PERFORMANCE WITH PURPOSE - PepsiCo

267419_L01_P02_07.v3.qxd 3/3/07 11:42 PM Page 5Questions & AnswersOur Chairman and President & Chief Executive Officer PerspectiveThe questions below reflect key questions shareholders often ask about our businesses,and are followed by joint responses from our Chairman, Steve Reinemund, and ourPresident and Chief Executive Officer, Indra Nooyi.U.S. Category Leaders#2CarbonatedSoft DrinksQ: PepsiCo’s product categories andtheir impact on health continues tocapture media, consumer and regulatoryfocus. How is PepsiCo’s portfolio faringin this environment?A: As the transformation of PepsiCo’sportfolio continues, we’re able to add morechoices for consumers to meet their needsfor products that can contribute to healthierlifestyles, and we’re proud of each and everychoice we offer.Our efforts are galvanized by threeimperatives: continue making our fun-foryouproducts more nutritious, develop newproducts that address the needs of the entirefood pyramid, and try to ensure consumersnever have to trade off nutrition and taste.The range of product choices we offergrows each year, as we develop or acquirenew products or platforms that range fromindulgent to good-for-you. At the same time,we’re improving the nutritional profiles of ourlarger, core brands. For example, changingcooking oils to sunflower oil for both Lay’sand Ruffles potato chips at FLNA andWalkers crisps in the United Kingdomreduces the saturated fat in these productswithout sacrificing taste. And we’re workingon developing new sweeteners and addingmore nutritious ingredients to our products— such as fiber to foods and beverages andomega-3 fatty acids to juices.Our portfolio of more nutritious choices isworking well in this environment, evidencedby over two-thirds of our North America topline growth in 2006 being driven by productsthat are PepsiCo Smart Spot eligible —meaning they meet authoritative nutritionalstatements developed by the NationalAcademy of Sciences or the U.S. Food andDrug Administration.Q: What, specifically, is PepsiCo doingto address regulatory pressures relatingto health concerns across the globe?A: On the regulatory and policy side, we’refirm believers in engaging a range of publicand private experts to come to workablesolutions on such things as how and whereour products are sold and marketed. We’reactively engaged with policy and thoughtleaders, as well as food and beverage industryleaders, to reach decisions on steps we cantake to support consumers in their quest forhealthier lifestyles. This includes insightsfrom PepsiCo’s Blue Ribbon Advisory Board, agroup of leading health and wellness expertsand third-party advisors from across theglobe, as well as our Ethnic Advisory Boardswho have provided insights relating to multiculturalconsumers.Most recently, PepsiCo’s work in theUnited States with the Clinton Foundation,the American Heart Association and thebeverage industry, are examples of workingproactively to set policies that put the rightkinds of products in the right locations — inthis case, schools. We’re working in ourinternational markets in much the same way.An advantaged portfolio of good- andbetter-for-you products — products that areSmart Spot eligible — has provided, and willcontinue to provide, growth opportunities atwhat we call the intersection of business andpublic interests.Q: How are you approaching innovationas a means to growth?A: Innovation demands that we constantlylook around the next corner to ensure we’reproviding products that our consumers andretail customers want. We have a relentlessfocus on innovation, as new productsconsistently deliver 15% to 20% of our totalgrowth. In 2006 alone, our North Americanbusinesses introduced new products thattotaled greater than $1 billion in retail sales.More strategically said, we’re focused ongame-changing innovation. Clearly, we needto keep our existing big brands fresh whiledeveloping products and venturing intonew categories.Through a disciplined approach to innovation,we’ve developed a very strong pipelinefor 2007 and beyond, including new productslike Flat Earth vegetable and fruit crisps fromFrito-Lay, and new beverage entries such asIzze, a sparkling beverage made with 70%fruit juice, and Naked Juice, a line of allnatural juices and juice smoothies, acquiredin January 2007. And we’ll expand on oursuccesses, such as introducing Baked Walkerscrisps in the United Kingdom.As the lifeblood of any successful consumerproducts company, we expect innovationwill continue to be a key tool for growth atPepsiCo going forward.#1Sports Drink#1Chilled Juices& JuiceDrinks#1Ready-to-DrinkCoffee#1PET WaterBrand(non-jug)#1EnhancedWaterBrand#1Ready-to-DrinkTea5

