 

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     2007    2006    2005    2007     2006     2005  
     Net Revenue    Operating Profit  

FLNA

   $ 11,586    $ 10,844    $ 10,322    $ 2,845     $ 2,615     $ 2,529  

QFNA

     1,860      1,769      1,718      568       554       537  

LAF

     4,872      3,972      3,719      714       655       583  

PAB

     11,090      10,362      9,849      2,487       2,315       2,247  

UKE

     5,492      4,750      4,176      774       700       619  

MEAA

     4,574      3,440      2,778      535       401       249  
                                             

Total division

     39,474      35,137      32,562      7,923       7,240       6,764  

Corporate

     —        —        —        (753 )     (738 )     (780 )
                                             
   $ 39,474    $ 35,137    $ 32,562    $ 7,170     $ 6,502     $ 5,984  
                                             

LOGO

Corporate

Corporate includes costs of our corporate headquarters, centrally managed initiatives, such as our ongoing business transformation initiative in North America, unallocated insurance and benefit programs, foreign exchange transaction gains and losses, and certain commodity derivative gains and losses, as well as profit-in-inventory elimination adjustments for our noncontrolled bottling affiliates and certain other items.

 

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Other Division Information

 

     2007    2006    2005    2007    2006    2005
      Total Assets    Capital Spending

FLNA

   $ 6,270    $ 5,969    $ 5,948    $ 624    $ 499    $ 512

QFNA

     1,002      1,003      989      41      31      31

LAF

     3,084      2,169      2,080      326      235      198

PAB

     7,780      7,129      6,794      450      516      343

UKE

     7,102      5,865      5,031      349      277      194

MEAA

     3,911      2,975      2,640      413      299      252
                                         

Total division

     29,149      25,110      23,482      2,203      1,857      1,530

Corporate (a)

     2,124      1,739      5,331      227      211      206

Investments in bottling affiliates

     3,355      3,081      2,914      —        —        —  
                                         
   $ 34,628    $ 29,930    $ 31,727    $ 2,430    $ 2,068    $ 1,736
                                         

 

(a) Corporate assets consist principally of cash and cash equivalents, short-term investments, and property, plant and equipment.

LOGO

 

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     2007    2006    2005    2007    2006    2005
     Amortization of Intangible
Assets
   Depreciation and Other
Amortization

FLNA

   $ 9    $ 9    $ 3    $ 437    $ 432    $ 419

QFNA

     —        —        —        34      33      34

LAF

     4      1      1      166      140      120

PAB

     16      83      82      321      298      281

UKE

     18      17      13      181      167      152

MEAA

     11      52      51      198      155      131
                                         

Total division

     58      162      150      1,337      1,225      1,137

Corporate

     —        —        —        31      19      21
                                         
   $ 58    $ 162    $ 150    $ 1,368    $ 1,244    $ 1,158
                                         
     2007    2006    2005    2007    2006    2005
     Net Revenue(a)    Long-Lived Assets(b)

U.S.

   $ 21,978    $ 20,788    $ 19,937    $ 12,498    $ 11,515    $ 10,723

Mexico

     3,498      3,228      3,095      1,067      996      902

United Kingdom

     1,987      1,839      1,821      2,090      1,995      1,715

Canada

     1,961      1,702      1,509      699      589      582

All other countries

     10,050      7,580      6,200      6,441      4,725      3,948
                                         
   $ 39,474    $ 35,137    $ 32,562    $ 22,795    $ 19,820    $ 17,870
                                         

 

(a) Represents net revenue from businesses operating in these countries.
(b) Long-lived assets represent property, plant and equipment, nonamortizable intangible assets, amortizable intangible assets, and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used.

LOGO

 

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Note 2 — Our Significant Accounting Policies

Revenue Recognition

We recognize revenue upon shipment or delivery to our customers based on written sales terms that do not allow for a right of return. However, our policy for DSD and chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that our consumers receive the product quality and freshness that they expect. Similarly, our policy for warehouse-distributed products is to replace damaged and out-of-date products. Based on our historical experience with this practice, we have reserved for anticipated damaged and out-of-date products. For additional unaudited information on our revenue recognition and related policies, including our policy on bad debts, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis. We are exposed to concentration of credit risk by our customers, Wal-Mart and PBG. In 2007, Wal-Mart (including Sam’s) represented approximately 12% of our total net revenue, including concentrate sales to our bottlers which are used in finished goods sold by them to Wal-Mart; and PBG represented approximately 9%. We have not experienced credit issues with these customers.

Sales Incentives and Other Marketplace Spending

We offer sales incentives and discounts through various programs to our customers and consumers. Sales incentives and discounts are accounted for as a reduction of revenue and totaled $11.3 billion in 2007, $10.1 billion in 2006 and $8.9 billion in 2005. While most of these incentive arrangements have terms of no more than one year, certain arrangements, such as fountain pouring rights, extend beyond one year. Costs incurred to obtain these arrangements are recognized over the shorter of the economic or contractual life, as a reduction of revenue, and the remaining balances of $287 million at December 29, 2007 and $297 million at December 30, 2006 are included in current assets and other assets on our balance sheet. For additional unaudited information on our sales incentives, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis.

Other marketplace spending, which includes the costs of advertising and other marketing activities, totaled $2.9 billion in 2007, $2.7 billion in 2006 and $2.8 billion in 2005 and is reported as selling, general and administrative expenses. Included in these amounts were advertising expenses of $1.9 billion in 2007, $1.7 billion in 2006 and $1.8 billion in 2005. Deferred advertising costs are not expensed until the year first used and consist of:

 

   

media and personal service prepayments,

 

   

promotional materials in inventory, and

 

   

production costs of future media advertising.

Deferred advertising costs of $160 million and $171 million at year-end 2007 and 2006, respectively, are classified as prepaid expenses on our balance sheet.

 

47


Distribution Costs

Distribution costs, including the costs of shipping and handling activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $5.1 billion in 2007, $4.6 billion in 2006 and $4.1 billion in 2005.

