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Unformatted text preview: Common Stock Information Shareholder Information Annual Meeting The Annual Meeting of Shareholders will be held at Frito-Lay Corporate Headquarters, 7701 Legacy Drive, Plano, Texas, on Wednesday, May 7, 2008, at 9:00 a.m. local time. Proxies for the meeting will be solicited by an independent proxy solicitor. This Annual Report is not part of the proxy solicitation. Contents 1 ...... Financial Highlights 2 ...... Letter to Shareholders 7 ...... Questions & Answers 10..... Leadership Team 12..... PepsiCo Americas Foods 14..... PepsiCo Americas Beverages 16..... PepsiCo International 19..... Purpose: Human, Environment, Talent 29..... PepsiCo Board of Directors 30..... Executive Officers 31..... Financial Review Stock Trading Symbol — PEP Stock Exchange Listings The New York Stock Exchange is the principal market for PepsiCo common stock, which is also listed on the Chicago and Swiss Stock Exchanges. Shareholders As of February 8, 2008, there were approximately 185,000 shareholders of record. PepsiCo Stock Purchase Program — for Canadian employees: Fidelity Stock Plan Services P.O. Box 5000 Cincinnati, OH 45273-8398 Telephone: 800-544-0275 Website: www.iStockPlan.com/ESPP Please have a copy of your most recent statement available when calling with inquiries. If using overnight or certified mail send to: Fidelity Investments 100 Crosby Parkway Mail Zone KC1F-L Covington, KY 41015 Inquiries Regarding Your Stock Holdings Registered Shareholders (shares held by you in your name) should address communications concerning transfers, statements, dividend payments, address changes, lost certificates and other administrative matters to: PepsiCo, Inc. c/o BNY Mellon Shareowner Services P.O. Box 358015 Pittsburgh, PA 15252-8015 Telephone: 800-226-0083 201-680-6685 (Outside the U.S.) E-mail: shrrelations@bnymellon.com Website: www.bnymellon.com/shareowner/isd or Manager Shareholder Relations PepsiCo, Inc. 700 Anderson Hill Road Purchase, NY 10577 Telephone: 914-253-3055 In all correspondence or telephone inquiries, please mention PepsiCo, your name as printed on your stock certificate, your Investor ID (IID), your address and telephone number. Dividend Policy We target an annual dividend payout of 50% of prior year’s earnings, excluding certain items. Dividends are usually declared in late January or early February, May, July and November and paid at the end of March, June and September and the beginning of January. The dividend record dates for these payments are, subject to approval of the Board of Directors, expected to be March 7, June 6, September 5 and December 5, 2008. We have paid consecutive quarterly cash dividends since 1965. Shareholder Services BuyDIRECT Plan Interested investors can make their initial purchase directly through The Bank of New York, transfer agent for PepsiCo, and Administrator for the Plan. A brochure detailing the Plan is available on our website www.pepsico.com or from our transfer agent: PepsiCo, Inc. c/o BNY Mellon Shareowner Services P.O. Box 358015 Pittsburgh, PA 15252-8015 Telephone: 800-226-0083 201-680-6685 (Outside the U.S.) E-mail: shrrelations@bnymellon.com Website: www.bnymellon.com/shareowner/isd Other services include dividend reinvestment, optional cash investments by electronic funds transfer or check drawn on a U.S. bank, sale of shares, online account access, and electronic delivery of shareholder materials. Stock Performance PepsiCo was formed through the 1965 merger of Pepsi-Cola Company and Frito-Lay, Inc. A $1,000 investment in our stock made on December 31, 2002 was worth about $1,964 on December 31, 2007, assuming the reinvestment of dividends into PepsiCo stock. This performance represents a compounded annual growth rate of 14%. The closing price for a share of PepsiCo common stock on the New York Stock Exchange was the price as reported by Bloomberg for the years ending 2003-2007. Past performance is not necessarily indicative of future returns on investments in PepsiCo common stock. SharePower Participants (employees with ShareCash Dividends Declared Per Share (In $) 1.425 Power options) should address all questions regarding your account, outstanding options or shares received through option exercises to: Merrill Lynch/SharePower Stock Option Unit 1600 Merrill Lynch Drive Mail Stop 06-02-SOP Pennington, NJ 08534 Telephone: 800-637-6713 (U.S., Puerto Rico and Canada) 609-818-8800 (all other locations) In all correspondence, please provide your account number (for U.S. citizens, this is your Social Security number), your address, your telephone number and mention PepsiCo SharePower. For telephone inquiries, please have a copy of your most recent statement available. Financial and Other Information PepsiCo’s 2008 quarterly earnings releases are expected to be issued the weeks of April 21, July 21, October 6, 2008, and February 2, 2009. Copies of PepsiCo’s SEC reports, earnings and other financial releases, corporate news and additional company information are available on our website www.pepsico.com. PepsiCo’s CEO and CFO Certifications required under Sarbanes-Oxley Section 302 were filed as an exhibit to our Form 10-K filed with the SEC on February 15, 2008. PepsiCo’s 2007 Domestic Company Section 303A CEO Certification was filed with the New York Stock Exchange (NYSE). In addition, we have a written statement of Management’s Report on Internal Control over Financial Reporting on page 83 of this annual report. If you have questions regarding PepsiCo’s financial performance contact: Jane Nielsen Vice President, Investor Relations PepsiCo, Inc. Purchase, NY 10577 Telephone: 914-253-3035 1.16 1.01 .850 .630 03 04 05 06 07 Employee Benefit Plan Participants PepsiCo 401(k) Plan & PepsiCo Stock Purchase Program The PepsiCo Savings & Retirement Center at Fidelity P.O. Box 770003 Cincinnati, OH 45277-0065 Telephone: 800-632-2014 (Overseas: Dial your country’s AT&T Access Number +800-632-2014. In the U.S., access numbers are available by calling 800-331-1140. From anywhere in the world, access numbers are available online at www.att.com/traveler.) Website: www.netbenefits.fidelity.com Year-end Market Price of Stock Based on calendar year-end (In $) 80 60 40 20 0 Independent Auditors KPMG LLP 345 Park Avenue New York, NY 10154-0102 Telephone: 212-758-9700 Corporate Headquarters PepsiCo, Inc. 700 Anderson Hill Road Purchase, NY 10577 Telephone: 914-253-2000 03 04 05 06 07 PepsiCo’s Annual Report contains many of the valuable trademarks owned and/or used by PepsiCo and its subsidiaries and affiliates in the United States and internationally to distinguish products and services of outstanding quality. PepsiCo Website: www.pepsico.com © 2008 PepsiCo, Inc. Design: Eisenman Associates. Printing: Earth - Thebault an EarthColor Company. Photography: Greg Kinch, PhotoBureau, Ben Rosenthal, Diana Scrimgeour, Stephen Wilkes. Financial Highlights PepsiCo, Inc. and Subsidiaries ($ in millions except per share amounts; all per share amounts assume dilution) Largest PepsiCo Brands 2007 Summary of Operations Total net revenue Division operating profit(b) Total operating profit(c) Net income(d) Earnings per share(d) Other Data Management operating cash flow(e) Net cash provided by operating activities Capital spending Common share repurchases Dividends paid Long-term debt $39,474 $8,025 $7,272 $5,599 $3.38 2006 $35,137 $7,307 $6,569 $5,065 $3.00 Chg(a) 12% 10% 11% 11% 13% $4,551 $6,934 $2,430 $4,300 $2,204 $4,203 $4,065 $6,084 $2,068 $3,000 $1,854 $2,550 12% 14% 17% 43% 19% 65% Estimated Worldwide Retail Sales $ in Billions Pepsi-Cola Mountain Dew Diet Pepsi Gatorade Thirst Quencher Tropicana Beverages Lay’s Potato Chips Quaker Foods and Snacks Doritos Tortilla Chips 7UP (outside U.S.) Lipton Teas (PepsiCo/Unilever Partnership) Cheetos Cheese Flavored Snacks Aquafina Bottled Water ( a ) Percentage changes are based on unrounded amounts. ( b ) Excludes corporate unallocated expenses and restructuring and impairment charges. See page 86 for a reconciliation to the most directly comparable financial measure in accordance with GAAP. ( c ) Excludes restructuring and impairment charges. See page 86 for a reconciliation to the most directly comparable financial measure in accordance with GAAP. ( d ) Excludes restructuring and impairment charges and certain tax items. See page 86 for a reconciliation to the most directly comparable financial measure in accordance with GAAP. ( e ) Includes the impact of net capital spending. Also, see “Our Liquidity and Capital Resources” in Management’s Discussion and Analysis. PepsiCo Estimated Worldwide Retail Sales: $98 Billion* *Includes estimated retail sales of all PepsiCo products, including those sold by our partners and franchised bottlers. 0 Ruffles Potato Chips Mirinda Tostitos Tortilla Chips Sierra Mist Walkers Potato Crisps Fritos Corn Chips 5 10 15 20 PepsiCo has 18 mega-brands that generate $1 billion or more each in annual retail sales. 1 Delivering Performance with Purpose in 2007 Dear Shareholders: We have titled this year’s annual report “Performance with Purpose: The Journey Continues.” That’s because in 2007 PepsiCo made great progress toward the long-term corporate objectives we set for ourselves last year: To achieve business and financial success while leaving a positive imprint on society. Once more, our extraordinary associates around the world delivered terrific performance, and I am delighted to share with you the following 2007 financial results: • Net revenue grew 12%, roughly three times the rate of global GDP growth. • Division operating profit grew 10%.* • Earnings per share grew 13%.* • Total return to shareholders was 26%. • Return on invested capital was 29%. • Cash flow from operations was $6.9 billion. In 2007 PepsiCo took important steps to support future growth. What makes me particularly proud is that our 2007 performance was strong — not just measured by these short-term metrics — but also with the long-term equally in mind: • We increased capital expenditures in plant and equipment worldwide to enable growth of core brands and expand into new platforms such as baked and crisp-bread snacks and non-carbonated beverages. • We added several tuck-in acquisitions in key markets and segments, and we further expanded our successful coffee and tea joint ventures. • We created the Chief Scientific Officer position to ensure our technical capabilities keep pace with increasingly sophisticated consumer demand; and we funded incremental investment to explore breakthrough R&D opportunities. • We maintained focus on building next-generation IT capabilities with Project One Up, to support our long-term growth prospects worldwide. *See page 86. Indra Nooyi Chairman and Chief Executive Officer 2 Our brands once again demonstrated competitive strength. On the ground, in cities and towns around the world, good brand strategies were implemented with operational excellence. I’d like to share a few notable examples of the big marketplace wins we enjoyed in 2007: • Our carbonated soft drink and savory snack brands gained market share in the United States and in many of our top international markets. • In the United Kingdom, Baked Walkers crisps was named “New Product of the Year” by Marketing Week magazine. • SunChips snacks delivered double-digit growth in the United States as a result of great, innovative marketing and in-store execution. • 7UP H2Oh! was our fastest-growing brand in value and volume share in Brazil in its launch year. • Pepsi Max came of age as a global brand, with outstanding performance in the United States as Diet Pepsi Max, after successes in Northern Europe and Australia and 2007 launches across Asia. • PepsiCo beverage brands crossed the $1 billion mark in Russia retail sales. • We posted double-digit volume growth in China beverages and high-single-digit beverage volume growth in India. And we did all of this while battling increased commodity inflation and more macroeconomic volatility than in previous years. In the next few pages you’ll learn a lot more about the performance of our individual businesses from the leaders of PepsiCo Americas Foods, PepsiCo Americas Beverages and PepsiCo International. Earnings Per Share* $3.38 $3.00 $2.66 2005 2006 2007 *See page 86. Management Operating Cash Flow** $ in Millions $4,551 $4,204 $4,065 2007 Scorecard 12% 4% Volume Net Revenue Division Operating Profit* 2005 2006 2007 10% 29% 26% **See page 55. 13% Earnings Per Share* Total Return to Shareholders Return on Invested Capital *See page 86. 3 You’ll see it’s been a good year commercially. I believe that is in part because we have moved our purpose agenda forward. In a networked global marketplace, companies must embrace the reality of rapid change and interconnectedness — and corporate strategy must holistically consider the complex factors shaping the landscape. That was why, last year, we said we would commit ourselves to deliver performance — but it would be performance with purpose. You see, our performance and our purpose are not two separate things. They are not even two sides of the same coin. They are merging. For example, portfolio transformation — offering consumers healthier choices — is equally about human sustainability and top-line growth. With great pride, I turn now to PepsiCo’s 2007 achievements in each of the three elements that together form our purpose agenda: human, environment and talent sustainability. The goal of human sustainability is to nourish consumers with a range of products, from treats to healthy eats. We are proud to give consumers choices across the spectrum. Our products deliver joy as well as nutrition — and always, great taste. In 2007 we made great progress toward human sustainability: • Reformulating some of our existing products to improve their nutritional profile. • Launching new products that reflect consumer demand for healthier, nutritious snacks and beverages. • Partnering with governments, health officials and non-governmental organizations to help address obesity concerns. • Continuing to grow our portfolio of Smart Spot* eligible products. • Providing consumers with many great new treat choices and innovations. You will find many examples of these efforts in the pages that follow. Select Portfolio Transformation Milestones 1964: Pepsi-Cola introduces Diet Pepsi. 1980: Frito-Lay begins “Light” line of lowfat snacks. 1989: Frito-Lay launches “1/3 Less Oil” line of snacks. 1991: Frito-Lay launches SunChips, its first multigrain snack. 1992: Pepsi-Cola launches Lipton Iced Teas in the United States. 1995: Baked Lay’s arrives as a major low-fat snack. 1998: PepsiCo acquires Tropicana. 2001: PepsiCo merges with Quaker Oats, including Gatorade. 2002: Frito-Lay announces removal of trans fats from Doritos, Tostitos and Cheetos snacks. 2004: PepsiCo introduces Smart Spot* symbol. 2006: Walkers introduces Baked Walkers Crisps with 70% less fat. 2007: Frito-Lay completes the conversion to sunflower oil across all potato chip brands in the United States, eliminating over 50% of the saturated fat in those brands. “Nothing would be more tiresome than eating and drinking if God had not made them a pleasure as well as a necessity.” — Voltaire *See page 21. 4 “Your descendants shall gather your fruits.” — Virgil 2007 Environmental Honors • PepsiCo was added to DJSI World Index and maintained its position on DJSI North America Index. The second component of purpose is environmental sustainability. Companies — like individuals — must act as custodians of our natural resources. As it is for each individual, it is a matter of moral urgency that companies do what they can. But it is a matter of business urgency too. Today, recruiting the best people is difficult without a good record on the environment — to say nothing of the direct link between resource conservation and business productivity. Our stated goal is to further reduce our water and energy usage and move towards the ideal of “net neutral.” By 2015, corporate-wide, we will reduce per-unit water consumption by 20%, electricity consumption by 20% and manufacturing fuel consumption by 25% — as compared with our consumption metrics in 2006. We evaluate each project against return on investment hurdles, but also consider intangible benefits and longer-term implications. Here are some of the ways we continued to make real progress in 2007: • Reusing water from processing, working with local communities to provide access to clean water, and supporting local farmers to deliver “more crop per drop.” • Incorporating consideration of environmental sustainability issues and opportunities as part of every capital expenditure evaluation for projects greater than $5 million. • Using new technologies to save energy, and working out ways to communicate our conservation efforts through brand marketing activities. • Offsetting the total purchased electricity used by all PepsiCo U.S.-based facilities, by purchasing renewable energy certificates. These initiatives pay. Since 1999, Frito-Lay North America has reduced per-pound water use by more than 38%, manufacturing fuels by more than 27%, and electricity by more than 21%, thereby saving $55 million in energy and utility costs compared with 1999. As a result of these and many other actions, detailed later in this report, we earned inclusion in the Dow Jones Sustainability Index (DJSI) in both their North America and World Indices. • The U.S. Environmental Protection Agency (EPA) recognized PepsiCo as Green Power Partner of the Year and Energy Star Partner of the Year. • Working Mother magazine named PepsiCo to its Best Green Companies for America’s Children List. • The Cause Marketing Forum awarded Sam’s Club/Aquafina’s “Return the Warmth“ program with the top environmental honor, the Halo Award. • CRO magazine recognized PepsiCo among the 2007 100 Best Corporate Citizens in the United States. • PepsiCo was ranked #10 in the LOHAS (Lifestyles of Health and Sustainability) Index for its corporate social responsibility program and communications. • The China Association of Enterprises with Foreign Investment (CAEFI) and WTO Tribune Magazine honored PepsiCo Investment (China) Ltd. with the Corporate Social Responsibility Outstanding Contribution Award. • Frito-Lay’s Jonesboro facility received the EPA Performance Track Distinction, which recognizes facilities that set goals for continuous improvements in environmental performance. • The U.S. Green Building Council Leadership in Energy and Environmental Design (LEED) program awarded LEED Gold Status to the Gatorade Blue Ridge facility in Wytheville, Virginia and Gatorade Tolleson facility in Arizona. • The Thailand Government Department of Energy gave PepsiCo’s Thailand Lamphun plant an Excellent Performance in Energy Conservation Award. • Frito-Lay was recognized in the EPA’s 2007 Water Efficiency Leader awards in recognition for exceptional commitment to water efficiency. • Seven PepsiCo China bottling plants were recognized as Best Water-Saving Companies in China’s beverage industry by the China Beverage Industry Association. 5 2007 Talent Honors • Corporate Research Foundation International, Holland’s professional publication and ranking organization, named PepsiCo among the Best Companies to Work for in Spain. • Latina STYLE named PepsiCo Company of the Year. • University students in China named PepsiCo one of the Best Graduate Employers in China for the second year in a row. • Catalyst honored PepsiCo with the 2007 Catalyst Award for its Woman of Color Multicultural Alliance. • China Rights Forum and China Business News Group named PepsiCo 2007 Outstanding Employer of China in the Shanghai Region. • Business Ethics magazine named PepsiCo to the 100 Best Corporate Citizens list. • DiversityBusiness named PepsiCo as one of America’s Top Organizations for Multicultural Business Opportunities. • Hispanic Business named PepsiCo among its Top 60 Diversity Elite. • PepsiCo was named among the Most Influential Multinationals in China for the third consecutive year. • The Human Rights Campaign named PepsiCo as one of the Best Places to Work for Gay/Lesbian/Bisexual/Transgender (GLBT) Equality. • The AIDS Responsibility Project (ARP) presented PepsiCo with the International Corporate Courage Award. • The Women’s Foodservice Forum (WFF) honored PepsiCo with the inaugural Jackie B. Trujillo SOAR Award. • Working Mother magazine named PepsiCo one of the top five among the Top 50 Best Companies for Multicultural Women. • Latin Business magazine named PepsiCo to its Corporate Diversity Honor Roll. • Essence magazine named PepsiCo one of the 25 Best Companies for Black Women. • The Chicagoland Chamber of Commerce awarded PepsiCo and EnAble with the Innovation Award. • The Times recognized PepsiCo U.K. & Ireland as a place Where Women Want to Work. • Black Enterprise magazine named PepsiCo as one of the 40 Best Companies for Diversity. All of this activity is crucial in its own right and crucial in fostering the third part of our purpose aims: Cherishing our employees, what we call talent sustainability. Catalyst, DiversityInc, Black Enterprise magazine, Latina STYLE magazine, Fortune, and others. We are proud to be recognized internationally as “a great company” for which to work. Doing better by doing better — that’s the ambition Performance with Purpose has sparked in us. It’s always been part of our DNA and our operating mind set. In 2007, it boosted the engagement and emotional commitment of associates across the company. All over the world, I have met associates who have embraced Performance with Purpose. New associates understand it instinctively and expect this sort of holistic approach from their employer. Veteran employees have embraced it with no less passion. For many it has rekindled their creative spirit and renewed their commitment to the company. “The way you see people is the way you treat them, and the way you treat them is what they become.” — Johann von Goethe PepsiCo is blessed with an extraordinary group of people. Talent sustainability is the process of treating them well and priming them to fulfill their dreams. So it is at PepsiCo. We pursue diversity to reflect the consumers we serve. We create an inclusive environment and encourage associates to bring their whole selves to work. We provide excellent benefits and training opportunities. Our associates respond accordingly and deliver the outstanding results we present to you here. They are great corporate citizens, in addition to being good parents, caregivers, coaches, and community leaders. They combine a wonderful can-do spirit with an earnest must-do sense of responsibility. Gathered together each day in offices, manufacturing facilities and distribution centers around the world, they make PepsiCo a company with a soul. Let me share some notable examples of the ways we continued to advance our talent sustainability goals in 2007: • Increasing female and minority representation in the management ranks. • Engaging employees in health and wellness programs. • Encouraging employees to participate in community service activities. • Creating rewarding job opportunities for people with different abilities. Again, these and other initiatives are detailed later in this report, and they helped PepsiCo earn accolades from several prominent organizations including Together, we are all building on the platform of human, environment and talent sustainability, while continuing to deliver great financial results. We can do that because all associates can see that performance and purpose go hand-in-hand. They see that what is good for society is also good for business. They see that we are walking the talk: measuring and tracking the things that we say are important. That is a great source of motivation across the company. We enter the new year with great results behind us and great prospects to come. I look forward to 2008, because I know we are a strong company, a responsible company, a good company. Indra K. Nooyi Chairman and Chief Executive Officer 6 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. Q: In November 2007, PepsiCo announced a new organizational structure. What drove this decision, and how will the restructuring impact financial results? A: 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: PepsiCo Americas Foods (PAF), PepsiCo Americas Beverages (PAB), and PepsiCo International (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. Results under the new structure for 2005, 2006, and 2007 can be found on our company website www.pepsico.com, under the “Investors” tab. Q: How is PepsiCo reacting to the changing global economy, particularly the slowing U.S. economy? A: 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. 