267419_L01_P02_07.v3.qxd 3/3/07 11:42 PM Page 6U.S. Category Leaders#1ExtrudedSnack#2Pretzels#1PotatoChips#1TortillaChips#1Corn Chips#1MultigrainSnackQ: How are you addressing risinginput costs in your businesses?A: Structural inflation is a reality webelieve will persist over the next few years.Agricultural commodities, energy and certainmetals are in a period of protracted inflationthat’s unlikely to moderate until supplycatches up.Fortunately, over the years we’ve demonstratedthe resilience of the PepsiCo portfolioto navigate through these headwindssuccessfully. And we are confident we willfind innovative solutions to cover rising inputcosts. It will mean pulling all available leversto address inflation, as we’ve always done,such as finding new productivity, strategicallyhedging our input costs, and executingprudent and judicious pricing.Q: How are you addressing thecarbonated soft drink (CSD) categorydecline in North America?A: Rejuvenating the CSD category requiresus to deliver new products, new packagingand new benefits to re-engage consumers.2007 has one of the strongest line-ups ofCSD innovation we’ve had in many years. Inessence, we plan to build a new category forus of “sparkling” beverages.Whether it’s through Izze sparkling beverages,our new Jazz line, increased distributionof Pepsi Max throughout our system, new“choreography” packaging for Pepsi, orother new product and packaging news forDiet Pepsi, Mountain Dew and Sierra Mist,we believe we’ve got an impressive lineupready for the marketplace. And we’resupporting our new products as we continueto support our established core brands.Looking ahead, we have increased ourinvestment in truly breakthrough innovationsto come, like new sweeteners that webelieve hold the power to restoring CSDcategory growth.Q: You have had good successpromoting senior executives from withinthe company. What are you doing toensure you maintain a strong bench andgood succession planning?A: We announced a number of senior executivechanges this year, ranging from CEOto senior executive talent of our operatingdivisions. Because of the deep bench strength,we were able to provide opportunities tocurrent PepsiCo executives — ensuringsmooth transitions and tapping into literallyhundreds of years’ worth of experiencewithin the company.If anything, this series of moves underscoresthe importance of continuously buildingbench strength in our management group.We continue to place a high priority onsustaining our pool of executive talent, andwe clearly understand that in the globalcompetition for talent our people planningprocesses must be world class.Q: How will Indra Nooyi’s appointmentto CEO change PepsiCo’s strategic focusor priorities?A: Our transition of the CEO role is asseamless a transition as any PepsiCo hasever done, largely reflecting the fact that wehave co-authored the strategies the companyis pursuing.There are no major new strategies thathave been put into place since the transitiontook effect in October of 2006, and wecontinue to aggressively pursue thosestrategies that have been driving thecompany’s growth.Q: How will PepsiCo’s work withdiversity and inclusion, and its workwith corporate social responsibilityand corporate governance evolve undernew leadership?A: Our commitment to diversity and inclusionas a means to drive our growth remainssteadfast. We continue to see the impact ofour efforts in our business results, as consumerproduct offerings, promotions and customerprogramming benefit from the diverseand inclusive workforce and environmentwe’re building.Our focus on corporate responsibility hasalways been strong and will even be strongeras we contribute to societal growth and helpaddress societal problems. Some would saywe have a moral and social obligation.Others would say it’s simply good business.Either way, we have a major role to play.Similarly for corporate governance, wecontinue to find ways to strengthen ourapproach, our tools and our reporting in thename of transparency for our shareholdersand the range of constituents who track ourbusiness. For example, in 2006, PepsiCoparticipated in a pilot program at the SECto test a new electronic filing system.These kinds of priorities, which tie directlyto our commitment to responsible corporatecitizenship, will remain front and center.6

267419_L01_P02_07.v3.qxd 3/3/07 11:42 PM Page 7Q: Where is PepsiCo in its investmentin business process transformation, andspecifically its SAP implementation?A: Business Process Transformation (BPT) isa multi-year transformation effort to simplifyand synchronize our business processes andtools into one common platform.In 2006, we began implementing SAP. Westreamlined our indirect procurement systemacross our U.S. divisions, and for Quaker,Tropicana and Gatorade, we also streamlinedcustomer orders, implemented a more efficientsystem for assessing and tracking capitalexpenditures and advertising and marketingspending, and provided common demandforecasting capability.The project has an attractive business caseincluding both IT cost savings and operatingproductivity. Additionally, we expect benefitsfrom increased business information.Q: International has been a bigcontributor to PepsiCo’s growth overthe past few years. How do you plan tosustain this growth?A: PepsiCo International continues to bethe growth engine for the company —delivering on our expectations to grow atabout twice the rate of our North Americanbusinesses. Growth internationally across awide range of markets is strong.We believe the strong growth achievedby our PepsiCo International business in 2006reflects the work of a world-class managementteam, years of investment, and the implementationof a deliberate strategy to createscale in key international markets that willdeliver profitable growth.The portfolio of international marketscontinues to broaden and strengthen as wedeliver exciting new products, tailored tolocal tastes, to consumers in approximately200 countries. And in developing andemerging markets in particular, growth inper capita GDP levels continues to generateincreased demand for our products.Q: PepsiCo made a number ofacquisitions in 2006 — both in NorthAmerica and internationally. How isthe integration of these businessesgoing? And what kinds of mergers andacquisitions activity can we expect tosee going forward?A: Our North American acquisitions withinthe last year included Stacy’s bagel and pitachips, Izze carbonated beverages and NakedJuice fruit beverages (acquired January 2, 2007).Each acquisition gives us a new opportunityfor growth, whether through new productcategories or greater reach into emergingretail channels.Internationally, we completed the acquisitionsof Duyvis nuts in the Netherlands andStar Foods snacks in Poland, as well asBluebird snacks in New Zealand in early2007. Here again, each provides opportunityfor growth through new geographies andnew product lines internationally.Before any acquisition is made, we applya disciplined approach to evaluating returnson the investment within a reasonable periodand focus on ensuring these businesses addprofitable growth to PepsiCo. We feel verygood about these acquisitions, and theirintegration is proceeding well.Going forward, you can expect us tocontinue acting on our stated strategy ofsmaller, tuck-in acquisitions as a means tohelp us grow.Q: What’s the next big Power ofOne frontier?A: Our Power of One initiatives — thosedirected at accelerating growth for PepsiCoand our retailers through the power ofthe entire PepsiCo portfolio — are mostdefinitely moving to a new level.In 2006, we conducted “InnovationSummits” with our customers to share aholistic view of how shopping and eatinghabits are fragmenting. Using the insightsfrom these summits, we’ve worked withour retail partners and tailored our productofferings — by account — to maximizethe potential of our categories and boostperformance and results.But our partnerships with customers gobeyond top-line driving initiatives. We’veexpanded it to include end-to-end supplychain efficiencies. We are refreshing ourselling and merchandising activities andcritically reviewing all touch points with ourcustomers to eliminate inefficiencies likeout-of-stocks and reduce “pain points,” ifany. This initiative extends beyond PepsiCoto include our bottling partners — membersof the extended PepsiCo family who workhand in hand with us on all of our initiatives.U.S. Category Leaders#1Hot Cereal#1Rice SideDish#2PancakeMix#1Grits#1BrandPancakeSyrup7