Cash Equivalents

Cash equivalents are investments with original maturities of three months or less which we do not intend to rollover beyond three months.

Software Costs

We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include only (i) external direct costs of materials and services utilized in developing or obtaining computer software, (ii) compensation and related benefits for employees who are directly associated with the software project and (iii) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to seven years. Net capitalized software and development costs were $652 million at December 29, 2007 and $537 million at December 30, 2006.

Commitments and Contingencies

We are subject to various claims and contingencies related to lawsuits, taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional information on our commitments, see Note 9.

Research and Development

We engage in a variety of research and development activities. These activities principally involve the development of new products, improvement in the quality of existing products, improvement and modernization of production processes, and the development and implementation of new technologies to enhance the quality and value of both current and proposed product lines. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $364 million in 2007, $282 million in 2006 and $280 million in 2005 and are reported as selling, general and administrative expenses.

 

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Other Significant Accounting Policies

Our other significant accounting policies are disclosed as follows:

 

   

Property, Plant and Equipment and Intangible Assets – Note 4, and for additional unaudited information on brands and goodwill, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis.

 

   

Income Taxes – Note 5, and for additional unaudited information, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis.

 

   

Pension, Retiree Medical and Savings Plans – Note 7, and for additional unaudited information, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis.

 

   

Risk Management – Note 10, and for additional unaudited information, see “Our Business Risks” in Management’s Discussion and Analysis.

Recent Accounting Pronouncements

In September 2006, the SEC issued SAB 108 to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires that we quantify misstatements based on their impact on each of our financial statements and related disclosures. On December 30, 2006, we adopted SAB 108. Our adoption of SAB 108 did not impact our financial statements.

In September 2006, the FASB issued SFAS 157 which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The provisions of SFAS 157 are effective as of the beginning of our 2008 fiscal year. However, the FASB has deferred the effective date of SFAS 157, until the beginning of our 2009 fiscal year, as it relates to fair value measurement requirements for nonfinancial assets and liabilities that are not remeasured at fair value on a recurring basis. We are currently evaluating the impact of adopting SFAS 157 on our financial statements. We do not expect our adoption to have a material impact on our financial statements.

In February 2007, the FASB issued SFAS 159 which permits entities to choose to measure many financial instruments and certain other items at fair value. The provisions of SFAS 159 are effective as of the beginning of our 2008 fiscal year. Our adoption of SFAS 159 will not impact our financial statements.

In December 2007, the FASB issued SFAS 141R and SFAS 160 to improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements. The provisions of SFAS 141R and SFAS 160 are effective as of the beginning of our 2009 fiscal year. We are currently evaluating the impact of adopting SFAS 141R and SFAS 160 on our financial statements.

 

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Note 3 — Restructuring and Impairment Charges

2007 Restructuring and Impairment Charge

In 2007, we incurred a charge of $102 million ($70 million after-tax or $0.04 per share) in conjunction with restructuring actions primarily to close certain plants and rationalize other production lines across FLNA, LAF, PAB, UKE and MEAA. The charge was comprised of $57 million of asset impairments, $33 million of severance and other employee-related costs and $12 million of other costs and was recorded in selling, general and administrative expenses in our income statement. Employee-related costs primarily reflect the termination costs for approximately 1,100 employees. Substantially all cash payments related to this charge are expected to be paid by the end of 2008.

A summary of the restructuring and impairment charge by division is as follows:

 

    Asset Impairments   Severance and Other
Employee Costs
  Other Costs   Total

FLNA

  $ 19   $ —     $ 9   $ 28

LAF

    25     14     —       39

PAB

    —       12     —       12

UKE

    4     2     3     9

MEAA

    9     5     —       14
                       
  $ 57   $ 33   $ 12   $ 102
                       

2006 Restructuring and Impairment Charge

In 2006, we incurred a charge of $67 million ($43 million after-tax or $0.03 per share) in conjunction with consolidating the manufacturing network at FLNA by closing two plants in the U.S., and rationalizing other assets, to increase manufacturing productivity and supply chain efficiencies. The charge was comprised of $43 million of asset impairments, $14 million of severance and other employee-related costs and $10 million of other costs. Employee-related costs primarily reflect the termination costs for approximately 380 employees. All cash payments related to this charge were paid by the end of 2007.

2005 Restructuring Charge

In 2005, we incurred a charge of $83 million ($55 million after-tax or $0.03 per share) in conjunction with actions taken to reduce costs in our operations, principally through headcount reductions. Of this charge, $34 million related to FLNA, $21 million to PAB, $13 million to UKE, $3 million to MEAA and $12 million to Corporate. Most of this charge related to the termination of approximately 700 employees. As of December 30, 2006, all terminations had occurred, and as of December 29, 2007, no accrual remains.

 

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Note 4 — Property, Plant and Equipment and Intangible Assets

 

     Average
Useful Life
   2007     2006     2005

Property, plant and equipment, net

         

Land and improvements

   10 – 34 yrs.    $ 864     $ 756    

Buildings and improvements

   20 – 44      4,577       4,095    

Machinery and equipment, including fleet and software

   5 – 14      14,471       12,768    

Construction in progress

        1,984       1,439    
                     
        21,896       19,058    

Accumulated depreciation

        (10,668 )     (9,371 )  
                     
      $ 11,228     $ 9,687    
                     

Depreciation expense

      $ 1,304     $ 1,182     $ 1,103
                         

Amortizable intangible assets, net

         

Brands

   5 – 40    $ 1,476     $ 1,288    

Other identifiable intangibles

   3 – 15      344       290    
                     
        1,820       1,578    

Accumulated amortization

        (1,024 )     (941 )  
                     
      $ 796     $ 637    
                     

Amortization expense

      $ 58     $ 162     $ 150
                         

Property, plant and equipment is recorded at historical cost. Depreciation and amortization are recognized on a straight-line basis over an asset’s estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. Amortization of intangible assets for each of the next five years, based on average 2007 foreign exchange rates, is expected to be $62 million in 2008, $60 million in 2009, $60 million in 2010, $59 million in 2011 and $59 million in 2012.