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. 7 Q: How are you responding to the category shift in consumer beverage consumption between carbonated soft drinks (CSDs) and non-carbonated beverages (NCB), particularly in the United States? A: 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 United States, 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 non-carbonated beverages, 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 readyto-drink tea and the number-one ready-to-drink coffee with Starbucks Frappuccino. PepsiCo defines the performance category with our numberone 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 enables us to adapt and continually meet consumer needs, while still leveraging the global strength of our flagship CSD beverage portfolio. Q: What progress has PepsiCo made in its SAP implementation? A: 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. These implementations build on earlier SAP releases, enhancing the order management and demand planning functions for the Quaker, Tropicana and Gatorade businesses 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. 8 Q: 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? A: 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. Q: In 2007, you expanded your joint venture agreements with Starbucks and Unilever. Does this represent a new growth model for PepsiCo? A: 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 United States and Canada. In 2007, Sabra was the top-selling and fastest-growing maker of hummus in the United States. 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. So there are tremendous opportunities for us to continue to grow — through partnerships, as well as organically, and with tuck-in acquisitions. Cumulative Total Shareholder Return Return on PepsiCo stock investment (including dividends), the S&P 500 and the S&P Average of Industry Groups.* 250 200 150 100 50 0 PepsiCo, Inc. S&P 500® S&P® Average of Industry Groups 2002 2003 2004 2005 2006 2007 Shareholders purchasing PepsiCo stock at the end of 2002 and holding it to the end of 2007 received a higher cumulative return than the returns of the S&P 500 and our industry groups. *The S&P Average of Industry Groups is derived by weighting the returns of two applicable S&P Industry Groups (Non-Alcoholic Beverages and Food) by PepsiCo’s sales in its beverage and foods businesses. The return on PepsiCo stock investment is calculated through December 28, 2007, the last trading day prior to the end of PepsiCo’s fiscal year. The return for the S&P 500 and the S&P Average indices is calculated through December 31, 2007. Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 PepsiCo, Inc. S&P 500® S&P® Avg. of Industry Groups $100 $100 $100 $113 $129 $110 $129 $143 $121 $149 $150 $118 $161 $173 $137 $202 $183 $152 9 Our Global Leadership Team PepsiCo’s strong results are driven by a deeply experienced, global leadership team that is aligned to position our new business structure for future growth. Our PepsiCo Executive Committee provides a solid bench of leadership talent, with over 415 years combined PepsiCo experience. We are also continually feeding and developing the leadership pipeline with our Leadership Development MBA internship program, through our annual “Ring of Honor” sales awards and leadership development program, our Multicultural Inclusion Summit, and by hiring the very best experienced leaders into strategic roles. And our new organizational structure provides more executives with the opportunity to run large businesses and gain global operating experience. Our leadership team is ready to instill the best of PepsiCo across all of our divisions and geographies to generate profitable growth, expand our global presence and continue our journey for Performance with Purpose. OUR NEW BUSINESS STRUCTURE In the fourth quarter of 2007, PepsiCo announced a strategic realignment of our organizational structure. Beginning in 2008, we are now organized into three business units, as follows: 1) PepsiCo Americas Foods (PAF), which includes Frito-Lay North America, Quaker Foods North America and all of our Latin America food and snack businesses, including our Sabritas and Gamesa businesses in Mexico. 2) PepsiCo Americas Beverages (PAB), which includes PepsiCo Beverages North America and all of our Latin America beverage businesses. 3) PepsiCo International (PI), which includes all PepsiCo businesses in the United Kingdom, Europe, Asia, Middle East and Africa. The financial section of this annual report (pages 31-86) is based on the 2007 reporting structure. Turn to pages 12-17 of this annual report for highlights of the successes and capabilities of the new business structure, as shared by the CEOs of PAF, PAB and PI. Diversity and Inclusion Statistics Total Board of Directors* Senior Executives** Executives (U.S.) All Managers (U.S.) All Employees (U.S.)*** 10 28 2,326 10,862 58,532 Women 3 3 763 4,037 15,125 % 30 11 33 37 26 Minority 3 12 470 3,003 17,936 % 30 43 20 28 31 At year-end we had approximately 185,000 associates worldwide. *Our Board of Directors is pictured on page 29. **Includes PepsiCo Executive Committee members listed on the next page. ***Includes full-time employees only. 10 PepsiCo Executive Committee Corporate 25 Indra K. Nooyi Chairman of the Board and Chief Executive Officer 13 Mitch Adamek Senior Vice President and Chief Procurement Officer 3 Rich Beck Executive Vice President PepsiCo Chicago 12 Robert Dixon Senior Vice President, Global Chief Information Officer PBSG 19 Richard Goodman Chief Financial Officer 20 Julie Hamp Senior Vice President PepsiCo Communications 10 Mehmood Khan Chief Scientific Officer 15 Ronald C. Parker Senior Vice President Chief Global Diversity and Inclusion Officer 17 Larry D. Thompson Senior Vice President Government Affairs, General Counsel and Secretary 6 Cynthia M. Trudell Senior Vice President PepsiCo Human Resources PepsiCo Americas Foods 22 John C. Compton Chief Executive Officer PepsiCo Americas Foods 24 Albert P. Carey President and Chief Executive Officer Frito-Lay North America 28 Mark Schiller President Quaker Foods and Snacks North America 18 Pedro Padierna President Sabritas Region 14 Jose Luis Prado President Gamesa-Quaker 16 Olivier Weber President South America Foods 26 Tom Greco President PepsiCo Sales PepsiCo Americas Beverages 21 Massimo F. d’Amore Chief Executive Officer PepsiCo Americas Beverages 8 Hugh Johnston President Pepsi-Cola North America 23 Todd Magazine President Gatorade 2 Luis Montoya President Latin America Beverages 27 Chris Furman President PepsiCo Foodservice 5 Neil Campbell President Tropicana PepsiCo International 7 Michael D. White Chief Executive Officer PepsiCo International Vice Chairman, PepsiCo 1 Tim Minges President PepsiCo Asia Pacific 9 Zein Abdalla President PepsiCo Europe 11 Saad Abdul-Latif President PepsiCo SAMEA Region 4 Salman Amin President PepsiCo United Kingdom 2 3 5 8 9 10 11 13 15 12 14 16 17 18 19 20 21 23 25 27 28 26 1 4 6 22 24 7 11 PepsiCo Americas Foods PepsiCo Americas Foods (PAF) may be new in terms of geography and organizational structure, but there’s nothing new about our success. PAF brings together a group of big, vibrant businesses like Frito-Lay and Quaker Foods in North America, Sabritas and Gamesa in Mexico and Elma Chips in Brazil. Collectively, they market and sell some of the world’s most popular snack and food brands. These businesses have been making major contributions to PepsiCo’s growth for many years. Our success is built on several advantages — some structural and some cultural. First, by keeping our ears to the ground and our eyes on the marketplace, we have been able to innovate and market our brands better than most. Second, our scale and vertical integration provide us advantages in manufacturing, warehousing and distribution. Third, our go-to-market systems provide ubiquitous reach, putting our brands virtually wherever consumers live, work and play. We operate over 35,000 direct-to-store selling routes and have access to a scaled warehouse and third-party distributors. Finally, and most importantly, we have the cultural advantage of having all of our associates empowered to make a difference. Our Performance with Purpose journey has many great 2007 highlights: • Frito-Lay North America (FLNA) is PAF’s largest operating division and had another tremendous year. Revenue grew 7%, led by doubledigit growth in Doritos snacks, multipacks, dips and SunChips snacks. Additionally, we continued to extend beyond the core by introducing Flat Earth baked fruit and vegetable crisps. And Stacy’s pita chips is the fastest-growing brand in the fast-growing salty snacks category. • Quaker Foods North America had solid revenue growth of 5% driven by our hot cereals business. • Sabritas continued to perform very well with operations in Mexico, Central America and the Caribbean. Strong sales results were complemented by record-high productivity savings and employee advancements throughout the region. • Mexico’s Gamesa-Quaker business posted exceptionally strong volume and share growth, with premium cookies leading the way. • Finally, our South America foods business — which includes operations in Brazil, Argentina, Colombia, Peru and Venezuela — grew organically and via acquisition, through the purchase of the Lucky snacks business in Brazil. 12 PERFORMANCE PepsiCo Net Revenue: $39,474 PepsiCo, Inc. and Subsidiaries $ in millions Quaker Foods North America 5% Frito-Lay North America 29% Latin America Foods 12% So, where do we grow from here? Middle East/ Africa/Asia 12% UK/Europe 14% PAB 28% PAF comprises 46% of PepsiCo Net Revenue PepsiCo Division Operating Profit: $7,923 PepsiCo, Inc. and Subsidiaries $ in millions Quaker Foods North America 7% Convenience and health and wellness will continue to drive consumers to our snack and food offerings. We have a balanced portfolio of fun and nutritious products with new additions like True North nut snacks and Quaker Simple Harvest Multigrain Hot Cereal. And we are introducing a new line of premium, wholesome cookies and snacks under the Quaker trademark. These are in addition to our usual strong offerings from brands like Doritos, Sabritas and Elma Chips. people who are committed to winning wherever and however we operate — from seed to shelf — while taking care of the world around us. We’re focused on delivering Performance with Purpose throughout the Americas. In PAF parlance, that’s savory food for thought. Our greatest source of growth will continue to come from the engagement of our people. Our new PAF structure provides opportunities to quickly share best practices and scale regional successes. We have a terrific team of diverse and devoted Frito-Lay North America 36% Latin America Foods 9% Middle East/ Africa/Asia 7% UK/Europe 10% PAB 31% John Compton CEO, PepsiCo Americas Foods PAF comprises 52% of PepsiCo Division Operating Profit 13 PepsiCo Americas Beverages Rejuvenating, replenishing, restoring, refreshing consumers’ thirst all over the Americas 440 million times a day is what we do in PepsiCo Americas Beverages (PAB). Across the United States, Canada and Latin America, PAB is shaped around great people, great brands and great consumer insights. We enjoy the number-one or -two share position in virtually every market in which we compete, and we continue to push the innovation envelope into emerging growth categories. Our powerful go-tomarket systems allow fast and flexible service across multiple trade channels. Here are some examples of how we performed in 2007: • PAB already has North America’s foremost non-carbonated beverage lineup. Growing our leadership positions in water, enhanced waters and isotonics, we’re focused on building on our hydration advantage. Including restaged SoBe Life Water, reformulated Aquafina Alive, the full Propel line, Gatorade Thirst Quencher and low-calorie G2 — the single-biggest new product innovation in Gatorade’s history — we now have the industry’s biggest, most comprehensive hydration portfolio, outselling our nearest competitor by a factor of nearly two to one. • What’s more, we’ve signed legendary golfer Tiger Woods to develop a signature line of sports performance beverages. Representing the firstever licensing deal for the Gatorade brand and Tiger Woods’ first-ever endorsed sports beverage, Gatorade Tiger, the first product in the new line, hit store shelves in March 2008. • Leveraging consumers’ inherent love of bubbles, we also have been working to reinvent carbonated soft drinks and provide greater variety in North America. Diet Pepsi Max, for example, is a great-tasting, zero-calorie cola with ginseng and extra caffeine to provide a kick of energy — a real point of difference. Launched in January 2008, Tava is another unique carbonated soft drink proposition. It’s a zero-calorie, zero-caffeine sparkling beverage in three exotic flavor blends. Light, crisp-tasting Tava is fortified with essential vitamins, minerals, and antioxidants, including Vitamins B6, E, Niacin and Chromium. • Answering the call for better-foryou innovation at the breakfast table (and beyond), we successfully launched Tropicana Pure Premium Healthy Heart — the United States’ first national orange juice fortified with Omega-3 fatty acids. • In Argentina and Brazil, 7UP H2Oh! — a lightly carbonated, distinctively flavored water — is a sensational new product that could easily become a global success. 14 PERFORMANCE PepsiCo Net Revenue: $39,474 PepsiCo, Inc. and Subsidiaries $ in millions PAB 28% UK/Europe 14% Frito-Lay North America 29% Latin America Foods 12% There are countless other examples of what we’re doing north and south of the border — initiatives that will allow us to selectively seize multicultural marketing opportunities in the United States and elsewhere. Middle East/ Africa/Asia 12% Breakthrough marketing is putting our brands where they belong — at the core of pop culture. We are leveraging the world’s most interactive communications environment to get there, creating unprecedented consumer “buzz” via internet blogs, online video views and interactive promotions. Wherever we operate, we’re offering an increasingly diverse portfolio of product choices to more and more variety-conscious consumers. Prevailing trends such as health and wellness will continue to drive our portfolio transformation and lead to growth opportunities like our acquisition of Naked Juice in 2007. Our R&D and marketing teams understand we have to move quickly to invest in better-for-you and good-for-you products, which is now reflected in our innovation pipeline. Going forward, we will continue to invest in marketing and insights to build our competitive advantage and accelerate future growth. We have only begun to show the power of our brands, the acuity of our strategic vision and the innovative thinking of our people. Be it new products, packages or programs, we are committed to promoting faster and more efficient transfer of ideas and best practices throughout the Americas. Ciao, Quaker Foods North America 5% Massimo d’Amore CEO, PepsiCo Americas Beverages PAB comprises 28% of PepsiCo Net Revenue PepsiCo Division Operating Profit: $7,923 PepsiCo, Inc. and Subsidiaries $ in millions PAB 31% UK/ Europe 10% Frito-Lay North America 36% Middle East/ Africa/Asia 7% Latin America Foods 9% Quaker Foods North America 7% PAB comprises 31% of PepsiCo Division Operating Profit 15 PepsiCo International 2007 was a year of exciting progress for PepsiCo International, marked by strong financial results and important gains in the marketplace. Once again PI was the largest contributor to PepsiCo’s revenue and profit growth in 2007. To convey the breadth of our progress, let me share a few 2007 highlights: • We dramatically strengthened our non-carbonated beverage portfolio by expanding our successful Unilever tea partnership and launching an international joint venture for Starbucks ready-to-drink coffee products. • In the United Kingdom, our Baked Walkers crisps, with 70% less fat than original Walkers, was declared “New Product of the Year” by Marketing Week magazine; while an important turnaround in beverage volume led to mid-single-digit volume growth. • We continued our portfolio transformation in Europe with the launch of Baked Lay’s crisps and integration of Duyvis nuts. We also enjoyed strong growth in non-carbonated drinks, complemented by the acquisition, with PepsiAmericas, of Ukraine’s leading juice company. • In Russia, annual beverage volume reached more than 200 million cases, while we strengthened our leadership in savory snacks and broke ground on our second snack plant. I am particularly proud of our 2007 performance because we built a strong foundation for future growth. We completed acquisitions in 2007 that are expected to add over $1 billion to our 2008 revenues. Importantly, they also advance the strategic transformation of our international portfolio. We also made major investments to transform our information systems and capability to be better equipped to support and enable further growth. • In the Middle East, zero-calorie Pepsi Max posted strong growth, and Mountain Dew surged ahead in markets like Nigeria and Pakistan; the Lay’s brand helped drive continued share gains in Turkey, while the Doritos brand drove healthy growth in Egypt. • In Asia, new marketing drove double-digit growth in non-sugar colas in virtually all markets; and new locally tailored flavors sparked strong growth in savory snacks, particularly in China and Thailand. 16 PERFORMANCE PepsiCo Net Revenue: $39,474 PepsiCo, Inc. and Subsidiaries $ in millions For all our progress, we still have enormous room to grow. Under PepsiCo’s new organization, PI today offers a diverse portfolio of scale businesses with critical mass and solid profit margins, spanning the United Kingdom, Europe, the Middle East, Asia, Australia and Africa. This is a vast area comprising 86% of the Earth’s population and 45 of the 50 fastest-growing economies — not only China, India and Russia, but many smaller, fast-growing markets like Vietnam, Pakistan, Turkey and Eastern Europe. Our business is well-balanced between developed and developing nations. And our expanding product portfolio, offering benefits ranging from simple refreshment to basic nutrition, positions us well to serve a wide range of consumer needs. Looking ahead, I see vast opportunity for PepsiCo International. I also am excited by our opportunities for progress in the corporate functions I now lead: Information Technology and Global Purchasing. And I feel especially privileged to have a major role in developing the next generation of PepsiCo leaders. Nothing is more important to our continued success. UK/Europe 14% Middle East/ Africa/Asia 12% Frito-Lay North America 29% PAB 28% Latin America Foods 12% Quaker Foods North America 5% PI comprises 26% of PepsiCo Net Revenue PepsiCo Division Operating Profit: $7,923 PepsiCo, Inc. and Subsidiaries $ in millions Middle East/ Africa/Asia 7% UK/ Europe 10% PAB 31% Frito-Lay North America 36% I’m confident we’ll fulfill PI’s mission, thanks to our outstanding team of PI associates and many valued partners, who work together every day, focused on common goals and embracing the core values of PepsiCo. We are deeply committed to Performance with Purpose and operating in sustainable ways that benefit our shareholders, employees, business partners and the communities we serve. Latin America Foods 9% Quaker Foods North America 7% Michael D. White Vice Chairman, PepsiCo CEO, PepsiCo International PI comprises 17% of PepsiCo Division Operating Profit 17 Power of One “Given shifting population movement around the world, our largest customers encourage PepsiCo Power of One teams to fully leverage our diverse global portfolio to accelerate growth. We dive deep to understand the unique shoppers of each strategic customer, which enables a greater flow of innovative and customized product solutions. We then leverage our portfolio to drive sales and profit growth for PepsiCo and our retail partners by offering relevant products and targeted programs to consumers in a more localized way worldwide.” — Tom Greco, President, PepsiCo Sales 18 Profit is where PepsiCo’s responsibility begins, not ends. Throughout our long history of delivering profit and performance for shareholders, a deep sense of purpose has been embedded in everything we do. It represents the fundamental commitment we have embraced for years — to give back as we grow. This is a continuing journey that spans three major areas of focus — human sustainability, environmental sustainability and talent sustainability. PepsiCo has made considerable progress on each of these priorities, from our industry-leading product labeling with the Smart Spot program in 2004, to last year’s purchase of renewable energy certificates, to our 2008 launch of PepsiCo University to develop tomorrow’s multicultural/multigenerational leaders. As a member of the Dow Jones Sustainability World Index (DJSI World) and the Dow Jones Sustainability North America Index (DJSI North America), PepsiCo is a recognized leader in sustainability. The DJSI World comprises the top 10% of the world’s 2,500 largest companies based on corporate economic, environmental and social performance. The DJSI North America captures the leading 20% of companies in sustainability out of the largest 600 North American companies of the Dow Jones Global Index. Nourishing our consumers with a range of fun and healthy products, and making the healthful choice an easier choice. Dow Jones Sustainability Indexes Replenishing the natural resources we can, and minimizing the impact we have on our environment. 2007 Contribution Summary $ in Millions PepsiCo Foundation . . . . . . . $23.4 Cherishing our employees, and making PepsiCo the most desirable place for people of all backgrounds to establish personal and professional growth. Corporate Contributions . . . . . 4.3 Division Contributions . . . . . . . 8.2 Estimated In-Kind Donations. . 