267419_L01_P08_15.v3.qxd 3/6/07 11:08 AM Page 8Superior performance starts with a wide selection ofpowerful brands and the capability to build more of them.8

267419_L01_P08_15.v2.qxd 3/4/07 1:01 AM Page 9PerformancePepsiCo has a history of delivering strong financial performance. We strive to increaserevenues, market share, volume, profits and earnings per share, while reducing costsand improving productivity. This, in turn, leads to strong returns for our shareholders.Our success in 2006 made PepsiCo the second–largest food and beverage companyin the world. We believe our performance is the result of our unique competitivestrengths: our structural and capability advantages, supported by a culture that isuniquely our own.Our Structural AdvantagesOur structural advantages reflect a presence in convenience categories that is both wide anddeep — with global operations that reach approximately 200 snack and beverage markets andan unmatched portfolio of leading brands. Combined with our flexible, multiple go-to-marketsystems, these structural advantages provide us with a solid base for growth.PepsiCoestimatedworldwideretail sales:$92 billion.*ConvenienceAs consumers’ lives becomemore time-starved, demandfor products that offer conveniencecontinues to grow. This“sweet spot” of conveniencefeatures categories that havebeen outgrowing the overallfood and beverage sector overthe past several years.Our innovation pipeline isbeing stoked to leverage ourgrowing presence in thesecategories. Products such asQuaker Oatmeal-to-Go barsmean more people can enjoya heart-healthy breakfast.With Tropicana FruitWise, aline of fruit strips and barsmade from real fruit andjuice, we offer consumers adelicious and portable way toeat one to two servings offruit per item. Starting in2007, consumers can chooseour breakthrough line of FlatEarth fruit and vegetablecrisps as a convenient snackoption that provides a halfserving of fruits or vegetablesper ounce.Our growing beverageportfolio offers consumerschoices from regular and dietcarbonated soft drinks toready-to-drink teas andcoffee, waters, sports drinks,energy drinks, and juicesand juice drinks — all in avariety of sizes for home oron-the-go enjoyment.Global OperationsWe are the largest savorysnack food business and thelargest sports drink producerin the world. Our size gives usdistinct advantages. No matterwhere consumers live ortravel in the world, we’reworking hard to ensure ourbrands are available. Ourreach provides a competitiveedge when introducing newproducts and distributing ourbrands. Retailers are eagerto stock our products becausethey know our brands providequality, variety, great taste andmove quickly off the shelves.We have U.S. categoryleadership positions — eitherfirst or second position — in18 categories of snacks, beveragesand foods. In beverages— including carbonated plusnon-carbonated — we havethe leading market share inthe United States.PepsiCo International hasdelivered consistent growthover the last three years, with18 businesses now generatingrevenues of at least $200million. We have a solid shareof snacks in major marketssuch as Mexico, the UnitedKingdom, Brazil, Australia,India and Russia. In developingmarkets, such as China, Pepsi*Includes estimated retail sales of all PepsiCo products, including those sold by our partners and franchised bottlers.Top Branded Food and Beverage Manufacturers$ Net Sales in BillionsFood and beverage sales, excludes food ingredients, pet and agricultural products.Includes fruit and dairy.DiageoUnileverCoca-ColaGroupe DanoneCadbury SchweppesAnheuser-BuschGeneral MillsPepsiCoKraft FoodsNestlé0 10 20 30 40 50 60 70 80PepsiCo is the world’s second largest food and beverage company.Cumulative Total Shareholder Return% Return on PepsiCo stock investment, the S&P 500 and the S&P Average of Industry Groups.15012510075PepsiCo Inc.S&P 500 ®S&P ® Average of Industry Groups5012/2001 12/2002 12/2003 12/2004 12/2005 12/2006Shareholders purchasing PepsiCo stock at the end of 2001 andholding it to the end of 2006 received a higher cumulative return thanthe returns of the S&P 500 and our industry group.9