Depreciable and amortizable assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. For additional unaudited information on our amortizable brand policies, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis.

Nonamortizable Intangible Assets

Perpetual brands and goodwill are assessed for impairment at least annually. If the carrying amount of a perpetual brand exceeds its fair value, as determined by its discounted cash flows, an impairment loss is recognized in an amount equal to that excess. No impairment charges resulted from the required impairment evaluations. The change in the book value of nonamortizable intangible assets is as follows:

 

51


     Balance,
Beginning
2006
   Acquisitions    Translation
and Other
    Balance,
End of
2006
   Acquisitions    Translation
and Other
   Balance,
End of
2007

FLNA

                   

Goodwill

   $ 145    $ 139    $ —       $ 284    $ —      $ 27    $ 311
                                                 

QFNA

                   

Goodwill

     175      —        —         175      —        —        175
                                                 

LAF

                   

Goodwill

     147      —        (3 )     144      —        3      147

Brands

     23      —        (1 )     22      —        —        22
                                                 
     170      —        (4 )     166      —        3      169
                                                 

PAB

                   

Goodwill

     2,164      39      —         2,203      146      20      2,369

Brands

     59      —        —         59      —        —        59
                                                 
     2,223      39      —         2,262      146      20      2,428
                                                 

UKE

                   

Goodwill

     1,156      128      128       1,412      122      92      1,626

Brands

     898      —        120       1,018      —        23      1,041
                                                 
     2,054      128      248       2,430      122      115      2,667
                                                 

MEAA

                   

Goodwill

     301      55      20       376      114      51      541

Brands

     105      —        8       113      —        13      126
                                                 
     406      55      28       489      114      64      667
                                                 

Corporate

                   

Pension intangible

     1      —        (1 )     —        —        —        —  
                                                 

Total goodwill

     4,088      361      145       4,594      382      193      5,169

Total brands

     1,085      —        127       1,212      —        36      1,248

Total pension intangible

     1      —        (1 )     —        —        —        —  
                                                 
   $ 5,174    $ 361    $ 271     $ 5,806    $ 382    $ 229    $ 6,417
                                                 

 

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Note 5 — Income Taxes

 

     2007     2006     2005  

Income before income taxes

 

   

U.S.

   $ 4,085     $ 3,844     $ 3,175  

Foreign

     3,546       3,145       3,207  
                        
   $ 7,631     $ 6,989     $ 6,382  
                        

Provision for income taxes

      

Current:      U.S. Federal

   $ 1,422     $ 776     $ 1,638  

Foreign

     489       569       426  

State

     104       56       118  
                        
     2,015       1,401       2,182  
                        

Deferred:    U.S. Federal

     22       (31 )     137  

Foreign

     (66 )     (16 )     (26 )

State

     2       (7 )     11  
                        
     (42 )     (54 )     122  
                        
   $ 1,973     $ 1,347     $ 2,304  
                        

Tax rate reconciliation

      

U.S. Federal statutory tax rate

     35.0 %     35.0 %     35.0 %

State income tax, net of U.S. Federal tax benefit

     0.9       0.5       1.4  

Lower taxes on foreign results

     (6.5 )     (6.5 )     (6.5 )

Tax settlements

     (1.7 )     (8.6 )     —    

Taxes on AJCA repatriation

     —         —         7.0  

Other, net

     (1.8 )     (1.1 )     (0.8 )
                        

Annual tax rate

     25.9 %     19.3 %     36.1 %
                        

Deferred tax liabilities

    

Investments in noncontrolled affiliates

   $ 1,163     $ 1,103    

Property, plant and equipment

     828       784    

Intangible assets other than nondeductible goodwill

     280       169    

Pension benefits

     148       —      

Other

     136       248    
                  

Gross deferred tax liabilities

     2,555       2,304    
                  

Deferred tax assets

      

Net carryforwards

     722       667    

Stock-based compensation

     425       443    

Retiree medical benefits

     528       541    

Other employee-related benefits

     447       342    

Pension benefits

     —         38    

Deductible state tax and interest benefits

     189       —      

Other

     618       592    
                  

Gross deferred tax assets

     2,929       2,623    

Valuation allowances

     (695 )     (624 )  
                  

Deferred tax assets, net

     2,234       1,999    
                  

Net deferred tax liabilities

   $ 321     $ 305    
                  

 

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     2007    2006    2005  

Deferred taxes included within:

        

Assets:

        

Prepaid expenses and other current assets

   $ 325    $ 223   

Liabilities:

        

Deferred income taxes

   $ 646    $ 528   
Analysis of valuation allowances         

Balance, beginning of year

   $ 624    $ 532    $ 564  

Provision/(benefit)

     39      71      (28 )

Other additions/(deductions)

     32      21      (4 )
                      

Balance, end of year

   $ 695    $ 624    $ 532  
                      

For additional unaudited information on our income tax policies, including our reserves for income taxes, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis.

In 2007, we recognized $129 million of non-cash tax benefits related to the favorable resolution of certain foreign tax matters. In 2006, we recognized non-cash tax benefits of $602 million, substantially all of which related to the IRS’s examination of our consolidated income tax returns for the years 1998 through 2002. In 2005, we repatriated approximately $7.5 billion in earnings previously considered indefinitely reinvested outside the U.S. and recorded income tax expense of $460 million related to the AJCA. The AJCA created a one-time incentive for U.S. corporations to repatriate undistributed international earnings by providing an 85% dividends received deduction.