38.9 Total . . . . . . . . . . . . . . . . . . $74.8 19 To nourish consumers is our fundamental commitment. It begins with product innovation and transformation, extends to marketing and labeling commitments that make the smart choice an easy choice for consumers, and continues with support for research and development programs to advance public health around the world. Finally, we balance the entire energy equation through community outreach programs designed to empower and motivate consumers to adopt healthier, more active lifestyles. Product Innovation We have been reinventing our brands to meet consumer needs for healthier lifestyles since we introduced Diet Pepsi in 1964. As we grow, PepsiCo will continue our transformation with a systematic plan to reduce sodium, added sugar and saturated fats in our products. We start with science and authoritative statements from the World Health Organization, the Food and Drug Administration and the U.S. National Academy of Sciences for identifying how we should best focus our efforts. We then look at nutrition-based standards including total calories, fat, carbohydrate and protein as well as vitamins and minerals, and then reformulate our products to offer smart choices that contribute to an overall healthier diet and lifestyle. We don’t stop there, because we also look for ways to add wholesome ingredients, such as fruit, whole grains and fiber to many of our products. Our transformation as a good company with nourishing products, from snacks to healthier treats, gained momentum across all of our businesses in 2007: • We reduced saturated fats in our Frito-Lay potato chip and Walkers crisp brands, by converting to sunflower oil. • We expanded our baked snacks in Brazil and introduced low-fat bread snacks in Chile, Puerto Rico, Spain, Turkey and Saudi Arabia. • Tropicana promoted cardiovascular health, by becoming the first national orange juice to include Omega-3s, the fatty acids known for helping to promote heart health. • Frito-Lay introduced Flat Earth fruit and vegetable crisps that combine great taste and nutrition in a breakthrough snack with a ½ serving of fruits or vegetables baked into each ounce. Quaker Mini Delights multigrain cakes are for calorie-conscious consumers who say they’re looking for a satisfying snack option that tastes great and helps them stay on track. Mini Delights bring three new benefits to the snack category: taste indulgence, 90-calorie portion packs and plenty of pieces in every pouch. • Our Gamesa-Quaker business in Mexico launched a new line of oat-based cookies and snacks, and our South Africa business launched a new health snack line called Sunbites pretzels. Marketing and Labeling Our commitment to nourish is fully embraced in our marketing and labeling programs around the world. Last year, PepsiCo was a founding member of a voluntary U.S. food and beverage industry initiative that redefined how we market products to children under 12. Today, less than 1% of PepsiCo’s total advertising budget in North America is allocated for advertising to kids, and 100% of that advertising is devoted exclusively to Smart Spot products. PepsiCo Europe has recently made a similar advertising and school marketing 20 With the addition of G2, a low-calorie lifestyle beverage, the broadened Gatorade line meets the hydration needs of athletes and active people on a 24/7 basis. With just 25 calories per 8-oz serving, G2 helps keep people hydrated when they are not playing sports or exercising. More than 200 associates at PepsiCo’s Chicago office commemorated the product launch by creating a G2 living logo. pledge, and full implementation with independent monitoring of this new program will begin next year. And in the United Kingdom, in partnership with dozens of other food and beverage companies and the Food and Drink Federation, PepsiCo has introduced front-of-package nutritional labeling across all its brands. The labels help consumers understand the percentage of their “Guideline Daily Amount (GDA)” of calories, sugars, fat, and salt that is contained in a portion of food or drink. GDAs are now being rolled out across PepsiCo Europe — all of our products in European Union countries will display GDAs by the end of 2008. PepsiCo is also a founding member of the Keystone Center Food and Nutrition Roundtable, which seeks to drive improvements in the American diet and long-term improvements in public health; its current focus is to establish common front-of-package nutritional labeling to help consumers identify healthier choices. In 2006, PepsiCo joined with the Alliance for a Healthier Generation — a joint initiative of the American Heart Association and the William J. Clinton Foundation — and other leaders in the U.S food and beverage industries to adopt voluntary guidelines for the foods and beverages we offer to grade schools in the United States. As the only food and beverage company to have embraced both the beverage and food guidelines for schools, PepsiCo is taking the lead to provide healthier choices to kids. As part of PepsiCo’s commitment, we agreed to remove full-calorie soft drinks from K-12 schools in the United States over three years. One year into our commitment, we have seen more than a 40% drop in the calories of beverages shipped to these schools. Supporting Research and Development The PepsiCo Foundation is deeply engaged in developing new partnership models which lead to healthier communities and new research insights. In the United States, the Foundation’s grant to Tufts University supported a groundbreaking project that resulted in measurable improvements in school children’s body mass index. Last year, we announced a new PepsiCo Foundation grant of $5.2 million to the Oxford Health Alliance, for implementation and evaluation of community-based health interventions in China, England, India and Mexico, impacting more than two million people. The Foundation’s grant helped launch a program to enhance scientific knowledge about the effectiveness of community interventions in reducing the prevalence of chronic diseases. In the United States and Canada, our green Smart Spot packaging symbol makes it easier for consumers to identify products that can contribute to healthier lifestyles. All PepsiCo products carrying the Smart Spot symbol meet nutrition criteria based on authoritative statements from the U.S. Food and Drug Administration and the National Academy of Sciences or provide other functional benefits. Getting Active through Community Outreach PepsiCo is committed to helping people achieve energy balance through physical activity. In China for example, PepsiCo introduced a “Sports and Music” promotion to encourage people to participate in sports; and the U.S.-based Gatorade Sport Science Institute established a branch in China to help Chinese athletes improve performance through scientific research. 21 Blue Ribbon Advisory Board Our Smart Spot Dance program in the United States launched a multi-city instructional dance program to provide a fun way for families, especially moms, to become more physically active. PepsiCo International Mexico launched the Vive Saludable Escuelas Health and Wellness program, an initiative to teach kids how to work towards a healthier lifestyle by combining daily physical activity and a balanced diet. Each student worked with interactive software that taught them about the calories in/calories out equation. Students were taught a daily physical education routine designed by Mexico’s Sports Commission and implemented by teachers at each school. The program will impact one million children in 3,000 schools throughout Mexico. The PepsiCo Blue Ribbon Advisory Board delivers high-level, independent insight about major health and wellness policies. It also offers science-based perspectives on product transformation, labeling and marketing and provides guidance on partnerships that promote physical activity. 1 2 1 Gro Harlem Brundtland, M.D., Former Director-General, World Health Organization, United Nations, Former Prime Minister, Norway 2 Antonia Demas, Ph.D., President, Food Studies Institute 3 4 3 James O. Hill, Ph.D., Professor of Pediatrics & Medicine, University of Colorado Health Sciences Center, Founder, America On the Move 4 Brock H. Leach, Seminary Student & Community Volunteer, PepsiCo Chief Innovation and Health & Wellness Officer, Retired 5 6 7 5 William Sears, M.D., Associate Clinical Professor of Pediatrics, University of California, Irvine, School of Medicine 6 Janet E. Taylor, M.D., Clinical Instructor of Psychiatry, Columbia University 7 Governor James B. Hunt, Jr., Former Governor of North Carolina 8 9 10 11 8 David A. Kessler, M.D., J.D., Dean, School of Medicine, Vice Chancellor for Medical Affairs, University of California, San Francisco 9 Kristy F. Woods, M.D., M.P.H., Former Director, Maya Angelou Research Center for Minority Health, Wake Forest University 10 David Heber, M.D., Ph.D., Professor of Medicine & Public Health and Director, UCLA Center for Human Nutrition 11 Raquel Malo, Sr. Vice President, High Performance Nutrition, Human Performance Institute (Joined 2008) “I’m proud of the work of the PepsiCo Blue Ribbon Advisory Board, which includes many of the world’s leading experts in health and nutrition. It is a tangible example of visionary leadership in establishing PepsiCo as a health and wellness leader in portfolio transformation, policy, and nutrition science.” — Dean Ornish, M.D., Chairman of the PepsiCo Blue Ribbon Advisory Board Founder & President, Preventive Medicine Research Institute Clinical Professor of Medicine, University of California, San Francisco 22 “Frito-Lay uses the energy from the sun in so many ways. Many of our products are distributed through our Phoenix, Arizona distribution center, where we have solar panels on the roof that generate electricity; and we are installing solar collectors at our plant in Modesto, California to provide up to 75% of the thermal energy the plant uses to make SunChips snacks in that location. As a six-year member of the Frito-Lay sales organization, I’m glad to work for a company that is finding many ways to use renewable energy.” — Carrie Carroll, National Account Manager, Frito-Lay North America 2007 PepsiCo President’s Ring of Honor Recipient for Top Sales Performance 23 We strive to replenish the resources we’ve used, where possible, as part of our commitment to being an environmentally responsible corporate citizen. Our associates are passionate about this vision and continue to drive programs to reduce our energy and water consumption, invest in new energy research and improve our packaging sustainability. We have proven that extraordinary results are possible. Frito-Lay has reduced per-pound water use by more than 38%, manufacturing fuels by more than 27% and electricity by more than 21% since 1999; and our Quaker, Tropicana and Gatorade businesses have reduced manufacturing fuels by 26%, electricity by 24% and water by 12% in the last three years. We’re achieving similar results in markets outside the United States. In Mexico, our Sabritas team has cut per-unit electricity use by more than 9% over the past five years, and water use by 26%. In China, our bottling plants have reduced water consumption by 40% and energy consumption by 38% over the past three years. Throughout the world, we have similar stories that demonstrate how we are taking this responsibility seriously, because it is the right thing to do, but also because it’s the smart thing to do for more efficient use of energy, water and packaging in our business operations. Conserving Energy and Harnessing Renewable Resources 2007 was a year of considerable progress for PepsiCo, beginning with external partnerships and programs focused on renewable energy and strategies to reduce greenhouse gas emissions. PepsiCo joined the U.S. Environmental Protection Agency (EPA) Climate Leaders, a voluntary partnership program that works to develop comprehensive climate change strategies, including supporting reduction in greenhouse gases. And we were the first consumer products company to join with other concerned companies and nongovernmental organizations in the U.S. Climate Action Partnership to encourage the federal government to enact climate legislation. These programs make good commercial sense for us and help us use our resources well. We are also proud of PepsiCo’s landmark purchase of renewable energy certificates. This financial instrument stimulates and supports the development of renewable electricity, and our investment matches the purchased electricity, used by all of PepsiCo U.S.-based manufacturing facilities, headquarters, distribution centers and regional offices. Our three-year purchase of more than one billion kilowatt-hours annually is the same amount of electricity needed to power nearly 90,000 average American homes annually, as estimated by the U.S. EPA based on national averages. We are already implementing many of our own renewable energy operations. In 2007, we announced major renewable energy projects including plans for our “net zero” plant in Casa Grande, Arizona. With plans to run almost entirely on renewable fuels and recycled water, this plant is scheduled to begin production by 2010. Frito-Lay North America flipped the switch last year on the largest businessowned, photovoltaic power system in Arizona. Producing no emissions, the system captures the energy of one of Arizona’s abundant natural resources — turning the power of the sun into electricity. It incorporates a 201-kilowatt photovoltaic array covering 27,000 square feet of roof space at the company’s service center in Phoenix. PepsiCo has already installed photovoltaic systems in six other distribution centers, from California to New York. Walkers is the first major food brand in the world to display a carbon footprint/reduction logo on its packs. The label was developed by the Carbon Trust, a U.K.-government-funded independent organization that works to accelerate the move to a low-carbon economy. Walkers has had a partnership with the Trust since 2001 and has reduced energy use per pack by a third and water use by almost half. One step in reducing carbon was sourcing the potatoes domestically to reduce the transport miles. The Walkers advertising campaign highlights that the brand now uses 100% Great British potatoes. 24 Our bottlers are also sourcing power from the sun. In 2007, The Pepsi-Cola Bottling Company of Eugene installed a 250-kilowatt solar electric system in their Oregon facility, which is now the second-largest photovoltaic system in the Pacific Northwest. The renewable energy generated from this system is the equivalent to the average annual energy consumption of approximately 21 Eugene homes and has a regional carbon dioxide offset of about 140 tons per year. Projects in other regions went live last year as well. PepsiCo India launched our international community to address water issues both in our own operations and our supply chain. We also affirmed support for the UN Millennium Development goals, which have wide-ranging ramifications for water programs. In China and India, the PepsiCo Foundation is helping to change the lives of an increasing number of people through our support of organizations that are focused on building sustainable water practices, including the Chinese Women’s Development Foundation and The Energy and Resources Institute in India. In early 2008, PepsiCo announced a partnership between the PepsiCo Foundation and the Earth Institute at Columbia University, one of the world’s premier institutions dedicated to global sustainable development. And the company announced a commitment to H2O Africa, a foundation focused on clean water initiatives in Africa. recycled content, the weight of a twoliter polyethylene terephthalate (PET) soft drink bottle has been reduced by 39% since 1980, and our Aquafina 500 ml PET bottle weight has been reduced by more than a third since 2000. We also team with business and community partners to encourage reuse and recycling. We continued our partnership for a second year with Sam’s Club and Keep America Beautiful to “Return the Warmth,” collecting and recycling over 70 million PET bottles via schools, and giving away over 25,000 backpacks made from recycled PET. PepsiCo put a spotlight on recycling at the Live Earth New York concert by making it easy for people to recycle their bottles and cans and by offering information about how they can make recycling a part of their everyday lives. Our commitment to environmental responsibility extends across the globe. One highly successful program is our PepsiCo India partnership with Exnora International, an environmental nongovernmental organization, to manage domestic solid waste. The program was recognized by UNICEF as a model project and as a center for international learning. Looking into the future, PepsiCo teams are developing innovative packaging solutions which include cutting-edge technologies for even more environmentally friendly packaging. PepsiCo has seven photovoltaicpowered distribution centers. first remote wind turbine, harnessing one of the most efficient, clean and renewable sources of energy. This turbine is connected to the public electricity grid with sufficient power to meet more than 75% of the electricity needs of the company’s local Mamandur plant, and it directly offsets up to 7% of our company-owned bottling operations’ power requirements for 2008. The initiative is estimated to help reduce carbon emissions by more than 3,500 tons annually, with the potential to offset 70,000 tons of carbon emissions over its entire 20-year life cycle. Building a Lifecycle of Environmentally Responsible Packaging We have formed a Sustainable Packaging Council to develop a roadmap that will guide us toward achieving packaging systems that are environmentally responsible throughout their entire lifecycle. Although beverage containers like ours are the most recycled consumer packaging in the United States, and they are designed for recycling, we continue to look for ways to reduce the amount of packaging used for our products. And we are achieving success. For example, Pepsi’s soft drink bottles contain 10% Improving Access to Water PepsiCo is addressing the world’s water challenge at all levels of our influence. In 2007, we announced support for global initiatives that seek to improve access to water. These include the CEO Water Mandate, a partnership with the 25 By inspiring, challenging and cherishing our associates, we’re making PepsiCo a company where coming to work means more than just having a job. And that’s important in today’s marketplace because global competition for talent has never been more intense. Companies that win provide the best opportunities for personal and professional growth. PepsiCo already has some of the very best talent in our industry, thanks to our industry-leading people processes. But as we evolve to meet future business needs, we must also continue to evolve our approach to recruiting, developing, rewarding and retaining our associates. We made excellent progress toward this objective in 2007 by enhancing our focus on “people results,” and further defining key ways to: nurture talent, empower people, and expand opportunities for diversity and inclusion. ensure that an associate focuses on the growth and development of the team as well as him or herself, while equally focusing on achieving business results. Putting accountability and 50/50 weighting to people priorities helps nurture PepsiCo’s already strong culture of diversity and inclusion where people feel valued and respected for their unique talents, perspectives and experiences. — to assure we reach our performance goals. Regardless of current role, level or career aspiration, every associate can use the model to understand which behaviors they should strive for today and what will contribute to their own personal success, as well as success for PepsiCo. Expanding Opportunities through Diversity and Inclusion We believe a sense of belonging in our professional lives is just as important as it is in our personal relationships; it builds trust, encourages teamwork and collaboration, and enables the free sharing of ideas that helps us develop, grow and innovate. This is why we continue to grow our efforts to promote diversity and inclusion around the globe. Empowering People with Clear Expectations Knowing what’s expected of us — and everyone around us — helps us act with responsibility, trust and understanding of how leadership and individual performance are rewarded. As a guide for associates in all functions and at all levels of our organization, we introduced the PepsiCo Leadership and Individual Effectiveness Model in 2007. By communicating what’s important at PepsiCo and what we value from each of our associates, we are helping to shape an unrivaled corporate environment that provides our company with the ultimate competitive advantage. The model details the key competencies and associated behaviors that are required — individually and collectively Nurturing Talent: Our Greatest Sustainable Advantage Our people are our greatest strength. Without great people, we can’t deliver great results for the long term. By focusing on the continuing development of our associates and their ability to work effectively together, we believe we will maximize PepsiCo’s performance and be even better positioned to build on our current success in the marketplace. We reinforced our people priorities in 2007 by changing how we evaluate performance, giving equal weight to the achievement of people results and business results. This new 50/50 balance of goals and objectives is designed to PepsiCo and its bottler community achieved 2007 spending of approximately $1.13 billion with U.S. minority-owned and women-owned suppliers, marking the fifth consecutive year of double-digit growth in supplier diversity spending. In the United States, our Diversity and Inclusion Networks promote a culture where everyone feels they have an equal opportunity to contribute and succeed. Each of our U.S. groups is represented at senior levels by an executive reporting directly to the chief executive officer. The groups include African Americans, Latinos/Hispanics, Asians, Native Americans, Women, Gay/Lesbian/ Bisexual/Transgender, Women of Color, Support Team/Non-exempt and EnAble, for individuals with different abilities. In 2007, we added a group dedicated to 26 ensuring that white males are included as an integral part of our diversity and inclusion journey. In that same year, diversity and inclusion councils were successfully established in all four continents of our PepsiCo International business — focusing on delivering locally relevant, regional diversity and inclusion strategies and plans. In January 2007, we initiated the Steve Reinemund Diversity and Inclusion Leadership Legacy Award to honor leaders who champion diversity and inclusion over time. The award, named for our former chairman, who was a relentless champion for diversity, is presented to leaders who move PepsiCo to new levels of diversity and inclusion accomplishments and behaviors. This award is in addition to the Harvey C. Russell Inclusion Award, introduced in 2003, which is presented to associates at all levels of the business in recognition of their distinctive achievements in diversity and inclusion. The award is named after Harvey C. Russell, who broke America’s color barrier when he became a vice president of PepsiCo in 1962 — the first African American executive at a Fortune 500 company. Filmed entirely in American Sign Language, the “Bob’s House” commercial was inspired by EnAble’s mission to make PepsiCo the employer of choice, partner of choice and brand of choice for people with different abilities. Response was overwhelming with nearly 850,000 views on video-sharing sites before it aired, a host of “thank you” videos posted on YouTube by the deaf community and mentions in over 3,000 blogs after it aired. Pictured left to right: “Bob’s House” creator, Clay Broussard, Project Manager, PepsiCo Customer Supply Chain & Logistics; co-stars, Brian Dowling, Warehouser II, Frito-Lay North America; Sheri Christianson, Sr. Specialist and Development Team Lead, PBSG; and Darren Therriault, Application Configuration Specialist, Project One Up, PepsiCo Chicago Today that spirit is alive and well, inspiring PepsiCo’s diverse and innovative workforce to contribute their best thinking in taking diversity and inclusion to the next level — while continuing to bring their insights to delivering innovative products for our consumers, retail customers, and the broad range of constituents we serve. An EnAble team demonstrated that spirit recently by producing and starring in “Bob’s House,” a silent but attention-getting television commercial that appeared on the FOX network’s pre-game show for Super Bowl XLII. associates continue developing the jobrelated and management skills that are needed to drive innovation and growth for the future. Also beginning in 2008, we will align our 360-degree feedback process with the PepsiCo Leadership and Individual Effectiveness Model to make it more robust and ensure that leaders know and understand what’s expected of them. As a new and significantly valuable addition, we will combine the 360-degree process with other feedback tools to further build self-awareness and provide participants with rich, one-on-one developmental feedback from trained and certified facilitators. Sharpening Our Focus on Employee Learning and Development Everyone at PepsiCo, from our newest associates to seasoned senior managers, has a responsibility to continue his or her own development journey by improving both personal and professional effectiveness. In 2008, with the launch of PepsiCo University, we will help “The commercial provided consumers with a true glimpse into the real culture of PepsiCo, because when we talk about diversity and inclusion it is not just lip service, it is part of our belief and core.” — Clay Broussard, creator, “Bob’s House” commercial 27 Ethnic Advisory Boards Our Ethnic Advisory Boards provide management with external viewpoints on issues related to diversity and inclusion, especially in the U.S. marketplace. African American Advisory Board 1 2 3 4 1 Keith Clinkscales Senior Vice President, Content Development and Enterprises, ESPN Publishing 2 Jerri DeVard Former Senior Vice President, Brand Management and Marketing Communications, Verizon Communications 3 Amy Hilliard President and Chief Executive Officer, The Hilliard Group & The ComfortCake Co. 4 Robert Holland Partner, Cordova, Smart and Willams, LLC 5 Reverend Dr. Franklyn Richardson Senior Pastor, Grace Baptist Church 6 Roderick D. Gillum Vice President, Corporate Responsibility and Diversity, General Motors Corporation Chairman, GM Foundation 7 Earl G. Graves, Jr. President and CEO, Black Enterprise Magazine 8 Glenda McNeal Senior Vice President Global Partnerships, American Express 5 6 7 8 “Since PepsiCo’s African American Advisory Board was formed in 1999, our members have provided valuable counsel to the company on a range of issues including reaching a more diverse consumer base, creating a more diverse workforce and strengthening its relationship with the community. We are pleased with the results. During our years of involvement, PepsiCo has increased the number of minorities in its management ranks and increased spending with minority-owned businesses.” — Benaree Pratt Wiley, Principal, The Wiley Group, Chairman of the Advisory Board Latino/Hispanic Advisory Board 1 2 3 4 1 Dr. Carlos H. Arce, Ph.D. President and Founder, NuStats 2 Maria Contreras-Sweet Chairwoman, Promerica Bank 5 6 7 3 Dr. Douglas X. Patiño Vice Chancellor Emeritus and Professor, California State University 4 Carlos A. Saladrigas Chairman, Premier American Bank 5 Deborah Rosado Shaw Partner, Multi-ethnic Success Ventures, LLC 6 Isabel Valdés Consultant, Author, Public Speaker 7 Cid Wilson Director of Equity Research, Kevin Dann and Partners LLC Roger Rivera President and Founder, National Hispanic Environmental Council (Not pictured, Joined 2008) “As a founding member of the PepsiCo Latino/Hispanic Advisory Board, I am honored to represent a group that provides the company with diverse points of view, which benefit consumers, PepsiCo and the communities in which it operates. These perspectives influence new products and marketing. We also provide insights to assist retailers with the effective planning of promotional outreach, product mix and support of healthier lifestyles. Because so much change is occurring in demographic mix and in lifestyle trends, our input helps to ensure that the tastes of consumers are met and that diverse talent is identified for employment opportunities.” — Raúl Yzaguirre, Presidential Professor, Center for Community Development and Civil Rights, Arizona State University, Chairman of the Advisory Board 28 PepsiCo Board of Directors 2 Dina Dublon Consultant, Former Executive Vice President and Chief Financial Officer JPMorgan Chase & Co. 54. Elected 2005. 