267419_L01_P08_15.v2.qxd 3/4/07 12:02 AM Page 11stores to large-format supermarkets.The Frito-Lay NorthAmerica team services nearly440,000 retail outlets weekly.We handle less perishableproducts — including Gatoradesports drinks, shelf-stableTropicana juices and Quakerproducts — through ourwarehouse distributionsystem. We deliver TropicanaPure Premium juices usingeither a refrigerated warehousesystem or chilleddirect-store-delivery system.The success of thesesystems can be measured inmany ways. For example,seven of the 15 largest brandssold in U.S. supermarkets arePepsiCo brands. No othercompany can make this claim.Our distribution systemsare part of one of the world’smost powerful supply chains.Worldwide, we own or leasenearly 300 factories, operatemore than 3,000 distributioncenters, and employ nearly70,000 salespeople workingto ensure our products areavailable, merchandised andsold in engaging ways everyhour of every day.Our Capability AdvantagesOur capability advantages include the strategic acuitynecessary to anticipate consumer needs and innovate to fulfillthem. Early on, we anticipated consumers moving fromcarbonated soft drinks to non-carbonated beverages, and webroadened our beverage portfolio to capture new growth inthe non-carbonated segment. Similarly, we were among thefirst food and beverage companies to anticipate increasedconsumer interest in health and wellness and to recognizethat we could help consumers live healthier lifestyles. Alongwith knowing our customers, we know our brands and howto build and market them. Add to this our demonstratedability to pinpoint, acquire and integrate businesses — bothbig and small — and we believe our capability advantageswill continue contributing to our strong performance.Strategic Acuity — Moveto Non-CarbonatedBeveragesCarbonated beverages remainthe most popular beveragecategory, with some 95% ofU.S. households purchasingthem. However, non-carbonatedbeverages represent afast-growing category — aplace where consumers aremigrating. Today, in theUnited States and Canada,non-carbonated beverages,which are 38% of our volume,generate 69% of our revenue.We recognized the need tobroaden our portfolio earlyon and moved to extend ourpresence in non-carbonatedbeverages in 1992, when weformed a partnership withThomas J. Lipton Co. to sellready-to-drink tea brands. In1994, we introduced Aquafinabottled water, and we alsobegan a strategic partnershipwith Starbucks to marketready-to-drink coffee. Weacquired Tropicana in 1998and we expanded the Dolebrand. We added SoBe, theproducer of several varietiesof tea and energy drinks, in2001. Active thirst leaders,Gatorade Thirst Quenchersports drinks and PropelFitness Water, became a partof our beverage businesswhen we merged withQuaker in 2001. In 2006, weannounced our alliance withOcean Spray to market, bottleand distribute single-servecranberry juice products andother product innovations.Now we’ve defined anew category within ourbeverage portfolio — sparklingPepsiCo InternationalSnack Volume% System Volume by RegionAsia11%PepsiCo InternationalBeverage Volume% System Volume by RegionIncludes Pepsi-Cola, 7UP, Gatorade,Tropicana and other beverages.Europe/Middle East/Africa45%Asia26%Latin America51%Europe/Middle East/Africa38%PepsiCo has the largest snackbusiness in the world.Latin America29%Our beverage portfolio is wellpositionedto take advantageof rising consumption indeveloping markets.PepsiCo InternationalNet Revenues% Net RevenuesBeverages30%Snacks and Foods70%Gatorade Thirst Quencher is among our biggest brands and is beingintroduced in markets around the globe.The major share of PepsiCoInternational revenues aregenerated by snacks and foods.11

267419_L01_P08_15.v2.qxd 3/4/07 12:02 AM Page 12beverages — and we added apremium brand to help uscapture the growth: IzzeBeverage Co. Acquired in2006, Izze is a maker of allnaturalsparkling fruit juices.To extend our lead in noncarbonatedbeverages, werecently completed theacquisition of Naked Juice, apremium juice producer in theUnited States whose portfolioincludes fruit juices andsmoothies made withoutadded sugars or preservatives.Internationally, we have avariety of non-carbonatedproducts including Tropicana,Gatorade and Lipton products,plus local juices such asCopella fruit juices and PJSmoothies in the UnitedKingdom, and Punica, aleading German maker offruit juices and juice drinks,acquired in 2005. A hugeopportunity awaits us in theworld of non-carbonatedbeverages, as we currentlyaccount for less than 2% ofan international non-carbonatedbeverage industry thatwe estimate to be about $70billion and growing.Strategic Acuity —Health and WellnessProviding consumers withchoices has long been a partof our mindset. We introducedDiet Pepsi in 1964 and ReducedFat Ruffles in the mid 80s. Wehave historically supportedactive lifestyles as well.Throughout the world, PepsiCois a frequent sponsor ofsports and active lifestylesthrough our marketing andour charitable donations.Our increasing commitmentto health and wellness isreflected in the transformationof our portfolio, such asthrough our acquisitions ofTropicana and Quaker. ThatPepsiCo offers a variety of products that are delicious and nutritious.commitment is behind ourcreation of a Blue RibbonHealth and Wellness AdvisoryBoard, a group that providesexpert advice on a variety ofinitiatives including newproducts, nutrition news andexercise programs. And it hasdriven our work to improvethe nutritional profile of ourexisting product lines. In2003, long before concernsabout trans fats became thesubject of mainstream media,PepsiCo removed trans fatsfrom Doritos, Cheetos andTostitos in the United Statesand Canada, by converting tocorn oil — a vegetable oilhigh in good fats, mono- andpolyunsaturated fatty acids.In 2006, we changed the oilsin our Lay’s and Ruffles brandpotato chips in the UnitedStates and internationally inWalkers crisps, moving tosunflower oil, which is lowerin saturated fat.We are pioneers in offeringconsumers smart choices. In2004, we introduced theSmart Spot symbol in theUnited States, a first-of-itskinddesignation that helpsconsumers identify PepsiCoproducts that can contributeto healthier lifestyles. Productswith the Smart Spot symbolmeet nutrition criteria basedon authoritative statementsfrom the U.S. Food andDrug Administration and theNational Academy of Sciencesor provide other functionalbenefits. More than 40% ofour revenues in the UnitedStates and Canada comefrom products that are SmartSpot eligible.Our goal is to make our products available wherever there are hungryor thirsty people.12