Reserves

A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows:

 

   

the U.S. – in 2006, the IRS issued a Revenue Agent’s Report (RAR) related to the years 1998 through 2002. We are in agreement with their conclusion, except for one matter which we continue to dispute. We made the appropriate cash payment during 2006 to settle the agreed-upon issues, and we do not anticipate the resolution of the open matter will significantly impact our financial statements. In 2007, the IRS initiated their audit of our U.S. tax returns for the years 2003 through 2005;

 

   

Mexico – in 2006, we completed and agreed with the conclusions of an audit of our tax returns for the years 2001 through 2005;

 

   

the United Kingdom – audits have been completed for all taxable years prior to 2004; and

 

54


   

Canada – audits have been completed for all taxable years through 2004. We are disputing some of the adjustments for the years 1999 through 2004. We do not anticipate the resolution of the 1999 through 2004 tax years will significantly impact our financial statements. The Canadian tax return for 2005 is currently under audit and no adjustments are expected to significantly impact our financial statements.

While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution.

For further unaudited information on the impact of the resolution of open tax issues, see “Other Consolidated Results.”

In 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that we recognize in our financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. We adopted the provisions of FIN 48 as of the beginning of our 2007 fiscal year. As a result of our adoption of FIN 48, we recognized a $7 million decrease to reserves for income taxes, with a corresponding increase to opening retained earnings.

As of December 29, 2007, the total gross amount of reserves for income taxes, reported in other liabilities, was $1.5 billion. Of that amount, $1.4 billion, if recognized, would affect our effective tax rate. Any prospective adjustments to our reserves for income taxes will be recorded as an increase or decrease to our provision for income taxes and would impact our effective tax rate. In addition, we accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $338 million as of December 29, 2007, of which $34 million was recognized in 2007.

 

55


A rollforward of our reserves in 2007 for all federal, state and foreign tax jurisdictions, is as follows:

 

Balance, beginning of year

   $ 1,435  

FIN 48 adoption adjustment to retained earnings

     (7 )

Reclassification of deductible state tax and interest benefits to other balance sheet accounts

     (144 )
        

Adjusted balance, beginning of year

     1,284  

Additions for tax positions related to the current year

     264  

Additions for tax positions from prior years

     151  

Reductions for tax positions from prior years

     (73 )

Settlement payments

     (174 )

Statute of limitations expiration

     (7 )

Currency translation adjustment

     16  
        

Balance, end of year

   $ 1,461  
        

Carryforwards and Allowances

Operating loss carryforwards totaling $7.1 billion at year-end 2007 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.5 billion in 2008, $5.6 billion between 2009 and 2027 and $1.0 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Undistributed International Earnings

At December 29, 2007, we had approximately $14.7 billion of undistributed international earnings. We intend to continue to reinvest earnings outside the U.S. for the foreseeable future and, therefore, have not recognized any U.S. tax expense on these earnings.

Mexico Tax Legislation

In October 2007, Mexico enacted new tax legislation effective January 1, 2008. The deferred tax impact was not material and is reflected in our effective tax rate in 2007.

Note 6 — Stock-Based Compensation

Our stock-based compensation program is a broad-based program designed to attract and retain employees while also aligning employees’ interests with the interests of our shareholders. A majority of our employees participate in our stock-based compensation program, which includes our broad-based SharePower program established in 1989 to grant an annual award of stock options to all eligible employees, based on job level or classification and, in the case of international employees, tenure as well. In addition, members of our Board of Directors participate in our stock-based compensation program in connection with their service on our Board. Beginning in 2007, members of our Board

 

56


of Directors no longer receive stock-based compensation grants. Stock options and restricted stock units (RSU) are granted to employees under the shareholder-approved 2007 Long-Term Incentive Plan (LTIP), our only active stock-based plan. Stock-based compensation expense was $260 million in 2007, $270 million in 2006 and $311 million in 2005. Related income tax benefits recognized in earnings were $77 million in 2007, $80 million in 2006 and $87 million in 2005. Stock-based compensation cost capitalized in connection with our ongoing business transformation initiative was $3 million in 2007, $3 million in 2006 and $4 million in 2005. At year-end 2007, 67 million shares were available for future stock-based compensation grants.

Method of Accounting and Our Assumptions

We account for our employee stock options, which include grants under our executive program and broad-based SharePower program, under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10-year term. The fair value of stock option grants is amortized to expense over the vesting period, generally three years. Executives who are awarded long-term incentives based on their performance are offered the choice of stock options or RSUs. Executives who elect RSUs receive one RSU for every four stock options that would have otherwise been granted. Senior officers do not have a choice and are granted 50% stock options and 50% RSUs. RSU expense is based on the fair value of PepsiCo stock on the date of grant and is amortized over the vesting period, generally three years. Each RSU is settled in a share of our stock after the vesting period. Vesting of RSU awards for senior officers is contingent upon the achievement of pre-established performance targets. There have been no reductions to the exercise price of previously issued awards, and any repricing of awards would require approval of our shareholders.

On January 1, 2006, we adopted SFAS 123R under the modified prospective method. Since we had previously accounted for our stock-based compensation plans under the fair value provisions of SFAS 123, our adoption did not significantly impact our financial position or our results of operations. Under SFAS 123R, actual tax benefits recognized in excess of tax benefits previously established upon grant are reported as a financing cash inflow. Prior to adoption, such excess tax benefits were reported as an operating cash inflow.

Our weighted-average Black-Scholes fair value assumptions are as follows:

 

     2007     2006     2005  

Expected life

   6 yrs.     6 yrs.     6 yrs.  

Risk free interest rate

   4.8 %   4.5 %   3.8 %

Expected volatility

   15 %   18 %   23 %

Expected dividend yield

   1.9 %   1.9 %   1.8 %

The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects

 

57


movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price.

A summary of our stock-based compensation activity for the year ended December 29, 2007 is presented below:

Our Stock Option Activity

 

     Options(a)     Average
Price(b)
   Average
Life
(years)(c)
   Aggregate
Intrinsic
Value(d)

Outstanding at December 30, 2006

   127,749     $ 44.24      

Granted

   11,671       65.12      

Exercised

   (28,116 )     39.34      

Forfeited/expired

   (2,496 )     56.04      
              

Outstanding at December 29, 2007

   108,808     $ 47.47    5.26    $ 3,216,316
              

Exercisable at December 29, 2007

   75,365     $ 42.65    3.97    $ 2,590,994

 

(a) Options are in thousands and include options previously granted under Quaker plans. No additional options or shares may be granted under the Quaker plans.
(b) Weighted-average exercise price.
(c) Weighted-average contractual life remaining.
(d) In thousands.