3 Victor J. Dzau, M.D. Chancellor for Health Affairs Duke University and President & CEO Duke University Health Systems 62. Elected 2005. 5 Ray L. Hunt Chief Executive Officer Hunt Oil Company and Chairman, Chief Executive Officer and President Hunt Consolidated, Inc. 64. Elected 1996. 7 Alberto Ibargüen President and Chief Executive Officer John S. and James L. Knight Foundation 64. Elected 2005. 9 Arthur C. Martinez Former Chairman of the Board, President and Chief Executive Officer Sears, Roebuck and Co. 68. Elected 1999. 10 Indra K. Nooyi Chairman of the Board and Chief Executive Officer PepsiCo 52. Elected 2001. 6 Sharon Percy Rockefeller President and Chief Executive Officer WETA Public Stations 63. Elected 1986. 1 James J. Schiro Chief Executive Officer Zurich Financial Services 62. Elected 2003. 8 Daniel Vasella Chairman of the Board and Chief Executive Officer Novartis AG 54. Elected 2002. 4 Michael D. White Chief Executive Officer PepsiCo International Vice Chairman PepsiCo 56. Elected 2006. Listings include age and year elected as a PepsiCo director. Welcome New Board Members PepsiCo is pleased to welcome two new members to our Board of Directors. Ian M. Cook and Lloyd G. Trotter have joined the board, effective March 14, 2008. They will bring a breadth of experience and knowledge to PepsiCo and its communities. Ian Cook, 55, is presently president and chief executive officer of Colgate-Palmolive Company, one of the world’s oldest and most respected consumer products companies. He joined Colgate in 1976 and progressed through marketing and other management roles in the United Kingdom, the United States Ian Cook and the Philippines until he became CEO in July 2007. Lloyd Trotter, 61, recently retired from his post as vice chairman of GE, after a 37-year career there. He has joined the New Yorkbased investment firm of GenNx360 Lloyd Trotter Capital Partners as one of the principals. The firm intends to focus on investments in commercial security, industrial water treatment, infrastructure and aerospace. 3 1 2 4 5 6 7 8 9 10 29 Corporate Information Executive Offices PepsiCo, Inc. 700 Anderson Hill Road Purchase, NY 10577 914-253-2000 John C. Compton Chief Executive Officer PepsiCo Americas Foods Massimo F. d’Amore Chief Executive Officer PepsiCo Americas Beverages Richard Goodman Chief Financial Officer Hugh Johnston President Pepsi-Cola North America Lionel L. Nowell III Senior Vice President and Treasurer Larry D. Thompson Senior Vice President, Government Affairs, General Counsel and Secretary Cynthia M. Trudell Senior Vice President PepsiCo Human Resources Michael D. White Chief Executive Officer PepsiCo International Vice Chairman, PepsiCo Co-founder of PepsiCo Donald M. Kendall Executive Officers* Indra K. Nooyi Chairman of the Board and Chief Executive Officer Peter A. Bridgman Senior Vice President and Controller Albert P. Carey President and Chief Executive Officer Frito-Lay North America * PepsiCo Officers subject to Section 16 of the Securities and Exchange Act of 1934. For a complete list of the PepsiCo Executive Committee, please see page 11. Values Our commitment is to deliver sustained growth, through empowered people, acting with responsibility and building trust. Mission We aspire to make PepsiCo the world’s premier consumer products company, focused on convenient foods and beverages. We seek to produce healthy financial rewards to investors as we provide opportunities for growth and enrichment to our employees, our business partners and the communities in which we operate. And in everything we do, we strive to act with honesty, openness, fairness and integrity. Primary Websites PepsiCo, Inc. — www.pepsico.com Frito-Lay North America — www.fritolay.com Pepsi-Cola North America — www.pepsi.com Tropicana North America — www.tropicana.com Quaker Foods — www.quakeroats.com Gatorade — www.gatorade.com Smart Spot — www.smartspot.com When market or market share are referred to in this report, the markets and share are defined by the sources of the information, primarily Information Resources, Inc. and ACNielsen. The Measured Channel Information excludes Wal*Mart and Sam’s, as Wal*Mart and Sam’s do not report volume to these services. This report is entirely recyclable. The cover was printed on Sterling Ultra Recycled Cover manufactured by NewPage. The editorial pages are printed on Sterling Ultra Recycled Dull Text with wood procurement practices certified by the Forest Stewardship Council©. The financial pages are printed on Plainfield Smooth Opaque Text, manufactured by Domtar Inc., using sustainable energy sources and wood procurement practices certified by the Forest Stewardship Council©. PepsiCo purchases Green-e certified renewable energy certificates to offset 100% of the purchased electricity used for our U.S. operations. This report was printed with 100% Green-e certified wind power. 30 Management’s Management’s Discussion and Analysis OUR BUSINESS Our Operations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 Our Customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 Our Distribution Network . . . . . . . . . . . . . . . . . . . . . . . . . 34 Our Competition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Other Relationships . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Note 5 — Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Our Business Risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 Note 6 — Stock-Based Compensation . . . . . . . . . . . . . . . 69 Notes to Consolidated Financial Statements Note 1 — Basis of Presentation and Our Divisions. . . . . . . 60 Note 2 — Our Significant Accounting Policies. . . . . . . . . . 63 Note 3 — Restructuring and Impairment Charges. . . . . . . 64 Note 4 — Property, Plant and Equipment and Intangible Assets . . . . . . . . . . . . . . . . . . . . . . . 65 OUR CRITICAL ACCOUNTING POLICIES Note 7 — Pension, Retiree Medical and Savings Plans. . . . 71 Revenue Recognition . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 Note 8 — Noncontrolled Bottling Affiliates . . . . . . . . . . . . 75 Brand and Goodwill Valuations. . . . . . . . . . . . . . . . . . . . . 41 Note 9 — Debt Obligations and Commitments. . . . . . . . . 77 Income Tax Expense and Accruals . . . . . . . . . . . . . . . . . . . 42 Note 10 — Risk Management. . . . . . . . . . . . . . . . . . . . . . 78 Pension and Retiree Medical Plans . . . . . . . . . . . . . . . . . . 43 Note 11 — Net Income per Common Share . . . . . . . . . . . 80 OUR FINANCIAL RESULTS Note 12 — Preferred Stock. . . . . . . . . . . . . . . . . . . . . . . . 80 Items Affecting Comparability . . . . . . . . . . . . . . . . . . . . . 46 Note 13 — Accumulated Other Comprehensive Loss . . . . 81 Results of Operations — Consolidated Review . . . . . . . . . 47 Note 14 — Supplemental Financial Information . . . . . . . . 82 Results of Operations — Division Review . . . . . . . . . . . . . 49 Frito-Lay North America . . . . . . . . . . . . . . . . . . . . . . . . 50 PepsiCo Beverages North America. . . . . . . . . . . . . . . . . 51 PepsiCo International . . . . . . . . . . . . . . . . . . . . . . . . . . 52 Quaker Foods North America . . . . . . . . . . . . . . . . . . . . 53 Our Liquidity and Capital Resources . . . . . . . . . . . . . . . . . 54 MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING . . . . . . . . . . . . . . . . . . . . 83 MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING . . . . . . . 83 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM . . . . . . . . . . . . . . . . . . . . . . 84 SELECTED FINANCIAL DATA. . . . . . . . . . . . . . . . . . 85 RECONCILIATION OF GAAP AND NON-GAAP INFORMATION . . . . . . . . . . . . . . . . . 86 GLOSSARY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 Consolidated Statement of Income . . . . . . . . . . . . 56 Consolidated Statement of Cash Flows . . . . . . . . . 57 Consolidated Balance Sheet . . . . . . . . . . . . . . . . . . 58 Consolidated Statement of Common Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . 59 31 OUR BUSINESS 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 86. 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. 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. Our commitment to sustainable growth, defined as Performance with Purpose, is focused on generating healthy financial returns while giving back to the comdivision sells products in approximately 200 countries, with our largest operations in Mexico and the United Kingdom. Additional information concerning our divisions and geographic areas is presented in Note 1. tea, coffee and water products through joint ventures with Unilever (under the Lipton brand name) and Starbucks. In addition, PBNA licenses the Aquafina water brand to its bottlers and markets this brand. PBNA sells concentrate and 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. PBNA’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. Frito-Lay North America 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. 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. munities 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. We are organized into four divisions: • Frito-Lay North America, • PepsiCo Beverages North America, • PepsiCo International, and • Quaker Foods North America. Our North American divisions operate in the U.S. and Canada. Our international PepsiCo Beverages North America PepsiCo Beverages North America (PBNA) manufactures or uses contract manufacturers, markets and sells beverage concentrates, fountain syrups and finished goods, under various beverage brands including Pepsi, Mountain Dew, Gatorade, Tropicana Pure Premium, Sierra Mist, Propel, Tropicana juice drinks, Dole, SoBe Life Water, Naked juice and Izze. PBNA also manufactures or uses contract manufacturers, markets and sells ready-to-drink PepsiCo International PepsiCo International (PI) manufactures through consolidated businesses as well as through noncontrolled affiliates, a number of leading salty and sweet snack brands including Gamesa, Lay’s, Doritos, Walkers, Cheetos, Ruffles and Sabritas. Further, PI manufactures or uses contract manufacturers, markets and sells many 32 Quaker brand cereals and snacks. PI also manufactures, markets and sells beverage concentrates, fountain syrups and finished goods under the brands Pepsi, 7UP, Mirinda, Mountain Dew, Gatorade and Tropicana. These brands are sold to authorized bottlers, independent distributors and retailers. However, in certain markets, PI operates its own bottling plants and distribution facilities. PI 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). In addition, PI licenses the Aquafina water brand to certain of its authorized bottlers. PI 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. (3) PepsiCo International (PI), which includes all PepsiCo businesses in the United Kingdom, Europe, Asia, Middle East and Africa. Quaker Foods North America 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, RiceA-Roni, Pasta Roni and Near East side dishes. These branded products are sold to independent distributors and retailers. In the fourth quarter of 2007, we announced a strategic realignment of our organizational structure into three new business units: PAF, PAB and PI. New Organizational Structure 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 FLNA, 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 PBNA and all of our Latin American beverage businesses; and In 2008, our three business units will be comprised of six reportable segments, as follows: • FLNA, • QFNA, • LAF, • PAB, • United Kingdom & Europe, and • Middle East, Africa & Asia. In the first quarter of 2008, our historical segment reporting will be restated to reflect the new structure. The segment amounts and discussions reflected in this annual report reflect the management reporting that existed through fiscal year-end 2007. 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 33 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. net income based on our percentage of economic ownership in our income statement as bottling equity income. We have designated three related party bottlers, PBG, PepsiAmericas, Inc. (PAS) 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 include our share of their Our anchor bottlers distribute approximately 58% of our North American beverage volume and approximately 18% of our international beverage volume. and Pepsi Bottling Ventures LLC (PBV), as our anchor bottlers. Our anchor bottlers distribute approximately 58% of our North American beverage volume and approximately 18% of our international beverage volume. 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. visibility and appeal. DSD is especially well-suited to products that are restocked often and respond to in-store promotion and merchandising. 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. DSD enables us to merchandise with maximum visibility and appeal. 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 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 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 CocaCola 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 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. 34 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 Demand for our products may be adversely affected by changes in consumer preferences and tastes or if we are unable to innovate or market our products effectively. Our continued success is also dependent on our product innovation, including maintaining a robust pipeline of new products, and the effectiveness of our advertising campaigns and marketing programs. There can be no assurance as to our continued ability either to develop and launch successful new products or variants of existing products, or to effectively execute advertising campaigns and marketing programs. In addition, both the launch and ongoing success of new products and advertising campaigns are inherently uncertain, especially as to their appeal to consumers. Our failure to successfully launch new products could decrease demand for our existing products by negatively affecting consumer perception of existing brands, as well as result in inventory write-offs and other costs. or tampering, whether or not valid, may reduce demand for our products or cause production and delivery disruptions. If any of our products becomes unfit for consumption, misbranded or causes injury, we may have to engage in a product recall and/or be subject to liability. A widespread product recall or a significant product liability judgment could cause our products to be unavailable for a period of time, which could further reduce consumer demand and brand equity. Failure to maintain high ethical, social and environmental standards for all of our operations and activities or adverse publicity regarding our responses to health concerns, our environmental impacts, including agricultural materials, packaging, energy and water use and waste management, or other sustainability issues, could jeopardize our reputation. Failure to comply with local laws and regulations, to maintain an effective system of internal controls or to provide accurate and timely financial statement information could also hurt our reputation. Damage to our reputation or loss of consumer confidence in our products for any of these reasons could have a material adverse effect on our business, financial condition and results of operations, as well as require additional resources to rebuild our reputation. We are a consumer products company operating in highly competitive markets and rely on continued demand for our products. To generate revenues and profits, we must sell products that appeal to our customers and to consumers. Any significant changes in consumer preferences and any inability on our part to anticipate and react to such changes could result in reduced demand for our products and erosion of our competitive and financial position. Our success depends on our ability to respond to consumer trends, such as consumer health concerns about obesity, product attributes and ingredients. In addition, changes in product category consumption or consumer demographics could result in reduced demand Our success depends on our ability to for our products. Consumer respond to consumer trends, such as preferences may shift due to a consumer health concerns about obesity, variety of factors, including the product attributes and ingredients. aging of the general population, changes in social trends, changes in travel, vacation or leisure activity patAny damage to our reputation terns, weather, negative publicity resultcould have an adverse effect on ing from regulatory action or litigation our business, financial condition against companies in the industry, or a and results of operations. downturn in economic conditions. Any Maintaining a good reputation globally of these changes may reduce consumers’ is critical to selling our branded products. willingness to purchase our products. See If we fail to maintain high standards for also “Changes in the legal and regulaproduct quality, safety and integrity, our tory environment could limit our business reputation could be jeopardized. Adverse activities, increase our operating costs, publicity about these types of concerns or reduce demand for our products or result the incidence of product contamination in litigation” below. 35 If we are not able to build and sustain proper information technology infrastructure, successfully implement our ongoing business transformation initiative or outsource certain functions effectively our business could suffer. We depend on information technology as an enabler to improve the effectiveness of our operations and to interface with our customers, as well as to maintain financial accuracy and efficiency. If we do not allocate and effectively manage the resources necessary to build and sustain the proper technology infrastructure, we could be subject to transaction errors, processing inefficiencies, the loss of customers, business disruptions, or the loss of or damage to intellectual property through security breach. We have embarked on a multi-year business transformation initiative that includes the delivery of an SAP enterprise in the future to achieve cost savings and efficiencies. If the service providers that we outsource these functions to do not perform effectively, we may not be able to achieve the expected cost savings and may have to incur additional costs to correct errors made by such service providers. Depending on the function involved, such errors may also lead to business disruption, processing inefficiencies or the loss of or damage to intellectual property through security breach, or harm employee morale. Our information systems could also be penetrated by outside parties intent on extracting information, corrupting information or disrupting business processes. Such unauthorized access could disrupt our business and could result in the loss of assets. uncertainty or governmental controls. We purchase these materials and energy mainly in the open market. If commodity price changes result in unexpected increases in raw materials and energy costs, we may not be able to increase our prices to offset these increased costs without suffering reduced volume, revenue and operating income. Our profitability may also be adversely impacted due to water scarcity and regulation. Water is a limited resource in many parts of the world. As demand for water continues to increase, we and our business partners may face disruption of supply or increased costs to obtain the water needed to produce our products. Our business could suffer if we are unable to compete effectively. Our businesses operate in highly competitive markets. We compete against global, regional and private label manufacturers on the basis of price, quality, product variety and effective distribution. Increased competition and actions by our competitors could lead to downward pressure on prices and/or a decline in our market share, either of which could adversely affect our results. See “Our Competition” for more information about our competitors. We depend on information technology as an enabler to improve the effectiveness of our operations and to interface with our customers. Our operating results may be adversely affected by increased costs, disruption of supply or shortages of raw materials and other supplies. We and our business partners use various raw materials and other supplies in our business, including aspartame, cocoa, corn, corn sweeteners, flavorings, flour, grapefruits and other fruits, juice and juice concentrates, oats, oranges, potatoes, rice, seasonings, sucralose, sugar, vegetable and essential oils, and wheat. Our key packaging materials include PET resin used for plastic bottles, film packaging used for snack foods, aluminum used for cans, glass bottles and cardboard. Fuel and natural gas are also important commodities due to their use in our plants and in the trucks delivering our products. Some of these raw materials and supplies are available from a limited number of suppliers. We are exposed to the market risks arising from adverse changes in commodity prices, affecting the cost of our raw materials and energy. The raw materials and energy which we use for the production of our products are largely commodities that are subject to price volatility and fluctuations in availability caused by changes in global supply and demand, weather conditions, agricultural resource planning application, as well as the migration to common business processes across our operations. There can be no certainty that these programs will deliver the expected benefits. The failure to deliver our goals may impact our ability to (1) process transactions accurately and efficiently and (2) remain in step with the changing needs of the trade, which could result in the loss of customers. In addition, the failure to either deliver the application on time, or anticipate the necessary readiness and training needs, could lead to business disruption and loss of customers and revenue. In addition, we have outsourced certain information technology support services and administrative functions, such as payroll processing and benefit plan administration, to third-party service providers and may outsource other functions Disruption of our supply chain could have an adverse effect on our business, financial condition and results of operations. Our ability and that of our suppliers, business partners, including bottlers, contract manufacturers, independent distributors and retailers, to make, move and sell products is critical to our success. Damage or disruption to our or their manufacturing or distribution capabilities due to weather, natural disaster, fire or explosion, terrorism, pandemics such as avian flu, strikes or other reasons, could impair our ability to manufacture or sell our products. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial condition 36 and results of operations, as well as require additional resources to restore our supply chain. Trade consolidation, the loss of any key customer, or failure to maintain good relationships with our bottling partners could adversely affect our financial performance. We must maintain mutually beneficial relationships with our key customers, including our retailers and bottling partners, to effectively compete. There is a greater concentration of our customer base around the world generally due to the continued consolidation of retail trade. As retail ownership becomes more concentrated, retailers demand lower pricing and increased promotional programs. Further, as larger retailers increase utilization of their own distribution networks and private label brands, the competitive advantages we derive from our go-tomarket systems and brand equity may be eroded. Failure to appropriately respond to these trends or to offer effective sales incentives and marketing programs to our customers could reduce our ability to secure adequate shelf space at our retailers and adversely affect our financial performance. Retail consolidation continues to increase the importance of major customers. In 2007, sales to Wal-Mart (including 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. Loss of any of our key customers, including Wal-Mart, could have an adverse effect on our business, financial condition and results of operations. Furthermore, if we are unable to provide an appropriate mix of incentives to our bottlers through a combination of advertising and marketing support, they may take actions that, while maximizing their own short-term profit, may be detrimental to us or our brands. Such actions could have an adverse effect on our profitability. In addition, any deterioration of our relationships with our bottlers could adversely affect our business or financial performance. See “Our Customers,” “Our Related Party Bottlers” and Note 8 for more information on our customers, including our anchor bottlers. Changes in the legal and regulatory environment could limit our business activities, increase our operating costs, reduce demand for our products or result in litigation. The conduct of our businesses, and the production, distribution, sale, advertising, labeling, safety, transportation and use of many of our products, are subject to various laws and regulations administered by federal, state and local governmental agencies in the United States, as well as to foreign laws and regulations administered by government entities and agencies in markets in which we operate. These laws and regulations may change, sometimes dramatically, as a result of political, economic or social events. Such regulatory environment changes include changes in food and drug laws, laws related to advertising and deceptive marketing practices, accounting standards, taxation requirements, competition laws and environmental laws, including laws relating to the regulation of water rights and treatment. Changes in laws, regulations or governmental policy and the related interpretations may alter the environment in which we do business and, therefore, may impact our results or increase our costs or liabilities. In particular, governmental bodies in jurisdictions where we operate may impose new labeling, product or production requirements, or other restrictions. For example, we are one of several companies that have been sued by the State of California under Proposition 65 to force warnings that certain potato-based products contain acrylamide. Acrylamide is a chemical compound naturally formed in a wide variety of foods when they are cooked (whether commercially or at home), including french fries, potato chips, cereal, bread and coffee. It is believed that acrylamide may cause cancer in laboratory animals when consumed in significant amounts. Studies are underway by various regulatory authorities and others to assess the effect on humans due to acrylamide in the diet. If we were required to label any of our products or place warnings in locations where our products are sold in California under Proposition 65, sales of those products could suffer not only in California but elsewhere. In addition, if consumer concerns about acrylamide increase as a result of these studies, other new scientific evidence, or for any other reason, whether or not valid, demand for our products could decline and we could be subject to additional lawsuits or new regulations that could affect sales of our products, any of which could have an adverse effect on our business, financial condition or results of operations. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions. Regulatory authorities under whose laws we operate may also have enforcement powers that can subject us to actions such as product recall, seizure of products or other sanctions, which could have an adverse effect on our sales or damage our reputation. If we are unable to hire or retain key employees, it could have a negative impact on our business. Our continued growth requires us to develop our leadership bench and to implement programs, such as our long-term incentive program, designed to retain talent. However, there is no assurance that we will continue to be able to hire or retain key employees. We compete to hire new employees, and then must train them and develop their skills and competencies. Our operating results could be adversely affected by increased costs due to increased competition for employees, higher employee turnover or 37 increased employee benefit costs. Any unplanned turnover could deplete our institutional knowledge base and erode our competitive advantage. Our continued growth requires us to develop our leadership bench and to implement programs, such as our long-term incentive program, designed to retain talent. have adverse impacts on our business results or financial condition. Our operations outside of the U.S. accounted for 44% and 35% of our net revenue and operating profit, respectively, for the year ended December 29, 2007. Our continued success depends on our ability to broaden and strengthen our presence in emerging markets, such as Brazil, Russia, India and China, and to create scale in key international markets. Forward-Looking and Cautionary Statements We discuss expectations regarding our future performance, such as our business outlook, in our annual and quarterly reports, press releases, and other written and oral statements. These “forwardlooking statements” are based on currently available information, operating plans and projections about future events and trends. They inherently involve risks and uncertainties that could cause actual results to differ materially from those predicted in any such forward-looking statements. Investors are cautioned not to place undue reliance on any such forward-looking statements, which speak only as of the date they are made. We undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. The discussion of risks above and elsewhere in this annual report is by no means all inclusive but is designed to highlight what we believe are important factors to consider when evaluating our trends and future results. Our business may be adversely impacted by unfavorable economic or environmental conditions or political or other developments and risks in the countries in which we operate. Unfavorable global economic or environmental changes, political conditions or other developments may result in business disruption, supply constraints, foreign currency devaluation, inflation, deflation or decreased demand. Unstable economic and political conditions or civil unrest in the countries in which we operate could Our continued success depends on our ability to broaden and strengthen our presence in emerging markets, such as Brazil, Russia, India and China. Market 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 We manage market risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging strategies. 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. 38 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. 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. Risk Management Framework The achievement of our strategic and operating objectives will necessarily involve taking risks. Our risk management We leverage an integrated risk management framework to identify, assess, prioritize, manage, monitor and communicate risks across the Company. 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. 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. 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. 39 OUR CRITICAL ACCOUNTING POLICIES An appreciation of our critical accounting policies Our critical accounting policies arise in conjunction is necessary to understand our financial results. with the following: These policies may require management to make • revenue recognition, difficult and subjective judgments regarding • brand and goodwill valuations, uncertainties, and as a result, such estimates may significantly impact our financial results. The • income tax expense and accruals, and precision of these estimates and the likelihood of • pension and retiree medical plans. 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. 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-ofdate 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. $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 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 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. 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, 40 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. 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 “Our Business Risks.” 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. We did not recognize any impairment charges for perpetual brands or goodwill in the years presented. 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 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 41 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 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 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. We adopted the provisions of FIN 48 as of the beginning of our 2007 fiscal year. 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. 42 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 balance sheet date. As a result of this change in measurement date, we will record an after-tax $7 million reduction 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. 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 equityand debt-based securities used collectively to 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 marketrelated valuation method for recognizing investment gains or losses. For this purpose, investment gains or losses are 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. As of the beginning of our 2008 fiscal year, in accordance with SFAS 158, 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 balance sheet date. 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 43 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 Pension Expense discount rate 6.3% 5.7% Expected rate of return on plan assets 7.6% 7.7% Expected rate of salary increases 4.4% 4.5% Retiree medical Expense discount rate 6.4% 5.8% Current health care cost trend rate 8.5% 9.0% 2006 5.6% 7.7% 4.4% 5.7% 10.0% 44 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-basispoint 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 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. 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. 45 OUR OUR FINANCIAL RESULTS Items Affecting Comparability The year-over-year comparisons of our financial results are affected by the following items: 2007 Operating profit Restructuring and impairment charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income Restructuring and impairment charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PepsiCo share of PBG tax settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net income per common share — diluted Restructuring and impairment charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PepsiCo share of PBG tax settlement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . For the items affecting our 2005 results, see Notes 3 and 5, as well as our 2006 Annual Report. 2006 $(67) $(43) $602 $18 $(0.03) $0.36 $0.01 $ (102) $ (70) $129 – $ (0.04) $ 0.08 – 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 across FLNA, PBNA and PI. 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. 46 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 Total net revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Operating profit FLNA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PBNA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . PI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . QFNA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Corporate unallocated. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total operating profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total operating profit margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2007 $ 39,474 $2,845 2,188 2,322 568 (753) $7,170 18.2% 2006 $35,137 $2,615 2,055 2,016 554 (738) $6,502 18.5% 2005 $32,562 $2,529 2,037 1,661 537 (780) $5,984 18.4% 2007 12% 9% 6% 15% 2.5% 2% 10% ( 0.3) 2006 8% 3% 1% 21% 3% (5)% 9% 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. 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 47 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. Other Consolidated Results Change Bottling equity income Interest expense, net Annual tax rate Net income Net income per common share — diluted 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 $ 560 $ (99) 25.9% $ 5,658 $ 3.41 2006 $553 $(66) 19.3% $5,642 $3.34 2005 $495 $(97) 36.1% $4,078 $2.39 2007 1% $ (33) – 2% 2006 12% $31 38% 40% 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. 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. 48 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 $11,586 $10,844 3% 4 0.5 – 7% FLNA $10,844 $10,322 1% 3 0.5 0.5 5% PBNA $10,230 $9,565 (2)% 6 – 2 7% PBNA $9,565 $9,146 3% 1 – – 5% PI $15,798 $12,959 7% 3.5 6 6 22% PI $12,959 $11,376 6% 4 1 3 14% QFNA $1,860 $1,769 2% 3 1 – 5% QFNA $1,769 $1,718 1% 2 1 – 3% Total $39,474 $35,137 3% 4 2 3 12% Total $35,137 $32,562 3% 3 1 1 8% Net Revenue, 2007. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Revenue, 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Impact of: Volume(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Effective net pricing(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisitions/divestitures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Change(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Revenue, 2006. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Revenue, 2005. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Impact of: Volume(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Effective net pricing(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign exchange . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Acquisitions/divestitures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . % Change(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (a) Excludes the impact of acquisitions and divestitures. For PBNA and PI, volume growth varies from the amounts disclosed in the following divisional discussions due primarily to non-consolidated joint venture volume and temporary timing differences between BCS and CSE. Our net revenue for PBNA and PI excludes nonconsolidated joint venture volume and 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. 49 Frito-Lay North America % Change Net revenue Operating profit 2007 $11,586 $2,845 2006 $10,844 $2,615 2005 $10,322 $2,529 2007 7 9 2006 5 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 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-singledigit revenue growth. In 2007, FLNA volume grew primarily due to high-single-digit growth in trademark Doritos and double-digit growth in dips, SunChips and multipack. 2006 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 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 FLNA’s Smart Spot eligible products low-single-digit declines in experienced double-digit revenue growth in trademark Lay’s and Doritos. both 2007 and 2006. The Stacy’s Pita Chip Company acquisition contributed approximately 0.5 percentage points to Smart Spot eligible products repboth revenue and volume growth. The resented approximately 15% of net absence of the prior year’s additional revenue. These products experienced week reduced volume and net revenue double-digit revenue growth, while the growth by 2 percentage points. balance of the portfolio had low-singledigit revenue growth. 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. 50 PepsiCo Beverages North America % Change Net revenue Operating profit 2007 $10,230 $2,188 2006 $9,565 $2,055 2005 $9,146 $2,037 2007 7 6 2006 5 1 2007 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-singledigit 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. 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 6% 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 Canadian 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 represented over 70% of net revenue. These products experienced mid-singledigit net revenue growth, while the balance of the portfolio grew in the high-single-digit range. 2006 BCS volume grew 4%. 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, Smart Spot eligible products represented over Gatorade, Lipton ready-to-drink 70% of PBNA’s total revenue in both 2007 teas, Tropicana juice drinks and and 2006. Propel. Tropicana Pure Premium experienced a low-single-digit decline in volume. The decline 1 percentage point, was fully offset in CSDs reflects a low-single-digit decline by the impact of charges taken in the in trademark Pepsi, partially offset by a fourth quarter of 2005 to reduce costs mid-single-digit increase in trademark in our operations, principally through Sierra Mist and a low-single-digit increase headcount reductions. in trademark Mountain Dew. Across the Smart Spot eligible products represented brands, regular CSDs experienced a lowover 70% of net revenue. These products single-digit decline and diet CSDs declined experienced high-single-digit revenue slightly. The additional week in 2005 had growth, while the balance of the portfolio no significant impact on volume growth declined in the low-single-digit range. as bottler volume is reported based on a calendar month. Net revenue grew 5%. Positive mix contributed to the revenue growth, reflecting the strength of non-carbonated beverages. 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 1% 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 substantially 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 51 PepsiCo International % Change Net revenue Operating profit 2007 $15,798 $2,322 2006 $12,959 $2,016 2005 $11,376 $1,661 2007 22 15 2006 14 21 2007 International snacks volume grew 9% reflecting double-digit growth in Russia, the Middle East and Turkey, partially offset by low-single-digit declines at Sabritas in Mexico and Walkers in the United Kingdom. Additionally, Gamesa in Mexico, India and China all grew at double-digit rates. Overall, the Europe, Middle East & Africa region grew 9%, the Latin America region grew 6% and the Asia Pacific region grew 20%. Acquisitions in Europe, New Zealand and Brazil increased the Europe, Middle East & Africa region volume growth by 1 percentage point, the Asia Pacific region volume growth by 7 percentage points and the Latin America region volume growth by 0.5 percentage points, respectively. In aggregate, acquisitions contributed almost 2 percentage points to the reported total PepsiCo International snack volume growth rate. PI experienced double-digit revenue and operating profit growth in both 2007 and 2006. point. CSDs grew at a high-single-digit rate while non-carbonated beverages grew at a double-digit rate. Net revenue grew 22% reflecting the volume growth and favorable effective net pricing. Foreign currency contributed 6 percentage points of growth primarily reflecting the favorable euro, British pound and Brazilian real. The net impact of acquisitions and divestitures also contributed 6 percentage points to net revenue growth. Operating profit grew 15% driven largely by the volume growth and favorable effective net pricing, partially offset by increased raw material costs. Foreign currency contributed 5 percentage points of growth primarily reflecting the favorable British pound, euro and Brazilian real. The net impact of acquisitions and divestitures on operating profit was minimal. 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 3 percentage points. 