267419_L01_P08_15.v2.qxd 3/5/07 10:31 PM Page 13We have a growing portfolioof brands marketed internationallythat provide a clearnutrition or health benefit —what we call “Good for You.”In Mexico, for example, weare pioneering new technologyto help preserve healthynutrients in our products. Acurrent example is a bakedpotato stick called Nutritas,which includes vegetables andis produced by microwavecooking, steaming and slowbaking. We’ve introducedbaked snacks in Mexico andthe United Kingdom and willcontinue to offer morechoices across the world.Throughout 2006, wecontinued adding productsthat fit into healthier lifestyles.At the start of the year, weacquired Stacy’s Pita ChipCompany, a U.S.-basedpremium natural-snacks company.In the water category,we introduced SoBe Life Water,a line of vitamin-enhancedwater beverages. At Frito-Lay,we launched Tostitos Multigrainto bring wholesome grains toone of America’s favoritetortilla chip brands, and weintroduced Baked! Cheetosand Doritos snacks in our lineof 100-Calorie Mini Bites, totake the guesswork out ofportion control. We introducedwhole grain side dishes aspart of our Rice-A-Roni brand.We are addressing the needsof serious athletes as well, withresearch-proven performancebeverages like GatoradeEndurance Formula. And thismomentum has continued into2007, with the introduction ofGatorade AM Thirst Quencher,with flavors that appeal tomorning exercisers.Brand BuildingBrand building is aboutextending a brand’s image. Andwe are adept at connectinglocal preferences to ourglobal brands, resulting inoverall growth.Take Lay’s as an example:we’ve expanded it worldwide,tailoring it to local palates.We start with the well-known“banner sun” brand, and wecultivate the brand across ourinternational markets —capitalizing on iconic namesin their own right like Walkersin the United Kingdom, Sabritasin Mexico, and Matutano inSpain, among others.Then we extend the brandwith flavors and seasoningsgeared to local tastes — chiliesin Latin America, beef andketchup in Europe, and prawnin Asia, for example. Next, webranch into entirely new variations,such as Lay’s Artesanasand Lay’s Mediterraneasmade with olive oil. We offerdifferent kinds of chips, likehard-bite kettle style chipsand, more recently, naturaland organic varieties.We apply the same processto our other snack andbeverage brands. The roomfor growth is huge.Recent examples of ourbrand building prowess fromour beverage portfolioinclude our 2006 U.S. introductionof Jazz from DietPepsi, a low-calorie, indulgentcola available in two flavors:Black Cherry French Vanillaand Strawberries & Cream.We launched Pepsi Limón inPeru, and in Argentina weintroduce 7UP H2OH!, a drinkthat bridges carbonatedwater drinks with flavoredwater. In the United States,U.S. PepsiCo BeverageDistribution Channels% VolumeFrito-Lay North AmericaDistribution Channels% VolumeLargest PepsiCo BrandsEstimated Worldwide Retail Sales $ in BillionsPepsi-ColaConvenience/Gas/Chilled DSD/Other Small Format17%Canada8%Gatorade Thirst QuencherMountain Dew (diet and regular)Diet PepsiLay’s Potato ChipsMassMerchandiser/Supercenters/Club/Drug/Other23%Restaurant/Foodservice/Vending27%Grocery33%Other 8%Convenience11%Foodservice/Vending 9%Supermarket/Grocery 37%Mass Merchandiser/Warehouse/Club 27%Doritos Tortilla ChipsTropicana Pure Premium Orange JuiceCheetos Cheese Flavored SnacksAquafina Bottled Water7UP (outside U.S.)Lipton TeasQuaker CerealsRuffles Potato ChipsMirindaTostitos Tortilla ChipsSierra Mist (diet and regular)Fritos Corn Chips0 5 10 15 20PepsiCo beverages are distributedby a powerful go-to-market systemthat includes company-ownedoperations, independently-ownedfranchised bottlers and warehousedelivery systems.Frito-Lay North America distributesto nearly 440,000 retail outletseach week.PepsiCo has 17 mega-brands that generate $1 billion or moreeach in annual retail sales.13