Our RSU Activity

 

     RSUs(a)     Average
Intrinsic
Value(b)
   Average
Life
(years)(c)
   Aggregate
Intrinsic
Value(d)

Outstanding at December 30, 2006

   7,885     $ 53.38      

Granted

   2,342       65.21      

Converted

   (2,361 )     47.83      

Forfeited/expired

   (496 )   $ 57.73      
              

Outstanding at December 29, 2007

   7,370     $ 58.63    1.28    $ 567,706
              

 

(a) RSUs are in thousands.
(b) Weighted-average intrinsic value at grant date.
(c) Weighted-average contractual life remaining.
(d) In thousands.

 

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Other Stock-Based Compensation Data

 

     2007    2006    2005

Stock Options

        

Weighted-average fair value of options granted

   $ 13.56    $ 12.81    $ 13.45

Total intrinsic value of options exercised(a)

   $ 826,913    $ 686,242    $ 632,603

RSUs

        

Total number of RSUs granted(a)

     2,342      2,992      3,097

Weighted-average intrinsic value of RSUs granted

   $ 65.21    $ 58.22    $ 53.83

Total intrinsic value of RSUs converted(a)

   $ 125,514    $ 10,934    $ 4,974

 

(a)

In thousands.

At December 29, 2007, there was $287 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation is expected to be recognized over a weighted-average period of 1.5 years.

Note 7 — Pension, Retiree Medical and Savings Plans

Our pension plans cover full-time employees in the U.S. and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the costs.

Other gains and losses resulting from actual experience differing from our assumptions and from changes in our assumptions are also determined at each measurement date. If this net accumulated gain or loss exceeds 10% of the greater of plan assets or liabilities, a portion of the net gain or loss is included in expense for the following year. The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in earnings on a straight-line basis over the average remaining service period of active plan participants, which is approximately 11 years for pension expense and approximately 13 years for retiree medical expense.

On December 30, 2006, we adopted SFAS 158. In connection with our adoption, we recognized the funded status of our Plans on our balance sheet as of December 30, 2006 with subsequent changes in the funded status recognized in comprehensive income in the years in which they occur. In accordance with SFAS 158, amounts prior to the year of adoption have not been adjusted. SFAS 158 also requires that, no later than 2008, our assumptions used to measure our annual pension and retiree medical expense be determined as of the balance sheet date, and all plan assets and liabilities be reported as of that date. Accordingly, as of the beginning of our 2008 fiscal year, we will change the measurement date for our annual pension and retiree medical expense and all plan assets

 

59


and liabilities from September 30 to our year-end balance sheet date. As a result of this change in measurement date, we will record an after-tax $39 million increase to 2008 opening shareholders’ equity which will be reflected in our 2008 first quarter Form 10-Q.

Selected financial information for our pension and retiree medical plans is as follows:

 

     Pension     Retiree Medical  
     2007     2006     2007     2006     2007     2006  
     U.S.     International              

Change in projected benefit liability

            

Liability at beginning of year

   $ 5,947     $ 5,771     $ 1,511     $ 1,263     $ 1,370     $ 1,312  

Service cost

     244       245       59       52       48       46  

Interest cost

     338       319       81       68       77       72  

Plan amendments

     147       11       4       8       —         —    

Participant contributions

     —         —         14       12       —         —    

Experience (gain)/loss

     (309 )     (163 )     (155 )     20       (80 )     (34 )

Benefit payments

     (319 )     (233 )     (46 )     (38 )     (77 )     (75 )

Settlement/curtailment loss

     —         (7 )     —         (6 )     —         —    

Special termination benefits

     —         4       —         —         —         1  

Foreign currency adjustment

     —         —         96       126       9       —    

Other

     —         —         31       6       7       48  
                                                

Liability at end of year

   $ 6,048     $ 5,947     $ 1,595     $ 1,511     $ 1,354     $ 1,370  
                                                

Change in fair value of plan assets

            

Fair value at beginning of year

   $ 5,378     $ 5,086     $ 1,330     $ 1,099     $ —       $ —    

Actual return on plan assets

     654       513       122       112       —         —    

Employer contributions/funding

     69       19       58       30       77       75  

Participant contributions

     —         —         14       12       —         —    

Benefit payments

     (319 )     (233 )     (46 )     (38 )     (77 )     (75 )

Settlement/curtailment loss

     —         (7 )     —         —         —         —    

Foreign currency adjustment

     —         —         91       116       —         —    

Other

     —         —         26       (1 )     —         —    
                                                

Fair value at end of year

   $ 5,782     $ 5,378     $ 1,595     $ 1,330     $ —       $ —    
                                                

Reconciliation of funded status

            

Funded status

   $ (266 )   $ (569 )   $     $ (181 )   $ (1,354 )   $ (1,370 )

Adjustment for fourth quarter contributions

     15       6       107       13       19       16  

Adjustment for fourth quarter special termination benefits

     (5 )     —         —         —         —         —    
                                                

Net amount recognized

   $ (256 )   $ (563 )   $ 107     $ (168 )   $ (1,335 )   $ (1,354 )
                                                

Amounts recognized

            

Other assets

   $ 440     $ 185     $ 187     $ 6     $ —       $ —    

Other current liabilities

     (24 )     (19 )     (3 )     (2 )     (88 )     (84 )

Other liabilities

     (672 )     (729 )     (77 )     (172 )     (1,247 )     (1,270 )
                                                

Net amount recognized

   $ (256 )   $ (563 )   $ 107     $ (168 )   $ (1,335 )   $ (1,354 )
                                                