2006 Beverage volume grew 8% led by double-digit growth in the Middle East, China and Pakistan, partially offset by a low-single-digit decline in Mexico and a high-single-digit decline in Thailand. Additionally, Russia and Brazil grew at double-digit rates. The Europe, Middle East & Africa region grew 11%, the Asia Pacific region grew 8% and the Latin America region grew 4%. The acquisition of a business in Europe increased the Europe, Middle East & Africa region volume growth by 1 percentage point and the total PepsiCo International beverage volume growth by nearly 1 percentage International snacks volume grew 9% reflecting double-digit growth in Russia, Turkey, Egypt and India and single-digit growth at Sabritas in Mexico. Overall, the Europe, Middle East & Africa region grew 17%, the Latin America region grew 2.5% and the Asia Pacific region grew 12%. Acquisitions of two businesses in Europe in 2006 increased the Europe, Middle East & Africa region volume growth by nearly 6 percentage points. The acquisition of a business in Australia increased the Asia Pacific region volume growth by 1 percentage point. In aggregate, acquisitions contributed 2 percentage points to the reported total PepsiCo International snack volume growth rate. The absence of the prior year’s additional week reduced the growth rate by 1 percentage point. Beverage volume grew 9% reflecting broad-based increases led by doubledigit growth in the Middle East, China, Argentina, Russia and Venezuela. The Europe, Middle East & Africa region grew 11%, the Asia Pacific region grew 9% and the Latin America region grew 7%. Acquisitions contributed 1 percentage point to the Europe, Middle East & Africa region volume growth rate and contributed slightly to the reported total PepsiCo International beverage volume growth rate. CSDs grew at a high-single-digit rate while non-carbonated beverages grew at a double-digit rate. Net revenue grew 14% primarily as a result of the broad-based volume growth and favorable effective net pricing. The net impact of acquisitions and divestitures contributed nearly 3 percentage points to net revenue growth. Foreign currency contributed 1 percentage point of growth. The absence of the prior year’s additional week reduced net revenue growth by 1 percentage point. Operating profit grew 21% driven primarily by the net revenue growth, partially offset by increased raw material and energy costs. The net impact of acquisitions and divestitures contributed 1 percentage point of growth. Foreign currency also contributed 1 percentage point of growth. The absence of the prior year’s additional week, which reduced the operating profit growth rate by 1 percentage point, was fully offset by the impact of charges taken in 2005 to reduce costs in our operations and rationalize capacity. 52 Quaker Foods North America % Change Net revenue Operating profit 2007 $1,860 $ 568 2006 $1,769 $554 2005 $1,718 $537 2007 5 2.5 2006 3 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-ARoni. 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 QFNA’s revenue and volume growth by a low-single-digit decline accelerated in 2007 to 5% and in Aunt Jemima syrup and mix 2%, respectively. and a mid-single-digit decline in Rice-A-Roni. Net revenue growth was also driven by Smart Spot eligible products reprefavorable effective net pricing, which sented approximately 55% of net revenue contributed almost 2 percentage points and had mid-single-digit net revenue to net revenue growth, and favorable growth. The balance of the portfolio Canadian foreign exchange rates which experienced a low-single-digit decline. contributed almost 1 percentage point. The absence of the prior year’s additional The absence of the prior year’s additional week negatively impacted these results. 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. 53 Our Liquidity and Capital Resources Our strong cash-generating capability and 2007 Cash Utilization 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 Other, net $357 of our fundamental strengths and provides us Long-term debt $1,589 with substantial financial flexibility in meeting Cash proceeds from sale of PBG stock $315 operating, investing and financing needs. In Stock option exercises $1,108 addition, we have revolving credit facilities that are further discussed in Note 9. Our cash provided from operating activities is somewhat Operating activities $6,934 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 Source of Cash generally lowest in the first quarter. 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. 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. Short-term investments $383 Acquisitions $1,320 Dividends $2,204 Capital spending $2,430 Share repurchases $4,312 Use of Cash Short-term borrowings $395 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. 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 stockbased compensation plans, with average net annual repurchases of 1.4% of outstanding shares for the last five years. 54 2006 Cash Utilization 2005 Cash Utilization Other, net $223 Short-term investments $2,017 Cash proceeds from sale of PBG stock $318 Stock option exercises $1,194 Long-term debt $106 Acquisitions $522 Dividends $1,854 Capital spending $2,068 Other, net $70 Short-term borrowings $1,848 Cash proceeds from sale of PBG stock $214 Stock option exercises $1,099 Long-term debt $152 Acquisitions $1,095 Dividends $1,642 Short-term investments $991 Operating activities $6,084 Share repurchases $3,010 Operating activities $5,852 Capital spending $1,736 Short-term borrowings $2,341 Source of Cash Use of Cash Source of Cash Use of Cash Share repurchases $3,031 Net cash provided by operating activities Capital spending Sales of property, plant and equipment Management operating cash flow 2007 $ 6,934 (2,430) 47 $ 4,551 2006 $ 6,084 (2,068) 49 $ 4,065 2005 $ 5,852 (1,736) 88 $ 4,204 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 above reconciles the net cash provided by operating activities, as reflected in our cash flow statement, to our management operating cash flow. 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 “Our Business Risks” for certain factors that may impact our operating cash flows. 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. 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. 55 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) Net Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Selling, general and administrative expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortization of intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Operating Profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Bottling equity income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income before Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net Income per Common Share Basic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Diluted . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . See accompanying notes to consolidated financial statements. 2007 $39,474 18,038 14,208 58 7,170 560 (224) 125 7,631 1,973 $ 5,658 $3.48 $3.41 2006 $35,137 15,762 12,711 162 6,502 553 (239) 173 6,989 1,347 $ 5,642 $3.42 $3.34 2005 $32,562 14,176 12,252 150 5,984 495 (256) 159 6,382 2,304 $ 4,078 $2.43 $2.39 Net Revenue $39,474 $32,562 $35,137 Operating Profit $7,170 $5,984 $6,502 2005 2006 2007 2005 2006 2007 Net Income $5,642 $4,078 $5,658 Net Income per Common Share $3.34 $2.39 $3.41 2005 2006 2007 2005 2006 2007 56 Consolidated 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 Operating Activities Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5,658 Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,426 Stock-based compensation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 260 Excess tax benefits from share-based payment arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (208) Cash payments for merger-related costs and restructuring charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . – Pension and retiree medical plan contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (310) Pension and retiree medical plan expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 535 Bottling equity income, net of dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (441) Deferred income taxes and other tax charges and credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 Change in accounts and notes receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (405) Change in inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (204) Change in prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (16) Change in accounts payable and other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500 Change in income taxes payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 Other, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (107) Net Cash Provided by Operating Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6,934 Investing Activities Capital spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,430) 47 Sales of property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Proceeds from (Investment in) finance assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Acquisitions and investments in noncontrolled affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (1,320) Cash proceeds from sale of PBG stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315 Divestitures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . – Short-term investments, by original maturity More than three months — purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (83) More than three months — maturities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 Three months or less, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (413) Net Cash Used for Investing Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3,744) Financing Activities Proceeds from issuances of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,168 Payments of long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (579) Short-term borrowings, by original maturity More than three months — proceeds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 More than three months — payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (133) Three months or less, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (345) Cash dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,204) Share repurchases — common . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,300) Share repurchases — preferred . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (12) Proceeds from exercises of stock options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,108 Excess tax benefits from share-based payment arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 Net Cash Used for Financing Activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (4,006) Effect of exchange rate changes on cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 (741) Net (Decrease)/Increase in Cash and Cash Equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash and Cash Equivalents, Beginning of Year. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,651 Cash and Cash Equivalents, End of Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 910 See accompanying notes to consolidated financial statements. 2006 $ 5,642 1,406 270 (134) – (131) 544 (442) (510) (330) (186) (37) 223 (295) 64 6,084 (2,068) 49 (25) (522) 318 37 (29) 25 2,021 (194) 51 (157) 185 (358) (2,168) (1,854) (3,000) (10) 1,194 134 (5,983) 28 (65) 1,716 $ 1,651 2005 $ 4,078 1,308 311 – (22) (877) 464 (414) 440 (272) (132) (56) 188 609 227 5,852 (1,736) 88 – (1,095) 214 3 (83) 84 (992) (3,517) 25 (177) 332 (85) 1,601 (1,642) (3,012) (19) 1,099 – (1,878) (21) 436 1,280 $ 1,716 57 Consolidated Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 29, 2007 and December 30, 2006 (in millions except per share amounts) ASSETS Current Assets Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Short-term investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts and notes receivable, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Current Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property, Plant and Equipment, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Amortizable Intangible Assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other nonamortizable intangible assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Nonamortizable Intangible Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investments in Noncontrolled Affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities Short-term obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accounts payable and other current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Current Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Long-Term Debt Obligations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Commitments and Contingencies Preferred Stock, no par value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Repurchased Preferred Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Common Shareholders’ Equity Common stock, par value 1 2/3¢ per share (authorized 3,600 shares, issued 1,782 shares) . . . . . . . . . . . . . . . . . . Capital in excess of par value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Accumulated other comprehensive loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Less: repurchased common stock, at cost (177 and 144 shares, respectively) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Common Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Liabilities and Shareholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . See accompanying notes to consolidated financial statements. 2007 2006 910 1,571 4,389 2,290 991 10,151 11,228 796 5,169 1,248 6,417 4,354 1,682 $34,628 $ $ 1,651 1,171 3,725 1,926 657 9,130 9,687 637 4,594 1,212 5,806 3,690 980 $29,930 $ – 7,602 151 7,753 4,203 4,792 646 $ 274 6,496 90 6,860 2,550 4,624 528 17,394 14,562 41 (132) 41 (120) 30 450 28,184 (952) 27,712 (10,387) 17,325 $34,628 30 584 24,837 (2,246) 23,205 (7,758) 15,447 $29,930 58 Consolidated Statement of Common Shareholders’ Shareholders’ Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2007, December 30, 2006 and December 31, 2005 2007 Shares Amount 1,782 $ 30 584 260 (347) (47) 450 24,837 7 24,844 5,658 (2,306) (2) (10) 28,184 (2,246) 719 (60) 21 – 464 135 – 9 6 (952) (144) (64) 28 3 (177) (7,758) (4,300) 1,582 89 (10,387) $17,325 2007 Comprehensive Income Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Currency translation adjustment . . . . . . . . . . . . . . . Cash flow hedges, net of tax. . . . . . . . . . . . . . . . . . Minimum pension liability adjustment, net of tax . . Pension and retiree medical, net of tax: Net prior service cost . . . . . . . . . . . . . . . . . . . . . Net gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unrealized gain on securities, net of tax . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total Comprehensive Income . . . . . . . . . . . . . . . . . . $5,658 719 (39) – (105) 704 9 6 $6,952 (126) (49) 31 – (144) 2006 Shares 1,782 Amount $ 30 614 270 (300) – 584 21,116 – – 5,642 (1,912) (1) (8) 24,837 (1,053) 465 (18) (5) (1,782) – – 138 9 – (2,246) (6,387) (3,000) 1,619 10 (7,758) $15,447 2006 $5,642 465 (23) 5 – – 9 – $6,098 (103) (54) 31 – (126) (in millions) Common Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Capital in Excess of Par Value Balance, beginning of year . . . . . . . . . . . . . . . . . . . Stock-based compensation expense . . . . . . . . . . . . Stock option exercises/RSUs converted(a) . . . . . . . . . Withholding tax on RSUs converted . . . . . . . . . . . . Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . Retained Earnings Balance, beginning of year . . . . . . . . . . . . . . . . . . . Adoption of FIN 48. . . . . . . . . . . . . . . . . . . . . . . . . Adjusted balance, beginning of year . . . . . . . . . . . . Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Cash dividends declared — common . . . . . . . . . . . Cash dividends declared — preferred . . . . . . . . . . . Cash dividends declared — RSUs . . . . . . . . . . . . . . Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . Accumulated Other Comprehensive Loss Balance, beginning of year . . . . . . . . . . . . . . . . . . . Currency translation adjustment . . . . . . . . . . . . . . . Cash flow hedges, net of tax: Net derivative (losses)/gains . . . . . . . . . . . . . . . . Reclassification of losses/(gains) to net income . . Adoption of SFAS 158 . . . . . . . . . . . . . . . . . . . . . . Pension and retiree medical, net of tax: Net pension and retiree medical gains . . . . . . . . Reclassification of net losses to net income. . . . . Minimum pension liability adjustment, net of tax . . Unrealized gain on securities, net of tax . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . Repurchased Common Stock Balance, beginning of year . . . . . . . . . . . . . . . . . . . Share repurchases . . . . . . . . . . . . . . . . . . . . . . . . . Stock option exercises . . . . . . . . . . . . . . . . . . . . . . Other, primarily RSUs converted . . . . . . . . . . . . . . . Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . Total Common Shareholders’ Equity . . . . . . . . . . . . 2005 Shares Amount 1,782 $ 30 618 311 (315) – 614 18,730 – – 4,078 (1,684) (3) (5) 21,116 (886) (251) 54 (8) – – – 16 24 (2) (1,053) (4,920) (2,995) 1,523 5 (6,387) $14,320 2005 $4,078 (251) 46 16 – – 24 (2) $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. 59 Notes 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%. Our share of the net income of our anchor bottlers is reported in our income statement as bottling equity income. 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. 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 PI’s 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, stockbased 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. Our Divisions We manufacture or use contract manufacturers, market and sell a variety of salty, sweet and grain-based snacks, carbonated and non-carbonated beverages, and foods through our North American and international business divisions. Our North American divisions include the U.S. and Canada. 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, 17% to PBNA, 34% to PI, 4% to QFNA 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. 60 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 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. In the first quarter of 2008, our historical segment reporting will be restated to reflect the new structure. The segment amounts and discussions reflected in this annual report reflect the management reporting that existed through fiscal yearend 2007. Frito-Lay North America (FLNA) PepsiCo Beverages North America (PBNA) PepsiCo International (PI) Quaker Foods North America (QFNA) Net Revenue FLNA PBNA PI QFNA Total division Corporate 2007 $11,586 10,230 15,798 1,860 39,474 – $ 39,474 2006 $10,844 9,565 12,959 1,769 35,137 – $35,137 2005 $10,322 9,146 11,376 1,718 32,562 – $32,562 2007 $2,845 2,188 2,322 568 7,923 (753) $7,170 Operating Profit 2006 $2,615 2,055 2,016 554 7,240 (738) $6,502 2005 $2,529 2,037 1,661 537 6,764 (780) $5,984 Net Revenue QFNA 5% Division Operating Profit 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 profitin-inventory elimination adjustments for our noncontrolled bottling affiliates and certain other items. QFNA 7% FLNA 29% PI 40% PBNA 26% PI 29% FLNA 36% PBNA 28% 61 Other Division Information Total Assets FLNA PBNA PI QFNA Total division Corporate(a) Investments in bottling affiliates 2007 $ 6,270 7,130 14,747 1,002 29,149 2,124 3,355 $ 34,628 2006 $ 5,969 6,567 11,571 1,003 25,110 1,739 3,081 $29,930 2005 $ 5,948 6,316 10,229 989 23,482 5,331 2,914 $31,727 2007 $ 624 430 1,108 41 2,203 227 – $2,430 Capital Spending 2006 $ 499 492 835 31 1,857 211 – $2,068 2005 $ 512 320 667 31 1,530 206 – $1,736 (a) Corporate assets consist principally of cash and cash equivalents, short-term investments, and property, plant and equipment. Total Assets Capital Spending QFNA 2% Corporate 9% FLNA 26% Net Revenue Long-Lived Assets QFNA 3% Other 16% FLNA 18% Other 25% United States 56% Canada 3% Mexico 9% United Kingdom 9% Other 28% United States 55% PBNA 20% PI 43% PI 45% PBNA 18% Canada 5% United Kingdom 5% Mexico 5% Amortization of Intangible Assets FLNA PBNA PI QFNA Total division Corporate 2007 $9 11 38 – 58 – $ 58 2006 $9 77 76 – 162 – $162 Net Revenue (a) U.S. Mexico United Kingdom Canada All other countries 2007 $21,978 3,498 1,987 1,961 10,050 $ 39,474 2006 $20,788 3,228 1,839 1,702 7,580 $35,137 2005 $19,937 3,095 1,821 1,509 6,200 $32,562 2007 $12,498 1,067 2,090 699 6,441 $22,795 2005 $3 76 71 – 150 – $150 2007 $ 437 302 564 34 1,337 31 $1,368 Depreciation and Other Amortization 2006 $ 432 282 478 33 1,225 19 $1,244 2005 $ 419 264 420 34 1,137 21 $1,158 Long-Lived Assets (b) 2006 $11,515 996 1,995 589 4,725 $19,820 2005 $10,723 902 1,715 582 3,948 $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. 62 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 WalMart; and PBG represented approximately 9%. We have not experienced credit issues with these customers. 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. 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. 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. 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. 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 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 63 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. 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, PBNA and PI. 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: Severance and Other Asset Impairments Employee Costs FLNA $19 $– PBNA – 11 PI 38 22 $57 $33 Other Costs $9 – 3 $12 Total $ 28 11 63 $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. 64 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 PBNA, $16 million to PI 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. Note 4 — Property, Plant and Equipment and Intangible Assets Average Useful Life Property, plant and equipment, net Land and improvements Buildings and improvements Machinery and equipment, including fleet and software Construction in progress Accumulated depreciation Depreciation expense Amortizable intangible assets, net Brands Other identifiable intangibles Accumulated amortization Amortization expense 10 – 34 yrs. 20 – 44 5 – 14 $ 2007 864 4,577 14,471 1,984 21,896 (10,668) $ 11,228 $1,304 $ 1,476 344 1,820 (1,024) $ 796 $ 58 2006 $ 756 4,095 12,768 1,439 19,058 (9,371) $ 9,687 $1,182 $1,288 290 1,578 (941) $ 637 $162 2005 $1,103 5 – 40 3 – 15 $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. 65 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: Balance, Beginning 2006 FLNA Goodwill PBNA Goodwill Brands PI Goodwill Brands QFNA Goodwill Corporate Pension intangible Total goodwill Total brands Total pension intangible $ 145 2,164 59 2,223 1,604 1,026 2,630 175 1 4,088 1,085 1 $5,174 Acquisitions $139 39 – 39 183 – 183 – – 361 – – $361 Translation and Other $– – – – 145 127 272 – (1) 145 127 (1) $271 Balance, End of 2006 $ 284 2,203 59 2,262 1,932 1,153 3,085 175 – 4,594 1,212 – $5,806 Acquisitions $– 146 – 146 236 – 236 – – 382 – – $382 Translation Balance, and Other End of 2007 $ 27 20 – 20 146 36 182 – – 193 36 – $229 $ 311 2,369 59 2,428 2,314 1,189 3,503 175 – 5,169 1,248 – $ 6,417 66 Note 5 — Income Taxes 2007 Income before income taxes U.S. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision for income taxes Current: U.S. Federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred: U.S. Federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Foreign. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,085 3,546 $7,631 $1,422 489 104 2,015 22 ( 66) 2 (42) $1,973 35.0% 0.9 ( 6.5) (1.7) – (1.8) 25.9% $1,163 828 280 148 136 2,555 722 425 528 447 – 189 618 2,929 ( 695) 2,234 $ 321 2006 $3,844 3,145 $6,989 $ 776 569 56 1,401 (31) (16) (7) (54) $1,347 35.0% 0.5 (6.5) (8.6) – (1.1) 19.3% $1,103 784 169 – 248 2,304 667 443 541 342 38 – 592 2,623 (624) 1,999 $ 305 2005 $3,175 3,207 $6,382 $1,638 426 118 2,182 137 (26) 11 122 $2,304 35.0% 1.4 (6.5) – 7.0 (0.8) 36.1% Tax rate reconciliation U.S. Federal statutory tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . State income tax, net of U.S. Federal tax benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Lower taxes on foreign results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax settlements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxes on AJCA repatriation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Annual tax rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax liabilities Investments in noncontrolled affiliates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property, plant and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Intangible assets other than nondeductible goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pension benefits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross deferred tax liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax assets Net carryforwards. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Stock-based compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Retiree medical benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other employee-related benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Pension benefits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deductible state tax and interest benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Gross deferred tax assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Valuation allowances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred tax assets, net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Net deferred tax liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Deferred taxes included within: Assets: Prepaid expenses and other current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Liabilities: Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Analysis of valuation allowances Balance, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Provision/(benefit) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other additions/(deductions). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 325 $ 646 $ 624 39 32 $ 695 $223 $528 $532 71 21 $624 $564 (28) (4) $532 67 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 • 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. A rollforward of our reserves in 2007 for all federal, state and foreign tax jurisdictions, is as follows: $1,435 (7) (144) 1,284 264 151 (73) (174) (7) 16 $1,461 Balance, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . FIN 48 adoption adjustment to retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reclassification of deductible state tax and interest benefits to other balance sheet accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Adjusted balance, beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions for tax positions related to the current year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Additions for tax positions from prior years . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reductions for tax positions from prior years. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Settlement payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Statute of limitations expiration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Currency translation adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Balance, end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 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. 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. 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. 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 stockbased 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 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 stockbased 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. 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. 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 BlackScholes 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 69 Our weighted-average Black-Scholes fair value assumptions are as follows: Expected life Risk free interest rate Expected volatility Expected dividend yield 2007 6 yrs. 4.8% 15% 1.9% 2006 6 yrs. 4.5% 18% 1.9% 2005 6 yrs. 3.8% 23% 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 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 Outstanding at December 30, 2006 Granted Exercised Forfeited/expired Outstanding at December 29, 2007 Exercisable at December 29, 2007 Options(a) 127,749 11,671 (28,116) (2,496) 108,808 75,365 Average Price(b) $44.24 65.12 39.34 56.04 $47.47 $42.65 Average Life (years)(c) Aggregate Intrinsic Value(d) 5.26 3.97 $3,216,316 $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 Outstanding at December 30, 2006 Granted Converted Forfeited/expired Outstanding at December 29, 2007 (a) RSUs are in thousands. (b) Weighted-average intrinsic value at grant date. (c) Weighted-average contractual life remaining. (d) In thousands. RSUs(a) 7,885 2,342 (2,361) (496) 7,370 Average Intrinsic Value(b) $53.38 65.21 47.83 $57.73 $58.63 Average Life (years)(c) Aggregate Intrinsic Value(d) 1.28 $567,706 Other Stock-Based Compensation Data Stock Options Weighted-average fair value of options granted Total intrinsic value of options exercised(a) RSUs Total number of RSUs granted(a) Weighted-average intrinsic value of RSUs granted Total intrinsic value of RSUs converted(a) (a) In thousands. 2007 $13.56 $ 826,913 2,342 $ 65.21 $125,514 2006 $12.81 $686,242 2,992 $58.22 $10,934 2005 $13.45 $632,603 3,097 $53.83 $4,974 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. 70 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 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 $7 million reduction 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: 71 Pension 2007 2006 2007 International $1,511 59 81 4 14 (155) (46) – – 96 31 $1,595 $1,330 122 58 14 (46) – 91 26 $1,595 $ – 107 – $107 $1,263 52 68 8 12 20 (38) (6) – 126 6 $1,511 $1,099 112 30 12 (38) – 116 (1) $1,330 $(181) 13 – $(168) $ 6 (2) (172) $(168) $475 24 $499 $2 6 6 (30) (29) 46 $1 $1,239 2006 U.S. Change in projected benefit liability Liability at beginning of year $ 5,947 $5,771 244 245 Service cost 338 319 Interest cost 147 11 Plan amendments – – Participant contributions (309) (163) Experience (gain)/loss (319) (233) Benefit payments – (7) Settlement/curtailment loss – 4 Special termination benefits – – Foreign currency adjustment – – Other Liability at end of year $ 6,048 $5,947 Change in fair value of plan assets $ 5,378 $5,086 Fair value at beginning of year Actual return on plan assets 654 513 69 19 Employer contributions/funding – – Participant contributions (319) (233) Benefit payments – (7) Settlement/curtailment loss – – Foreign currency adjustment – – Other $ 5,782 $5,378 Fair value at end of year Reconciliation of funded status Funded status $ (266) $(569) 15 6 Adjustment for fourth quarter contributions ( 5) – Adjustment for fourth quarter special termination benefits Net amount recognized $ (256) $(563) Amounts recognized Other assets $ 440 $ 185 (24) (19) Other current liabilities ( 672) (729) Other liabilities Net amount recognized $ (256) $(563) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss $1,136 $1,836 156 13 Prior service cost/(credit) $1,292 $1,849 Total Components of the (decrease)/increase in net loss Change in discount rate $ (292) $(123) – (45) Employee-related assumption changes (17) 5 Liability-related experience different from assumptions (255) (122) Actual asset return different from expected return (136) (164) Amortization of losses Other, including foreign currency adjustments and 2003 Medicare Act – (3) $ (700) $(452) Total Liability at end of year for service to date $ 5,026 $4,998 Retiree Medical 2007 2006 $1,370 48 77 – – ( 80) (77) – – 9 7 $1,354 $– – 77 – (77) – – – $– $ (1,354) 19 – $ (1,335) $ – ( 88) (1,247) $ (1,335) $276 ( 88) $188 $ (50) ( 9) (21) – (18) 10 $ (88) $1,312 46 72 – – (34) (75) – 1 – 48 $1,370 $– – 75 – (75) – – – $– $(1,370) 16 – $(1,354) $ – (84) (1,270) $(1,354) $ 364 (101) $ 263 $(30) – (4) – (21) 17 $(38) $187 (3) (77) $107 $287 28 $ 315 $ (224) 61 7 (25) (30) 23 $ (188) $1,324 72 Components of benefit expense are as follows: Pension 2007 Components of benefit expense Service cost Interest cost Expected return on plan assets Amortization of prior service cost/(credit) Amortization of net loss Settlement/curtailment loss Special termination benefits Total 2006 U.S. $ 244 338 (399) 5 136 324 – 5 $ 329 $ 245 319 (391) 3 164 340 3 4 $ 347 $ 213 296 (344) 3 106 274 – 21 $ 295 $ 59 81 ( 97) 3 30 76 – – $ 76 2005 2007 2006 International $ 52 68 (81) 2 29 70 – – $ 70 $ 32 55 (69) 1 15 34 – – $ 34 $ 48 77 – (13) 18 130 – – $ 130 $ 46 72 – (13) 21 126 – 1 $ 127 $ 40 78 – (11) 26 133 – 2 $ 135 2005 2007 Retiree Medical 2006 2005 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 Net loss Prior service cost/(credit) Total U.S. $56 20 $76 International $20 3 $23 $7 (12) $ (5) 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 Weighted-average assumptions Liability discount rate Expense discount rate Expected return on plan assets Rate of salary increases 2006 U.S. 6.2% 5.8% 7.8% 4.7% 5.8% 5.7% 7.8% 4.5% 5.7% 6.1% 7.8% 4.4% 5.8% 5.2% 7.3% 3.9% 2005 2007 2006 International 5.2% 5.1% 7.3% 3.9% 5.1% 6.1% 8.0% 4.1% 6.1% 5.8% 5.8% 5.7% 5.7% 6.1% 2005 2007 2006 2005 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 U.S. Selected information for plans with liability for service to date in excess of plan assets Liability for service to date Fair value of plan assets Selected information for plans with benefit liability in excess of plan assets Benefit liability Fair value of plan assets 2006 2007 International 2006 2007 2006 $ (364) $– $(387) $1 $ (72) $13 $(286) $237 $ (707) $– $(754) $1 $ (384) $278 $(1,387) $1,200 $ (1,354) $(1,370) 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. 73 Future Benefit Payments and Funding Our estimated future benefit payments are as follows: Pension Retiree medical(a) 2008 $290 $95 2009 $315 $100 2010 $350 $105 2011 $385 $110 2012 $425 $115 2013-17 $2,755 $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. 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 highquality 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 equityand 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 Equity strategies Fixed income strategies Other, primarily cash Total 2007 61% 38% 1% 100% 2006 61% 39% – 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. 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: 74 2007 service and interest cost components 2007 benefit liability 1% Increase 1% Decrease $5 $(4) $55 $(48) 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. 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. 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. PBG’s summarized financial information is as follows: 2007 Current assets $ 3,086 Noncurrent assets 10,029 $13,115 Total assets Current liabilities $ 2,215 7,312 Noncurrent liabilities 973 Minority interest $10,500 Total liabilities Our investment $2,022 Net revenue $13,591 Gross profit $ 6,221 $1,071 Operating profit Net income $ 532 2006 $ 2,749 9,178 $11,927 $2,051 7,252 540 $9,843 $1,842 $12,730 $5,830 $1,017 $522 2005 $11,885 $5,540 $1,023 $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. 75 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 $ 5,308 $ 4,207 Total assets Current liabilities $ 903 $ 694 2,274 1,909 Noncurrent liabilities Minority interest 273 – $ 3,450 $ 2,603 Total liabilities $1,118 $1,028 Our investment Net revenue $ 4,480 $3,972 $3,726 Gross profit $1,823 $1,608 $1,562 $ 436 $356 $393 Operating profit 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 2007 $ 4,874 $ 91 $163 $106 2006 $4,837 $87 $175 $62 2005 $4,633 $143 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: Net revenue Selling, general and administrative expenses Accounts and notes receivable Accounts payable and other current liabilities 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. 76 Note 9 — Debt Obligations and Commitments 2007 Short-term debt obligations Current maturities of long-term debt Commercial paper (4.3% and 5.3%) Other borrowings (7.2% and 7.3%) Amounts reclassified to long-term debt Long-term debt obligations Short-term borrowings, reclassified Notes due 2008-2026 (5.3% and 6.0%) Zero coupon notes, $375 million due 2008-2012 (13.3%) Other, due 2008-2016 (6.1% and 6.1%) Less: current maturities of long-term debt obligations The interest rates in the above table reflect weighted-average rates at year-end. 2006 $ 605 792 377 (1,500) $ 274 $1,500 1,148 299 208 3,155 (605) $2,550 $ 526 361 489 (1,376) $ – $1,376 2,673 285 395 4,729 ( 526) $ 4,203 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. 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. 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 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. 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% 77 Long-Term Contractual Commitments(a) Payments Due by Period Long-term debt obligations(b) Interest on debt obligations(c) Operating leases Purchasing commitments Marketing commitments Other commitments Total $ 2,827 938 1,105 3,767 1,251 248 $10,136 2008 $ – 184 260 1,182 329 44 $1,999 2009-2010 $ 171 300 340 1,713 551 127 $3,202 2011-2012 $1,340 285 191 509 278 75 $2,678 2013 and beyond $1,316 169 314 363 93 2 $2,257 (a) Reflects non-cancelable commitments as of December 29, 2007 based on year-end foreign exchange rates and excludes any reserves for income taxes under FIN 48 as we are unable to reasonably predict the ultimate amount or timing of settlement of our reserves for income taxes. (b) Excludes short-term borrowings reclassified as long-term debt of $1,376 million and includes $273 million of accrued interest related to our zero coupon notes. (c) Interest payments on floating-rate debt are estimated using interest rates effective as of December 29, 2007. Most long-term contractual commitments, except for our long-term debt obligations, are not recorded on our balance sheet. Non-cancelable operating leases primarily represent building leases. Non-cancelable purchasing commitments are primarily for oranges and orange juice, packaging materials and cooking oil. Non-cancelable marketing commitments are primarily for sports marketing. Bottler funding is not reflected in our long-term contractual commitments as it is negotiated on an annual basis. See Note 7 regarding our pension and retiree medical obligations and discussion below regarding our commitments to noncontrolled bottling affiliates and former restaurant operations. 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. In connection with these transactions, we have guaranteed $2.3 billion of Bottling Group, LLC’s long-term debt through 2012 and $18 million of YUM! Brands, Inc.’s (YUM) outstanding obligations, primarily property leases, through 2020. The terms of our Bottling Group, LLC debt guarantee are intended to preserve the structure of PBG’s separation from us and our payment obligation would be triggered if Bottling Group, LLC failed to perform under these debt obligations or the structure significantly changed. Our guarantees of certain obligations ensured YUM’s continued use of certain properties. These guarantees would require our cash payment if YUM failed to perform under these lease obligations. See Note 8 regarding contracts related to certain of our bottlers. See “Our Liquidity and Capital Resources” in Management’s Discussion and Analysis for further unaudited information on our borrowings. Note 10 — Risk Management We are exposed to market risks arising from adverse changes in: • commodity prices, affecting the cost of our raw materials and energy, • foreign exchange risks, and • interest rates. In the normal course of business, we manage these risks through a variety of strategies, including 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. See “Our Business Risks” in Management’s Discussion and Analysis for further unaudited information on our business risks. For cash flow hedges, changes in fair value are deferred in accumulated other comprehensive loss within shareholders’ equity until the underlying hedged item is recognized in net income. For fair value hedges, changes in fair value are recognized immediately in earnings, consistent with the underlying hedged item. Hedging transactions are limited to an underlying exposure. As a result, any change in the value of our derivative instruments would be substantially offset by an opposite change in the value of the underlying hedged items. Hedging ineffectiveness and a net earnings impact occur when the change in the value of the hedge does not offset the change in the value of the underlying hedged item. If the derivative instrument is terminated, we continue to defer the related gain or loss and include it as a component of the cost of the underlying hedged item. Upon determination that the underlying hedged item will not be part of an actual transaction, we recognize the related gain or loss in net income in that period. We also use derivatives that do not qualify for hedge accounting treatment. We account for such derivatives at market value with the resulting gains and losses reflected in our income statement. We do not use derivative instruments for trading or speculative purposes, and we limit our exposure to individual counterparties to manage credit risk. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price purchase orders, pricing agreements, geographic diversity and derivatives. We use derivatives, with terms of no more than two years, to economically hedge 78 price fluctuations related to a portion of our anticipated commodity purchases, primarily for natural gas, diesel fuel and fruit. For those derivatives that qualify for hedge accounting, any ineffectiveness is recorded immediately. However, such commodity cash flow hedges have not had any significant ineffectiveness for all periods presented. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. During the next 12 months, we expect to reclassify net gains of $1 million related to cash flow hedges from accumulated other comprehensive loss into net income. Derivatives used to hedge commodity price risks that do not qualify for hedge accounting are marked to market each period and reflected in our income statement. Foreign Exchange 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. On occasion, we enter into hedges, primarily forward contracts with terms of no more than two years, to reduce the effect of foreign exchange rates. Ineffectiveness of these hedges has not been material. 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. These swaps are entered into only with strong creditworthy counterparties and are settled on a net basis. 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 Fair Value All derivative instruments are recognized on our balance sheet at fair value. The fair value of our derivative instruments is generally based on quoted market prices. Book and fair values of our derivative and financial instruments are as follows: 2007 Book Value Assets Cash and cash equivalents(a) Short-term investments(b) Forward exchange contracts(c) Commodity contracts(d) Prepaid forward contracts(e) Interest rate swaps(f) Cross currency interest rate swaps(f) Liabilities Forward exchange contracts(c) Commodity contracts(d) Debt obligations Interest rate swaps(g) Cross currency interest rate swaps(g) $ 910 $1,571 $ 32 $10 $74 $ 36 $– $ 61 $7 $ 4,203 $– $8 Fair Value $910 $1,571 $32 $10 $74 $36 $– $61 $7 $4,352 $– $8 Book Value $1,651 $1,171 $8 $2 $73 $– $1 $24 $29 $2,824 $4 $– 2006 Fair Value $1,651 $1,171 $8 $2 $73 $– $1 $24 $29 $2,955 $4 $– The above items are included on our balance sheet under the captions noted or as indicated below. In addition, derivatives qualify for hedge accounting unless otherwise noted below. (a) Book value approximates fair value due to the short maturity. (b) Principally short-term time deposits and includes $189 million at December 29, 2007 and $145 million at December 30, 2006 of mutual fund investments used to manage a portion of market risk arising from our deferred compensation liability. (c) The 2007 asset includes $20 million related to derivatives that do not qualify for hedge accounting and the 2007 liability includes $5 million related to derivatives that do not qualify for hedge accounting. The 2006 liability includes $10 million related to derivatives that do not qualify for hedge accounting. Assets are reported within current assets and other assets, and liabilities are reported within current liabilities and other liabilities. (d) The 2007 asset includes $10 million related to derivatives that do not qualify for hedge accounting and the 2007 liability includes $7 million related to derivatives that do not qualify for hedge accounting. The 2006 liability includes $28 million related to derivatives that do not qualify for hedge accounting. Assets are reported within current assets and other assets, and liabilities are reported within current liabilities and other liabilities. (e) Included in current assets and other assets. (f) Asset included within other assets. (g) Reported in other liabilities. This table excludes guarantees, including our guarantee of $2.3 billion of Bottling Group, LLC’s long-term debt. The guarantee had a fair value of $35 million at December 29, 2007 and December 30, 2006 based on our estimate of the cost to us of transferring the liability to an independent financial institution. See Note 9 for additional information on our guarantees. 79 Note 11 — Net Income per Common Share Basic net income per common share is net income available to common shareholders divided by the weighted average of common shares outstanding during the period. Diluted net income per common share is calculated using the weighted average of common shares outstanding adjusted to include the effect that would occur if in-the-money employee stock options were exercised and RSUs and preferred shares were converted into common shares. Options to purchase 2.7 million shares in 2007, 0.1 million shares in 2006 and 3.0 million shares in 2005 were not included in the calculation of diluted earnings per common share 2007 Net income Preferred shares: Dividends Redemption premium Net income available for common shareholders Basic net income per common share Net income available for common shareholders Dilutive securities: Stock options and RSUs ESOP convertible preferred stock Diluted Diluted net income per common share (a) Weighted-average common shares outstanding. because these options were out-of-themoney. Out-of-the-money options had average exercise prices of $65.18 in 2007, $65.24 in 2006 and $53.77 in 2005. The computations of basic and diluted net income per common share are as follows: 2006 (a) 2005 Shares (a) Income $ 5,658 (2) (10) $ 5,646 $ 3.48 $ 5,646 – 12 $ 5,658 $ 3.41 Shares Income $5,642 (2) (9) $5,631 $3.42 $5,631 – 11 $5,642 $3.34 Income $4,078 (2) (16) $4,060 $2.43 $4,060 – 18 $4,078 $2.39 Shares(a) 1,621 1,621 35 2 1,658 1,649 1,649 36 2 1,687 1,669 1,669 35 2 1,706 Note 12 — Preferred Stock As of December 29, 2007 and December 30, 2006, there were 3 million shares of convertible preferred stock authorized. The preferred stock was issued only for an ESOP established by Quaker and these shares are redeemable for common stock by the ESOP participants. The preferred stock accrues dividends at an annual rate of $5.46 per share. At year-end 2007 and 2006, there were 803,953 preferred shares issued and 287,553 and 320,853 shares outstanding, respectively. The outstanding preferred shares had a fair value of $108 million as of December 29, 2007 and $100 million as of December 30, 2006. Each share is 2007 Preferred stock Repurchased preferred stock Balance, beginning of year Redemptions Balance, end of year (a) Does not sum due to rounding. convertible at the option of the holder into 4.9625 shares of common stock. The preferred shares may be called by us upon written notice at $78 per share plus accrued and unpaid dividends. Quaker made the final award to its ESOP plan in June 2001. 2006 Amount $41 $120 12 $132 Shares 0.8 0.5 – 0.5 Amount $41 $110 10 $120 Shares 0.8 0.4 0.1 0.5 2005 Amount $41 $ 90 19 $110(a) Shares 0.8 0.5 – 0.5 80 Note 13 — Accumulated Other Comprehensive Loss Comprehensive income is a measure of income which includes both net income and other comprehensive income or loss. Other comprehensive income or loss results from items deferred from recognition into our income statement. Accumulated other comprehensive loss is separately presented on our balance sheet as part of common shareholders’ equity. Other comprehensive income/(loss) was $1,294 million in 2007, $456 million in 2006 and $(167) million in 2005. The accumulated balances for each component of other comprehensive loss were as follows: Currency translation adjustment Cash flow hedges, net of tax(a) Unamortized pension and retiree medical, net of tax(b) Minimum pension liability adjustment(c) Unrealized gain on securities, net of tax Other Accumulated other comprehensive loss $ 2007 213 (35) (1,183) – 49 4 $ ( 952) 2006 $ (506) 4 (1,782) – 40 (2) $ (2,246) 2005 $ (971) 27 – (138) 31 (2) $ (1,053) (a) Includes $3 million after-tax gain in 2007 and 2006 and no impact in 2005 for our share of our equity investees’ accumulated derivative activity. (b) Net of taxes of $645 million in 2007 and $919 million in 2006. (c) Net of taxes of $72 million in 2005. Also includes $120 million for our share of our equity investees’ minimum pension liability adjustments, net of tax. 81 Note 14 — Supplemental Financial Information 2007 Accounts receivable Trade receivables Other receivables Allowance, beginning of year Net amounts charged/(credited) to expense Deductions(a) Other(b) Allowance, end of year Net receivables Inventories(c) Raw materials Work-in-process Finished goods $ 3,670 788 4,458 64 5 (7) 7 69 $ 4,389 $ 1,056 157 1,077 $2,290 2006 $3,147 642 3,789 75 10 (27) 6 64 $3,725 $ 860 140 926 $1,926 2005 $ 97 (1) (22) 1 $ 75 (a) Includes accounts written off. (b) Includes currency translation effects and other adjustments. (c) Inventories are valued at the lower of cost or market. Cost is determined using the average, first-in, first-out (FIFO) or last-in, first-out (LIFO) methods. Approximately 14% in 2007 and 19% in 2006 of the inventory cost was computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. 