267419_L01_P08_15.v2.qxd 3/5/07 10:32 PM Page 14PepsiCo Beverages NorthAmerica CarbonatedSoft Drink Volume vs.Non-Carbonated SoftDrink VolumeNon-CarbonatedSoft Drinks38%PepsiCo Beverages NorthAmerica CarbonatedSoft Drink Revenue vs.Non-Carbonated SoftDrink RevenueNon-CarbonatedSoft Drinks69%Carbonated Soft Drinks62%Carbonated soft drinksgenerate the largest volumes.CarbonatedSoft Drinks31%Non-carbonated beveragesgenerate the largest revenue.we’ve recently extendedAquafina with vitaminfortifiedAquafina Alive, andwe’re now offering TropicanaOrganics and TropicanaEssentials, juices with omega-3’s, the fatty acids known forhelping to promote hearthealth. Our Propel enhancedwater brand, which wasamong the first entries intothe enhanced water category,continues to meet consumerdesires for more healthfuloptions through brandextensions like Propel Calcium.Through our North AmericanCoffee Partnership withStarbucks, we introducedStarbucks Iced Coffee as wellas Strawberries and CrèmeFrappuccino and StarbucksDoubleShot Light.Creating new products isnot the only way we buildbrands. We are experts atcapturing consumer attentionwith our brands. In 2006, wesolidified Pepsi’s popularityamong music fans whenGrammy award-winning artistMariah Carey wrote andrecorded original ringtones forthe Pepsi Cool Tones andMotorola Phones promotion.In international markets, aPepsi advertising campaignincluded an engaging themesong called “DaDaDa” thatcaught on by connectingsoccer fans around the world.We give our brands specialattention. For example, in 2006we unveiled new packagingand a new logo for Doritostortilla chips to communicatethe brand’s powerful crunchand bold flavor. We reformulatedDiet Mountain Dewand gave consumers a tasteduring the largest single-daysampling event in Pepsi history.Similarly, we kicked off thebiggest marketing campaignfor Cheetos in the brand’shistory. And keep your eyeson Fritos corn chips as wecelebrate the brand’s 75thanniversary in 2007 withspecial retro packaging.Mergers andAcquisitionsOur people have the skills topinpoint, acquire and seamlesslyintegrate businesses —big and small. This hasenabled us to successfully addlarge companies, like Quakerand Tropicana, and regularlyadd smaller “tuck-in” dealsthat enhance and expand ourexisting operations. Theseinclude our recent acquisitionsof Izze Beverage Co., NakedJuice, and Stacy’s Pita ChipCompany in the UnitedStates, as well as Star Foodsin Poland, Bluebird Foodsin New Zealand and Duyvisnuts in the Netherlandsand Belgium.We are disciplined buyers,with a rigorous process fordue diligence to ensure thatany potential acquisitionmakes complete sense fromboth a business and culturestandpoint. As diligentintegrators, we have a specialunderstanding of the entrepreneurialnature of smaller“tuck-in” acquisitions andexercise a thoughtfulapproach to helping thesenew businesses preserve andbuild upon their uniquecapabilities, such as the highlevel of involvement Stacy’shas with its consumers. Wenot only sign the deals, butwe are committed to makingthem work.Quaker Oatmeal and Tropicana Pure Premium are important brands inour health and wellness portfolio of products.14

267419_L01_P08_15.v2.qxd 3/4/07 12:03 AM Page 15Our products are known by trusted brand names in each region of the world, such as Sabritas in Mexico.U.S. Liquid RefreshmentBeverage Market Share% Volume in Measured ChannelsOther19%PepsiCo26%Private Label14%Nestlé8%Coca-Cola23%CadburySchweppes10%PepsiCo has the leadingshare of the liquid refreshmentbeverage market.Our Unique CulturePepsiCo’s most important advantage resides in our people and the way we operate. Wework hard to recruit, train, develop and — most of all — retain a diverse team of the bestand brightest. We emphasize results, personal ownership and operational excellence.PepsiCo Net Revenues fromSmart Spot Eligible ProductsU.S. and Canada% Net RevenueOur PeopleOur people representPepsiCo’s ultimate competitiveadvantage. Diversity andinclusion are fundamental toour success. We recognizethat a diverse workforce anda diverse supplier base helpus understand and meet theneeds of our diverse consumerbase. An inclusive atmosphereallows everyone to contributefully, generating new ideasand driving innovation.Our “ownership culture”empowers our associates. Weare a big company that thinkslike a small enterprise. Ourassociates fundamentally seetheir jobs as finding solutionsfor customers and consumersand doing what it takes toexceed their expectations.Most of all, we share aset of PepsiCo Values —represented in a commitmentto deliver sustained growththrough empowered people,operating with responsibilityand building trust.The Way We OperateWe make, move and sell millionsof products every day, whichis why day-to-day operationalexcellence is so critical.Our Business ProcessTransformation (BPT) issimplifying and acceleratingthe speed of our informationtechnology processes. Ourgoal is to make it easier forour retail and other customersto do business with us. Forexample, the BPT efforts willhelp us provide one invoiceto our customers, rather thanmultiple invoices from ourvarious businesses.PepsiCo’s Power of Oneinitiatives continue to bringnew efficiencies to ourrelationships with customers.For example, through“Innovation Summits” withour customers, we deepen ourunderstanding of their needsand can build on the benefitswe bring, with both ourproducts and delivery systemsacross the entire supply chain.Non-Smart Spot57%Smart Spot43%A wide variety of PepsiCoproducts carry the Smart Spotsymbol to identify choices that cancontribute to healthier lifestyles.15

267419_L01_P16_21.v2.qxd 3/4/07 12:15 AM Page 16In 2006, PepsiCo associate volunteers and KABOOM, anot–for–profit organization, built 12 playgrounds in inner citiesto encourage children to be more physically active.16