Amounts included in accumulated other comprehensive loss (pre-tax)

            

Net loss

   $ 1,136     $ 1,836     $ 287     $ 475     $ 276     $ 364  

Prior service cost/(credit)

     156       13       28       24       (88 )     (101 )
                                                

Total

   $ 1,292     $ 1,849     $ 315     $ 499     $ 188     $ 263  
                                                

 

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     Pension     Retiree Medical  
     2007     2006     2007     2006     2007     2006  
     U.S.     International              

Components of the (decrease)/increase in net loss

            

Change in discount rate

   $ (292 )   $ (123 )   $ (224 )   $ 2     $ (50 )   $ (30 )

Employee-related assumption changes

     —         (45 )     61       6       (9 )     —    

Liability-related experience different from assumptions

     (17 )     5       7       6       (21 )     (4 )

Actual asset return different from expected return

     (255 )     (122 )     (25 )     (30 )     —         —    

Amortization of losses

     (136 )     (164 )     (30 )     (29 )     (18 )     (21 )

Other, including foreign currency adjustments and 2003 Medicare Act

     —         (3 )     23       46       10       17  
                                                

Total

   $ (700 )   $ (452 )   $ (188 )   $ 1     $ (88 )   $ (38 )
                                                

Liability at end of year for service to date

   $ 5,026     $ 4,998     $ 1,324     $ 1,239      

Components of benefit expense are as follows:

 

     Pension     Retiree Medical  
     2007     2006     2005     2007     2006     2005     2007     2006     2005  
     U.S.     International                    

Components of benefit expense

                  

Service cost

   $ 244     $ 245     $ 213     $ 59     $ 52     $ 32     $ 48     $ 46     $ 40  

Interest cost

     338       319       296       81       68       55       77       72       78  

Expected return on plan assets

     (399 )     (391 )     (344 )     (97 )     (81 )     (69 )     —         —         —    

Amortization of prior service cost/(credit)

     5       3       3       3       2       1       (13 )     (13 )     (11 )

Amortization of net loss

     136       164       106       30       29       15       18       21       26  
                                                                        
     324       340       274       76       70       34       130       126       133  

Settlement/curtailment loss

     —         3       —         —         —         —         —         —         —    

Special termination benefits

     5       4       21       —         —         —         —         1       2  
                                                                        

Total

   $ 329     $ 347     $ 295     $ 76     $ 70     $ 34     $ 130     $ 127     $ 135  
                                                                        

The estimated amounts to be amortized from accumulated other comprehensive loss into benefit expense in 2008 for our pension and retiree medical plans are as follows:

 

     Pension    Retiree Medical  
     U.S.    International       

Net loss

   $ 56    $ 20    $ 7  

Prior service cost/(credit)

     20      3      (12 )
                      

Total

   $ 76    $ 23    $ (5 )
                      

 

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The following table provides the weighted-average assumptions used to determine projected benefit liability and benefit expense for our pension and retiree medical plans:

 

     Pension     Retiree Medical  
     2007     2006     2005     2007     2006     2005     2007     2006     2005  
     U.S.     International                    

Weighted average assumptions

                  

Liability discount rate

   6.2 %   5.8 %   5.7 %   5.8 %   5.2 %   5.1 %   6.1 %   5.8 %   5.7 %

Expense discount rate

   5.8 %   5.7 %   6.1 %   5.2 %   5.1 %   6.1 %   5.8 %   5.7 %   6.1 %

Expected return on plan assets

   7.8 %   7.8 %   7.8 %   7.3 %   7.3 %   8.0 %      

Rate of salary increases

   4.7 %   4.5 %   4.4 %   3.9 %   3.9 %   4.1 %      

The following table provides selected information about plans with liability for service to date and total benefit liability in excess of plan assets:

 

     Pension     Retiree Medical  
     2007     2006     2007     2006     2007     2006  
     U.S.     International              

Selected information for plans with liability for service to date in excess of plan assets

 

Liability for service to date

   $ (364 )   $ (387 )   $ (72 )   $ (286 )    

Fair value of plan assets

   $ —       $ 1     $ 13     $ 237      

Selected information for plans with benefit liability in excess of plan assets

 

Benefit liability

   $ (707 )   $ (754 )   $ (384 )   $ (1,387 )   $ (1,354 )   $ (1,370 )

Fair value of plan assets

   $ —       $ 1     $ 278     $ 1,200      

Of the total projected pension benefit liability at year-end 2007, $658 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment.

Future Benefit Payments and Funding

Our estimated future benefit payments are as follows:

 

       2008      2009      2010      2011      2012      2013-17

Pension

     $ 290      $ 315      $ 350      $ 385      $ 425      $ 2,755

Retiree medical(a)

     $ 95      $ 100      $ 105      $ 110      $ 115      $ 640

 

(a)

Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $10 million for each of the years from 2008 through 2012 and approximately $70 million in total for 2013 through 2017.

These future benefits to beneficiaries include payments from both funded and unfunded pension plans.

In 2008, we expect to make pension contributions of up to $150 million, with up to $75 million expected to be discretionary. Our cash payments for retiree medical are estimated to be approximately $85 million in 2008.