2007 Other assets Noncurrent notes and accounts receivable Deferred marketplace spending Unallocated purchase price for recent acquisitions Pension plans Other Accounts payable and other current liabilities Accounts payable Accrued marketplace spending Accrued compensation and benefits Dividends payable Other current liabilities Other supplemental information Rent expense Interest paid Income taxes paid, net of refunds Acquisitions(a) Fair value of assets acquired Cash paid and debt issued SVE minority interest eliminated Liabilities assumed $ 121 205 451 635 270 $1,682 $2,562 1,607 1,287 602 1,544 $7,602 $ 303 $251 $1,731 $ 1,611 (1,320) – $ 291 2006 $ 149 232 196 197 206 $ 980 $ 2,102 1,444 1,143 492 1,315 $ 6,496 $291 $215 $2,155 $ 678 (522) – $ 156 $228 $213 $1,258 $ 1,089 (1,096) 216 $ 209 (a) In 2005, these amounts include the impact of our acquisition of General Mills, Inc.’s 40.5% ownership interest in SVE for $750 million. The excess of our purchase price over the fair value of net assets acquired was $250 million and reported in goodwill. We also reacquired rights to distribute global brands for $263 million which is included in other nonamortizable intangible assets. 82 Management’s Responsibility for Financial Reporting To Our Shareholders: At PepsiCo, our actions — the actions of all our associates — are governed by our Worldwide Code of Conduct. This code is clearly aligned with our stated values — a commitment to sustained growth, through empowered people, operating with responsibility and building trust. Both the code and our core values enable us to operate with integrity — both within the letter and the spirit of the law. Our code of conduct is reinforced consistently at all levels and in all countries. We have maintained strong governance policies and practices for many years. The management of PepsiCo is responsible for the objectivity and integrity of our consolidated financial statements. The Audit Committee of the Board of Directors has engaged independent registered public accounting firm, KPMG LLP, to audit our consolidated financial statements and they have expressed an unqualified opinion. We are committed to providing timely, accurate and understandable information to investors. Our commitment encompasses the following: Maintaining strong controls over financial reporting. Our system of internal control is based on the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in their report titled Internal Control — Integrated Framework. The system is designed to provide reasonable assurance that transactions are executed as authorized and accurately recorded; that assets are safeguarded; and that accounting records are sufficiently reliable to permit the preparation of financial statements that conform in all material respects with accounting principles generally accepted in the U.S. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the specified time periods. We monitor these internal controls through self-assessments and an ongoing program of internal audits. Our internal controls are reinforced through our Worldwide Code of Conduct, which sets forth our commitment to conduct business with integrity, and within both the letter and the spirit of the law. Exerting rigorous oversight of the business. We continuously review our business results and strategies. This encompasses financial discipline in our strategic and daily business decisions. Our Executive Committee is actively involved — from understanding strategies and alternatives to reviewing key initiatives and financial performance. The intent is to ensure we remain objective in our assessments, constructively challenge our approach to potential business opportunities and issues, and monitor results and controls. Engaging strong and effective Corporate Governance from our Board of Directors. We have an active, capable and diligent Board that meets the required standards for independence, and we welcome the Board’s oversight as a representative of our shareholders. Our Audit Committee is comprised of independent directors with the financial literacy, knowledge and experience to provide appropriate oversight. We review our critical accounting policies, financial reporting and internal control matters with them and encourage their direct communication with KPMG LLP, with our General Auditor, and with our General Counsel. We also have a senior compliance officer to lead and coordinate our compliance policies and practices. Providing investors with financial results that are complete, transparent and understandable. The consolidated financial statements and financial information included in this report are the responsibility of management. This includes preparing the financial statements in accordance with accounting principles generally accepted in the U.S., which require estimates based on management’s best judgment. PepsiCo has a strong history of doing what’s right. We realize that great companies are built on trust, strong ethical standards and principles. Our financial results are delivered from that culture of accountability, and we take responsibility for the quality and accuracy of our financial reporting. Management’s Report on Internal Control over Financial Reporting To Our Shareholders: Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting is effective as of December 29, 2007. KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. During our fourth fiscal quarter of 2007, we continued migrating certain of our financial processing systems to SAP software. This software implementation is part of our ongoing global business transformation initiative, and we plan to continue implementing such software throughout other parts of our businesses over the course of the next few years. In connection with the SAP implementation and resulting business process changes, we continue to enhance the design and documentation of our internal control processes to ensure suitable controls over our financial reporting. Except as described above, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during our fourth fiscal quarter of 2007. Peter A. Bridgman Senior Vice President and Controller Richard Goodman Chief Financial Officer Indra K. Nooyi Chairman of the Board of Directors and Chief Executive Officer 83 Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders PepsiCo, Inc.: We have audited the accompanying Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries (“PepsiCo, Inc.” or the “Company”) as of December 29, 2007 and December 30, 2006, and the related Consolidated Statements of Income, Cash Flows and Common Shareholders’ Equity for each of the years in the three-year period ended December 29, 2007. We also have audited PepsiCo, Inc.’s internal control over financial reporting as of December 29, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). PepsiCo, Inc.’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PepsiCo, Inc. as of December 29, 2007 and December 30, 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 29, 2007, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, PepsiCo, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 29, 2007, based on criteria established in Internal Control — Integrated Framework issued by COSO. New York, New York February 15, 2008 84 Selected Financial Data (in millions except per share amounts, unaudited) First Second Third Fourth Quarterly Quarter Quarter Quarter Quarter Net revenue 2007 $7,350 $9,607 $10,171 $12,346 2006 $6,719 $8,714 $9,134 $10,570 Gross profit 2007 $4,065 $5,265 $5,544 $6,562 2006 $3,757 $4,852 $5,026 $5,740 Restructuring and impairment charges(a) 2007 – – – $102 2006 – – – $67 Tax benefits(b) 2007 – – $(115) $(14) 2006 – – – $(602) Net income 2007 $1,096 $1,557 $1,743 $1,262 2006 $947 $1,375 $1,494 $1,826 Net income per common share — basic 2007 $0.67 $0.96 $1.08 $0.78 2006 $0.57 $0.83 $0.90 $1.11 Net income per common share — diluted 2007 $0.65 $0.94 $1.06 $0.77 2006 $0.56 $0.81 $0.89 $1.09 Cash dividends declared per common share 2007 $0.30 $0.375 $0.375 $0.375 2006 $0.26 $0.30 $0.30 $0.30 (c) 2007 stock price per share High $65.54 $69.64 $70.25 $79.00 Low $61.89 $62.57 $64.25 $68.02 Close $64.09 $66.68 $67.98 $77.03 2006 stock price per share(c) High $60.55 $61.19 $65.99 $65.99 Low $56.00 $56.51 $58.65 $61.15 Close $59.34 $59.70 $64.73 $62.55 2006 results reflect our change in reporting calendars of certain operating units within PI. (a) The restructuring and impairment charge in 2007 was $102 million ($70 million or $0.04 per share after-tax). The restructuring and impairment charge in 2006 was $67 million ($43 million or $0.03 per share after-tax). See Note 3. (b) In 2007, represents non-cash tax benefits related to the favorable resolution of certain foreign tax matters. In 2006, represents non-cash tax benefits primarily related to the IRS’s examination of our consolidated income tax returns for the years 1998 through 2002. See Note 5. (c) Represents the composite high and low sales price and quarterly closing prices for one share of PepsiCo common stock. Five-Year Summary Net revenue Net income Income per common share — basic Income per common share — diluted Cash dividends declared per common share Total assets Long-term debt Return on invested capital(a) 2007 2006 2005 $ 39,474 $35,137 $32,562 $ 5,658 $5,642 $4,078 $ 3.48 $3.42 $2.43 $ 3.41 $3.34 $2.39 $1.425 $1.16 $1.01 $ 34,628 $29,930 $31,727 $ 4,203 $2,550 $2,313 28.9% 30.4% 22.7% 2004 2003 $29,261 $26,971 $4,174 $3,568 $4,212 $3,568 $2.45 $2.07 Five-Year Summary (cont.) Net revenue Income from continuing operations Net income Income per common share — basic, continuing operations Income per common share — diluted, continuing operations Cash dividends declared per common share Total assets Long-term debt Return on invested capital(a) $2.41 $2.05 $0.85 $0.63 $27,987 $25,327 $2,397 $1,702 27.4% 27.5% (a) Return on invested capital is defined as adjusted net income divided by the sum of average shareholders’ equity and average total debt. Adjusted net income is defined as net income plus net interest expense after-tax. Net interest expense after-tax was $63 million in 2007, $72 million in 2006, $62 million in 2005, $60 million in 2004 and $72 million in 2003. • Includes restructuring and impairment charges of: 2007 Pre-tax After-tax Per share $102 $70 $ 0.04 2006 $67 $43 $0.03 2005 $83 $55 $0.03 2004 $150 $96 $0.06 2003 $147 $100 $0.06 • Includes Quaker merger-related costs of: 2003 Pre-tax After-tax Per share $59 $42 $0.02 • In 2007, we recognized $129 million ($0.08 per share) 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 ($0.36 per share) primarily in connection with the IRS’s examination of our consolidated income tax returns for the years 1998 through 2002. In 2005, we recorded income tax expense of $460 million ($0.27 per share) related to our repatriation of earnings in connection with the AJCA. In 2004, we reached agreement with the IRS for an open issue related to our discontinued restaurant operations which resulted in a tax benefit of $38 million ($0.02 per share). • On December 30, 2006, we adopted SFAS 158 which reduced total assets by $2,016 million, total common shareholders’ equity by $1,643 million and total liabilities by $373 million. • The 2005 fiscal year consisted of 53 weeks compared to 52 weeks in our normal fiscal year. The 53rd week increased 2005 net revenue by an estimated $418 million and net income by an estimated $57 million ($0.03 per share). 85 Reconciliation of GAAP and Non-GAAP Information The financial measures listed below are not measures defined by generally accepted accounting principles. However, we believe investors should consider these measures as they are more indicative of our ongoing performance and how management evaluates our operational results and trends. Specifically, investors should consider the following: • Our 2007 and 2006 division operating profit; • Our 2007 and 2006 division operating profit and total operating profit without the impact of restructuring and impairment charges; and our 2007 division operating profit growth and total operating profit growth without the impact of restructuring and impairment charges; • Our 2007 and 2006 net income without the impact of our 2007 and 2006 non-cash tax benefits and restructuring and impairment charges; our 2007 net income growth without the impact of the aforementioned items; and • Our 2007 and 2006 diluted EPS without the impact of our 2007 and 2006 non-cash tax benefits and restructuring and impairment charges; our 2007 diluted EPS growth without the impact of the aforementioned items; and our 2005 diluted EPS without the impact of the AJCA tax charge, restructuring charges and the extra week in 2005. Operating Profit Reconciliation Total PepsiCo Reported Operating Profit Impact of Restructuring and Impairment Charges Total Operating Profit Excluding above Item Impact of Corporate Unallocated PepsiCo Total Division Operating Profit Excluding above Items 2007 $7,170 102 7,272 753 $8,025 2006 $6,502 67 6,569 738 $7,307 10% 11% Growth 10% Operating Profit Reconciliation Frito-Lay North America Operating Profit Quaker Foods North America Operating Profit Latin America Foods Operating Profit PepsiCo Americas Beverages Operating Profit United Kingdom & Europe Operating Profit Middle East, Africa & Asia Operating Profit PepsiCo Total Division Operating Profit Impact of Corporate Unallocated Total PepsiCo Reported Operating Profit Net Income Reconciliation Reported Net Income Tax Benefits Restructuring and Impairment Charges Net Income Excluding above Items 2007 $ 2,845 568 714 2,487 774 535 7,923 (753) $7,170 2007 $ 5,658 (129) 70 $ 5,599 2006 $2,615 554 655 2,315 700 401 7,240 (738) $6,502 2006 $5,642 (620) 43 $5,065 2007 Growth 2% 11% Growth – 2007 Percentage of Total 36% 7 9 31 10 7 100% Diluted EPS Reconciliation Reported Diluted EPS Tax Benefits AJCA Tax Charge Extra Week Restructuring and Impairment Charges Diluted EPS Excluding above Items *Does not sum due to rounding. 2007 $ 3.41 ( 0.08) 2006 $ 3.34 (0.37) 2005 $ 2.39 0.27 (0.03) 0.04 $ 3.38* 0.03 $ 3.00 13% 0.03 $ 2.66 GLOSSARY Anchor bottlers: The Pepsi Bottling Group (PBG), PepsiAmericas (PAS) and Pepsi Bottling Ventures (PBV). Bottler: customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area. Bottler Case Sales (BCS): measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our bottlers. Bottler funding: financial incentives we give to our bottlers to assist in the distribution and promotion of our beverage products. Concentrate Shipments and Equivalents (CSE): measure of our physical beverage volume shipments to bottlers, retailers and independent distributors. This measure is reported on our fiscal year basis. Consumers: people who eat and drink our products. CSD: carbonated soft drinks. Customers: authorized bottlers and independent distributors and retailers. Derivatives: financial instruments that we use to manage our risk arising from changes in commodity prices, interest rates, foreign exchange rates and stock prices. Direct-Store-Delivery (DSD): delivery system used by us and our bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised. Effective net pricing: reflects the year-overyear impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. Management operating cash flow : net cash provided by operating activities less capital spending plus sales of property, plant and equipment. It is our primary measure used to monitor cash flow performance. Marketplace spending: sales incentives offered through various programs to our customers and consumers (trade spending), as well as advertising and other marketing activities. Servings: common metric reflecting our consolidated physical unit volume. Our divisions’ physical unit measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products. Smart Spot: our initiative that helps consumers find our products that can contribute to healthier lifestyles. Transaction gains and losses: the impact on our consolidated financial statements of exchange rate changes arising from specific transactions. Translation adjustments: the impact of the conversion of our foreign affiliates’ financial statements to U.S. dollars for the purpose of consolidating our financial statements. 86 Common Stock Information Shareholder Information Annual Meeting The Annual Meeting of Shareholders will be held at Frito-Lay Corporate Headquarters, 7701 Legacy Drive, Plano, Texas, on Wednesday, May 7, 2008, at 9:00 a.m. local time. Proxies for the meeting will be solicited by an independent proxy solicitor. This Annual Report is not part of the proxy solicitation. Contents 1 ...... Financial Highlights 2 ...... Letter to Shareholders 7 ...... Questions & Answers 10..... Leadership Team 12..... PepsiCo Americas Foods 14..... PepsiCo Americas Beverages 16..... PepsiCo International 19..... Purpose: Human, Environment, Talent 29..... PepsiCo Board of Directors 30..... Executive Officers 31..... Financial Review Stock Trading Symbol — PEP Stock Exchange Listings The New York Stock Exchange is the principal market for PepsiCo common stock, which is also listed on the Chicago and Swiss Stock Exchanges. Shareholders As of February 8, 2008, there were approximately 185,000 shareholders of record. PepsiCo Stock Purchase Program — for Canadian employees: Fidelity Stock Plan Services P.O. Box 5000 Cincinnati, OH 45273-8398 Telephone: 800-544-0275 Website: www.iStockPlan.com/ESPP Please have a copy of your most recent statement available when calling with inquiries. If using overnight or certified mail send to: Fidelity Investments 100 Crosby Parkway Mail Zone KC1F-L Covington, KY 41015 Inquiries Regarding Your Stock Holdings Registered Shareholders (shares held by you in your name) should address communications concerning transfers, statements, dividend payments, address changes, lost certificates and other administrative matters to: PepsiCo, Inc. c/o BNY Mellon Shareowner Services P.O. Box 358015 Pittsburgh, PA 15252-8015 Telephone: 800-226-0083 201-680-6685 (Outside the U.S.) E-mail: shrrelations@bnymellon.com Website: www.bnymellon.com/shareowner/isd or Manager Shareholder Relations PepsiCo, Inc. 700 Anderson Hill Road Purchase, NY 10577 Telephone: 914-253-3055 In all correspondence or telephone inquiries, please mention PepsiCo, your name as printed on your stock certificate, your Investor ID (IID), your address and telephone number. Dividend Policy We target an annual dividend payout of 50% of prior year’s earnings, excluding certain items. Dividends are usually declared in late January or early February, May, July and November and paid at the end of March, June and September and the beginning of January. The dividend record dates for these payments are, subject to approval of the Board of Directors, expected to be March 7, June 6, September 5 and December 5, 2008. We have paid consecutive quarterly cash dividends since 1965. Shareholder Services BuyDIRECT Plan Interested investors can make their initial purchase directly through The Bank of New York, transfer agent for PepsiCo, and Administrator for the Plan. A brochure detailing the Plan is available on our website www.pepsico.com or from our transfer agent: PepsiCo, Inc. c/o BNY Mellon Shareowner Services P.O. Box 358015 Pittsburgh, PA 15252-8015 Telephone: 800-226-0083 201-680-6685 (Outside the U.S.) E-mail: shrrelations@bnymellon.com Website: www.bnymellon.com/shareowner/isd Other services include dividend reinvestment, optional cash investments by electronic funds transfer or check drawn on a U.S. bank, sale of shares, online account access, and electronic delivery of shareholder materials. Stock Performance PepsiCo was formed through the 1965 merger of Pepsi-Cola Company and Frito-Lay, Inc. A $1,000 investment in our stock made on December 31, 2002 was worth about $1,964 on December 31, 2007, assuming the reinvestment of dividends into PepsiCo stock. This performance represents a compounded annual growth rate of 14%. The closing price for a share of PepsiCo common stock on the New York Stock Exchange was the price as reported by Bloomberg for the years ending 2003-2007. Past performance is not necessarily indicative of future returns on investments in PepsiCo common stock. SharePower Participants (employees with ShareCash Dividends Declared Per Share (In $) 1.425 Power options) should address all questions regarding your account, outstanding options or shares received through option exercises to: Merrill Lynch/SharePower Stock Option Unit 1600 Merrill Lynch Drive Mail Stop 06-02-SOP Pennington, NJ 08534 Telephone: 800-637-6713 (U.S., Puerto Rico and Canada) 609-818-8800 (all other locations) In all correspondence, please provide your account number (for U.S. citizens, this is your Social Security number), your address, your telephone number and mention PepsiCo SharePower. For telephone inquiries, please have a copy of your most recent statement available. Financial and Other Information PepsiCo’s 2008 quarterly earnings releases are expected to be issued the weeks of April 21, July 21, October 6, 2008, and February 2, 2009. Copies of PepsiCo’s SEC reports, earnings and other financial releases, corporate news and additional company information are available on our website www.pepsico.com. PepsiCo’s CEO and CFO Certifications required under Sarbanes-Oxley Section 302 were filed as an exhibit to our Form 10-K filed with the SEC on February 15, 2008. PepsiCo’s 2007 Domestic Company Section 303A CEO Certification was filed with the New York Stock Exchange (NYSE). In addition, we have a written statement of Management’s Report on Internal Control over Financial Reporting on page 83 of this annual report. If you have questions regarding PepsiCo’s financial performance contact: Jane Nielsen Vice President, Investor Relations PepsiCo, Inc. Purchase, NY 10577 Telephone: 914-253-3035 1.16 1.01 .850 .630 03 04 05 06 07 Employee Benefit Plan Participants PepsiCo 401(k) Plan & PepsiCo Stock Purchase Program The PepsiCo Savings & Retirement Center at Fidelity P.O. Box 770003 Cincinnati, OH 45277-0065 Telephone: 800-632-2014 (Overseas: Dial your country’s AT&T Access Number +800-632-2014. In the U.S., access numbers are available by calling 800-331-1140. From anywhere in the world, access numbers are available online at www.att.com/traveler.) Website: www.netbenefits.fidelity.com Year-end Market Price of Stock Based on calendar year-end (In $) 80 60 40 20 0 Independent Auditors KPMG LLP 345 Park Avenue New York, NY 10154-0102 Telephone: 212-758-9700 Corporate Headquarters PepsiCo, Inc. 700 Anderson Hill Road Purchase, NY 10577 Telephone: 914-253-2000 03 04 05 06 07 PepsiCo’s Annual Report contains many of the valuable trademarks owned and/or used by PepsiCo and its subsidiaries and affiliates in the United States and internationally to distinguish products and services of outstanding quality. PepsiCo Website: www.pepsico.com © 2008 PepsiCo, Inc. Design: Eisenman Associates. Printing: Earth - Thebault an EarthColor Company. Photography: Greg Kinch, PhotoBureau, Ben Rosenthal, Diana Scrimgeour, Stephen Wilkes. ...
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