267419_L01_P16_21.v3.qxd 3/5/07 10:50 PM Page 17PurposeToday’s consumers increasingly view their spending decisions as a way to make adifference in the world. They want to see their values reflected in the products they buyand their communities strengthened by the businesses they support. At PepsiCo, webelieve we are in a perfect position to meet these needs. We strive to do better by doingbetter. In delivering on this commitment, we’ve identified three areas where we believewe can have the most impact: human sustainability, environmental sustainability andtalent sustainability.Human SustainabilityPeople need to be nourished in many ways, ranging from what they eat to how they live. Wecall this human sustainability, and the areas where we can make the greatest difference arethrough the products we offer consumers and through our efforts to encourage consumers toadopt more active lifestyles. As we pursue these priorities, we tap into the deep expertise andcounsel of our Blue Ribbon Health and Wellness Advisory Board, established to help usaddress health and wellness opportunities.ProductsIn the United States, our SmartSpot symbol makes it easier forconsumers to identify ourproducts that are nutritious,can contribute fiber, vitaminsor other important nutrients,or are reduced in fat, sugar orsodium. Products with theSmart Spot symbol meetnutrition criteria based onauthoritative statementsfrom the U.S. Food and DrugAdministration and theNational Academy of Sciencesor provide other functionalbenefits. Today, more than 250of our products carry the SmartSpot symbol. On the frontpanel of the product packagingconsumers see the greenSmart Spot symbol that says“Smart Choices Made Easy.”And on the back of the packagingwe describe what makeseach product a better choice.As new technologies andingredients become available,we’re committed to makingour core products betterchoices. For example, Frito-LayNorth America’s Ruffles andLay’s potato chips and WalkersUnited Kingdom’s snacksreduced the saturated fat intheir leading potato crisp andchip brands by switching tosunflower oil, which deliversimproved nutrition withoutsacrificing taste.The PepsiCo Smart Spot symbol helps consumers select products suchas Baked! Cheetos, which are lower in calories.Active LifestylesWe’re committed to helpingconsumers fight obesity and livehealthier lives by supportingprograms that help themengage in more active lifestyles.Among the programs we’reproud to sponsor is AmericaOn the Move (AOM), a nationaleffort in the United Statesdedicated to helpingindividuals, families andcommunities make positivechanges in their health andquality of life. AOM recommendsmaking small changes,such as walking 2,000 moresteps and consuming 100fewer calories per day, asa way for consumers toincorporate healthy habitsinto their everyday lives andavoid weight gain. TheAfrican American and Latinocommunities face some of thegreatest health risks. That’swhy in partnership with theNational Urban League andthe National Council of La Raza,we're using the messagesand methods of AOM topromote healthier livingamong these constituencies.We believe it is important todevelop the habit of exercisingearly in life so we have manyprograms for young people. Inthe United States, our alliancewith the YMCA, the largestprovider of fitness programs, isexpected to reach more thanOur MissionWe aspire to make PepsiCothe world’s premier consumerproducts company, focused onconvenient foods andbeverages. We seek to producehealthy financial rewards forinvestors as we provideopportunities for growth andenrichment to our employees,our business partners and thecommunities in which weoperate. And in everythingwe do, we strive to act withhonesty, openness, fairnessand integrity.nine million youths. We haveprograms on the local levelas well. For example, inChicago through the ChicagoCommunities in Schools andthe Consortium to LowerObesity in Chicago Children(CLOCC) we are collaboratingon an effort to pilot, test anddeliver a health promotionprogram in six Chicagocommunities and schools.Outside the United States,we support initiatives such asthe Gatorade Schools programin Brazil, which encouragesgood nutrition and physicalactivity. In Mexico, we supporta program to construct recreationalareas in indigenousshelters in order to promotesports in these communities.17

267419_L01_P16_21.v2.qxd 3/4/07 12:15 AM Page 18School ProgramsWe recognize the criticalimportance of helping childrenlearn to make healthy foodchoices. In 2006, PepsiCo wasthe only company to be partof two historic agreements —one for beverages and onefor snacks — to provide schoolsin the United States withproducts that can contributeto healthier lifestyles.Through our partnershipwith the Alliance for aHealthier Generation — ajoint initiative of the WilliamJ. Clinton Foundation and theAmerican Heart Association— we will offer U.S. schoolsproducts that meet specificnutritional guidelines. Underthe beverage guidelines, weno longer will offer full-caloriesoft drinks, juice drinks orteas in any K-12 schools, andwe’ll limit the calories andportion sizes of beverages,including sports drinks andjuices. On the snacks side,we helped set the first-evervoluntary guidelines for whatwill be offered in U.S. schools.Both agreements represent abreakthrough step to adopta practical policy for snack,food and beverage offeringsin U.S. schools.MarketingWe have begun to enlist ourproducts in promoting keyissues. Through the NorthAmerican Coffee Partnership,our joint venture withStarbucks Coffee Company,we entered into an agreementto increase distribution ofEthos Water to retail stores inthe United States. For eachbottle of Ethos Water that issold, a $0.05 donation ismade to help children andtheir communities around theworld get access to cleandrinking water.Frito-Lay’s SunChipsbrand sponsored the KomenRace for the Cure NationalVolunteer RecognitionProgram in the United States.The partnership includedSunChips’ “Crunch for theCure” pink bags, with part ofthe proceeds going to theSusan G. Komen Breast CancerFoundation to support thefight against breast cancer.Through our North American Coffee Partnership, our joint venturewith Starbucks, PepsiCo is working to increase distribution of EthosWater, which will donate $0.05 for every bottle sold to help childrenaround the world get clean drinking water.Environmental SustainabilityEnvironmental sustainability means replenishing resources weuse — on our planet and in the communities we serve. We havedefined our focus areas to be water, packaging and energy. Inour communities we are supporting the fight against HIV/AIDSas well as other philanthropic and volunteer activities.WaterOur water program goalsbegin with making sure ourpractices are responsible. Wework closely with governments,municipalities and technicalexperts when locating ourfacilities to ensure adequatequantity and quality of watersupply. We have programsto reduce our use of waterand reuse water wheneverpossible. Gatorade, for example,is reducing its water useby installing waterless rinsingsystems to clean its bottles.We are focused on findingnew opportunities to savewater. For example, acrossFrito-Lay North America ourwater conservation initiativeshave reduced the quantity ofwater used in processingsnack chips by more than onethirdsince 1999.Where water shortages arean issue, we recognize ourresponsibility to help makesure the communities inwhich we operate have accessto sufficient water. Forexample, in India, PepsiCo issupporting The Energy andResources Institute (TERI) tohelp improve water processesand management. Theseprojects include an evaluationof water resources andpreparation of area-widemanagement plans, includingthe rejuvenation of traditionalwater systems.The PepsiCo Foundation isworking with the ChinaWomen’s DevelopmentFoundation on a researchinitiative to expand availabilityof safe drinking water for thepeople of Western and CentralChina. PepsiCo China’s workwith the Mothers’ Water CellarProject has already broughtwater to thousands of familiesin remote locations by buildingwater storage wells and thecapability to harvest rainwater.18