 

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Pension Assets

Our pension plan investment strategy is reviewed annually and is established based upon plan liabilities, an evaluation of market conditions, tolerance for risk, and cash requirements for benefit payments. Our investment objective is to ensure that funds are available to meet the plans’ benefit obligations when they are due. Our overall investment strategy is to prudently invest plan assets in high-quality and diversified equity and debt securities to achieve our long-term return expectation. As part of our investment strategy, we employ certain equity strategies which, in addition to investing in U.S. and international common and preferred stock, include investing in certain equity- and debt-based securities used collectively to generate returns in excess of certain equity-based indices. Debt-based securities represent approximately a third of our equity strategy portfolio as of year-end 2007 and 2006. Our investment policy also permits the use of derivative instruments to enhance the overall return of the portfolio. Our expected long-term rate of return on U.S. plan assets is 7.8%, reflecting estimated long-term rates of return of 9.3% from our equity strategies, and 5.8% from our fixed income strategies. Our target investment allocation is 60% for equity strategies and 40% for fixed income strategies. Our actual pension plan asset allocations, consistent with our investment approach and with how we view and manage our overall investment portfolio, for the plan years 2007 and 2006, are as follows:

 

     Actual
Allocation
 

Asset Category

   2007     2006  

Equity strategies

   61 %   61 %

Fixed income strategies

   38 %   39 %

Other, primarily cash

   1 %   —    
            

Total

   100 %   100 %
            

The expected return on pension plan assets is based on our historical experience, our pension plan investment strategy and our expectations for long-term rates of return. We use a market-related valuation method for recognizing investment gains or losses. For this purpose, investment gains or losses are the difference between the expected and actual return based on the market-related value of assets. This market-related valuation method recognizes investment gains or losses over a five-year period from the year in which they occur, which has the effect of reducing year-to-year volatility. Pension expense in future periods will be impacted as gains or losses are recognized in the market-related value of assets over the five-year period.

Pension assets include 5.5 million shares of PepsiCo common stock with a market value of $401 million in 2007, and 5.5 million shares with a market value of $358 million in 2006. Our investment policy limits the investment in PepsiCo stock at the time of investment to 10% of the fair value of plan assets.

As of December 29, 2007, approximately 3%, or approximately $165 million, of securities in the investment portfolio of our U.S. pension plans are subprime mortgage holdings. We do not believe that the ultimate realization of such investments will result in a material impact to future pension expense, future contributions or the funded status of our plans.

 

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Retiree Medical Cost Trend Rates

An average increase of 8.5% in the cost of covered retiree medical benefits is assumed for 2008. This average increase is then projected to decline gradually to 5% in 2014 and thereafter. These assumed health care cost trend rates have an impact on the retiree medical plan expense and liability. However, the cap on our share of retiree medical costs limits the impact. A 1-percentage-point change in the assumed health care trend rate would have the following effects:

 

     1%
Increase
   1%
Decrease
 

2007 service and interest cost components

   $ 5    $ (4 )

2007 benefit liability

   $ 55    $ (48 )

Savings Plan

Our U.S. employees are eligible to participate in 401(k) savings plans, which are voluntary defined contribution plans. The plans are designed to help employees accumulate additional savings for retirement. We make matching contributions on a portion of eligible pay based on years of service. In 2007 and 2006, our matching contributions were $62 million and $56 million, respectively.

For additional unaudited information on our pension and retiree medical plans and related accounting policies and assumptions, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis.

Note 8 — Noncontrolled Bottling Affiliates

Our most significant noncontrolled bottling affiliates are PBG and PAS. Sales to PBG reflect approximately 9% of our total net revenue in 2007 and approximately 10% in 2006 and 2005.

The Pepsi Bottling Group

In addition to approximately 35% and 38% of PBG’s outstanding common stock that we own at year-end 2007 and 2006, respectively, we own 100% of PBG’s class B common stock and approximately 7% of the equity of Bottling Group, LLC, PBG’s principal operating subsidiary. Bottling equity income includes $174 million, $186 million and $126 million of pre-tax gains on our sales of PBG stock in 2007, 2006 and 2005, respectively.

 

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PBG’s summarized financial information is as follows:

 

     2007    2006    2005

Current assets

   $ 3,086    $ 2,749   

Noncurrent assets

     10,029      9,178   
                

Total assets

   $ 13,115    $ 11,927   
                

Current liabilities

   $ 2,215    $ 2,051   

Noncurrent liabilities

     7,312      7,252   

Minority interest

     973      540   
                

Total liabilities

   $ 10,500    $ 9,843   
                

Our investment

   $ 2,022    $ 1,842   
                

Net revenue

   $ 13,591    $ 12,730    $ 11,885

Gross profit

   $ 6,221    $ 5,830    $ 5,540

Operating profit

   $ 1,071    $ 1,017    $ 1,023

Net income

   $ 532    $ 522    $ 466

Our investment in PBG, which includes the related goodwill, was $507 million and $500 million higher than our ownership interest in their net assets at year-end 2007 and 2006, respectively. Based upon the quoted closing price of PBG shares at year-end 2007 and 2006, the calculated market value of our shares in PBG exceeded our investment balance, excluding our investment in Bottling Group, LLC, by approximately $1.7 billion and $1.4 billion, respectively.

Additionally, in 2007, we formed a joint venture with PBG, comprising our concentrate and PBG’s bottling businesses in Russia. PBG holds a 60% majority interest in the joint venture and consolidates the entity. We account for our interest of 40% under the equity method of accounting.

 

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PepsiAmericas

At year-end 2007 and 2006, we owned approximately 44% of PAS, and their summarized financial information is as follows:

 

     2007    2006    2005

Current assets

   $ 922    $ 675   

Noncurrent assets

     4,386      3,532   
                

Total assets

   $ 5,308    $ 4,207   
                

Current liabilities

   $ 903    $ 694   

Noncurrent liabilities

     2,274      1,909   

Minority interest

     273      —     
                

Total liabilities

   $ 3,450    $ 2,603   
                

Our investment

   $ 1,118    $ 1,028   
                

Net revenue

   $ 4,480    $ 3,972    $ 3,726

Gross profit

   $ 1,823    $ 1,608    $ 1,562

Operating profit

   $ 436    $ 356    $ 393

Net income

   $ 212    $ 158    $ 195

Our investment in PAS, which includes the related goodwill, was $303 million and $316 million higher than our ownership interest in their net assets at year-end 2007 and 2006, respectively. Based upon the quoted closing price of PAS shares at year-end 2007 and 2006, the calculated market value of our shares in PAS exceeded our investment by $855 million and $173 million, respectively.

Additionally, in 2007, we completed the joint purchase of Sandora, LLC with PAS. PAS holds a 60% majority interest in the joint venture and consolidates the entity. We account for our interest of 40% under the equity method of accounting.

Related Party Transactions

Our significant related party transactions include our noncontrolled bottling affiliates. We sell concentrate to these affiliates, which they use in the production of CSDs and non-carbonated beverages. We also sell certain finished goods to these affiliates, and we receive royalties for the use of our trademarks for certain products. Sales of concentrate and finished goods are reported net of bottler funding. For further unaudited information on these bottlers, see “Our Customers” in Management’s Discussion and Analysis. These transactions with our bottling affiliates are reflected in our consolidated financial statements as follows:

 

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     2007    2006    2005

Net revenue

   $ 4,874    $ 4,837    $ 4,633

Selling, general and administrative expenses

   $ 91    $ 87    $ 143

Accounts and notes receivable

   $ 163    $ 175   

Accounts payable and other current liabilities

   $ 106    $ 62   

Such amounts are settled on terms consistent with other trade receivables and payables. See Note 9 regarding our guarantee of certain PBG debt.

In addition, we coordinate, on an aggregate basis, the contract negotiations of sweeteners and other raw material requirements for certain of our bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, these transactions are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our bottlers, but we consider this exposure to be remote.

Note 9 — Debt Obligations and Commitments

 

     2007     2006  

Short-term debt obligations

    

Current maturities of long-term debt

   $ 526     $ 605  

Commercial paper (4.3% and 5.3%)

     361       792  

Other borrowings (7.2% and 7.3%)

     489       377  

Amounts reclassified to long-term debt

     (1,376 )     (1,500 )
                
   $ —      $ 274  
                

Long-term debt obligations

    

Short-term borrowings, reclassified

   $ 1,376     $ 1,500  

Notes due 2008-2026 (5.3% and 6.0%)

     2,673       1,148  

Zero coupon notes, $375 million due 2008-2012 (13.3%)

     285       299  

Other, due 2008-2016 (6.1% and 6.1%)

     395       208  
                
     4,729       3,155  

Less: current maturities of long-term debt obligations

     (526 )     (605 )
                
   $ 4,203     $ 2,550  
                

 

The interest rates in the above table reflect weighted-average rates at year-end.

In the second quarter of 2007, we issued $1 billion of senior unsecured notes maturing in 2012. We used a portion of the proceeds from the issuance of the notes to repay existing short-term debt of $500 million, bearing interest at 3.2% per year and maturing on May 15, 2007, with the balance of the proceeds used primarily for general corporate purposes. Additionally, in the second quarter of 2007, we extended the maturity of our $1.5 billion unsecured revolving credit agreement by one year to 2012, and, in the third quarter of 2007, we increased the amount of this agreement from $1.5 billion to $2 billion. Funds borrowed under this agreement may be used for general corporate purposes, including supporting our outstanding commercial paper issuances. This line of credit remains unused as of December 29, 2007.

 

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In the third quarter of 2007, we updated our U.S. $2.5 billion euro medium term note program following the expiration of the existing program. Under the program, we may issue unsecured notes under mutually agreed upon terms with the purchasers of the notes. Proceeds from any issuance of notes may be used for general corporate purposes, except as otherwise specified in the related prospectus. As of December 29, 2007, we have no outstanding notes under the program.

In the fourth quarter of 2007, we issued $1 billion of senior unsecured notes maturing in 2013. We used the proceeds from the issuance of the notes for general corporate purposes, including the repayment of outstanding short-term indebtedness.

As of December 29, 2007, we have reclassified $1.4 billion of short-term debt to long-term based on our intent and ability to refinance on a long-term basis.

In addition, as of December 29, 2007, $806 million of our debt related to borrowings from various lines of credit is maintained for our international divisions. These lines of credit are subject to normal banking terms and conditions and are fully committed to the extent of our borrowings.

Interest Rate Swaps

In connection with the issuance of the $1 billion notes in the second quarter of 2007, we entered into an interest rate swap to effectively convert the interest rate from a fixed rate of 5.15% to a variable rate based on LIBOR. We previously entered into an interest rate swap in 2004 to effectively convert the interest rate of a specific debt issuance from a fixed rate to a variable rate. This interest rate swap matured in May 2007. The terms of the swaps match the terms of the debt they modify. The notional amounts of the interest rate swaps outstanding at December 29, 2007 and December 30, 2006 were $1 billion and $500 million, respectively.

At December 29, 2007, approximately 56% of total debt, after the impact of the related interest rate swap, was exposed to variable interest rates, compared to 63% at December 30, 2006. In addition to variable rate long-term debt, all debt with maturities of less than one year is categorized as variable for purposes of this measure.

Cross Currency Interest Rate Swaps

In 2004, we entered into a cross currency interest rate swap to hedge the currency exposure on U.S. dollar denominated debt of $50 million held by a foreign affiliate. The terms of this swap match the terms of the debt it modifies. The swap matures in 2008. The unrealized loss related to this swap was approximately $8 million at December 29, 2007, resulting in a U.S. dollar liability of $58 million. The unrealized gain related to this swap was less than $1 million at December 30, 2006, resulting in a U.S. dollar liability of $50 million.

We also entered into cross currency interest rate swaps to hedge the currency exposure on U.S. dollar denominated intercompany debt of $45 million at December 29, 2007 and $95

 

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million at December 30, 2006. The terms of the swaps match the terms of the debt they modify. The net unrealized losses related to these swaps was less than $1 million at December 29, 2007 and December 30, 2006. The outstanding swap matures in 2008.

Long-Term Contractual Commitments(a)

 

     Payments Due by Period
     Total    2008    2009 –
2010
   2011 –
2012
   2013
and
beyond

Long-term debt obligations(b)

   $ 2,827    $ —      $ 171    $ 1,340    $ 1,316

Interest on debt obligations(c)

     938      184      300      285      169

Operating leases

     1,105      260      340      191      314

Purchasing commitments

     3,767      1,182      1,713      509      363

Marketing commitments

     1,251      329      551      278