267419_L01_P16_21.v3.qxd 3/5/07 10:51 PM Page 19Programs with the National Council of La Raza and the NationalUrban League encourage physical activity and healthier eating andaddress health concerns of African American and Latino consumers.Our Ethos Water distributionagreement has a goalof contributing at least $10million by the end of 2010to help children and theircommunities around the worldget clean drinking water. Oursupport of The Safe WaterNetwork, a not-for-profitorganization we helped establish,is focused on developingand deploying new affordablewater purification technologyto provide safe water tocommunities in need.We also share our waterexpertise. In India, for example,we’ve shown farmers techniquesthat save water bydirectly seeding rice paddies,rather than growing the ricethrough highly water-intensiveconventional seeding.PackagingWe are committed to reducing,reusing and recycling our packagingand waste. To help usachieve our goals, we haveestablished a SustainablePackaging Team. Its objectivesinclude developing alternativepackaging material technologiesand supporting responsibledisposal practices.We begin with ouroperations. For example, inthe United States today a20-ounce Gatorade ThirstQuencher bottle weighs10% less and uses 70% lesspackaging to deliver theproduct than the samesize bottle sold in 1998.Tropicana re-engineered theway it delivers apple juiceconcentrate in the UnitedStates. Its move to recyclable“flexi” bags eliminated nearly43,000 steel drums annually.For decades, our snack foodoperations have recoveredstarch released in the potatochip making process. In 2006,our United Kingdom snackfood operation receivedgovernment approval for aprocess that creates foodgradelevel starch, muchof which can be used in ourown products.Recycling is a way of life atPepsiCo. The Frito-Lay directstore-deliverysystem enablesour associates to recoverdelivery cartons after use. Atypical carton makes about sixtrips, eliminating some 60billion pounds of solid waste ayear. We helped found theNational Recycling Partnership,an initiative to increase recyclingacross the United States.And we have supported KeepAmerica Beautiful’s (KAB) GreatAmerican Cleanup, the nation’slargest voluntary clean-upprogram, since its inception.In 2006, Pepsi-Cola NorthAmerica partnered with Sam’sClub and KAB in an innovativeprogram called “Returnthe Warmth.” KAB helpedA Pepsi-Cola North America program with Keep America Beautifuland Sam’s Club encouraged recycling by providing grants to schoolsthat recycled the most beverage containers and donating fleecejackets made with recycled plastic to needy children in the community.Selected 2006Environmental Honors PepsiCo China: fourawards for Mothers’Water Cellar Project. PepsiCo: Vision forAmerica Award from KeepAmerica Beautiful. Frito-Lay North America:Energy Star Partner of theYear from the EnvironmentalProtection Agency (EPA)and the Department ofEnergy (DOE). Frito-Lay San Antonio, Texas:WaterSaver Award. Frito-Lay California:Bakersfield and Modestofacilities won the stateWRAP award for outstandingperformance in reducingsolid waste.communities recycle morethan 36 million beveragebottles. Sam’s Clubs providedschool grants, as well asfleece jackets made withrecycled plastic, for needychildren in the area.Helping to reduce waste isjust as important in ourmarkets outside the UnitedStates. In India, for example,we convert packaging filmwaste to boards, building andfurniture material.EnergyIn 2006, Frito-Lay wasrecognized by the United StatesEnvironmental ProtectionAgency (EPA) and the U.S.Department of Energy (DOE)for energy conservation.The EPA and DOE conferredPartner-of-The-Year in EnergyManagement to Frito-LayNorth America for itsvoluntary efforts to reducegreenhouse gas emissionsthrough energy efficiency.At Tropicana we reducedour electricity demand byeliminating some refrigeration19

267419_L01_P16_21.v2.qxd 3/4/07 12:16 AM Page 20and instead storing juiceblends in aseptic tanks atabove freezing temperatures.The operation also co-generatespower and heat to meetmost of our on-site electricityneeds. Three of our Gatoradeplants capture and reusebiogas, a by-product of watertreatment operations, asboiler fuel.One way we are reducinggreenhouse gas emissions isby using alternative powermore and more. For example,in Cupar, Scotland, our Quakeroat mill is using electricityfrom 100% renewable sources.And at our Frito-Lay plant inModesto, California, we’rebuilding a production line inwhich nearly three-quartersof the heat needed toproduce SunChips brandmultigrain snacks will comefrom solar thermal energy.Our focus extends to thepages you are reading. ThisPepsiCo water programs reach into communities to help address watershortages. In India, programs are bringing water to drought strickenareas and developing water management programs in areas wheremonsoons are common.annual report was made withrecycled paper and “GreenPower,” which means that thepower used in the creation ofsome of the paper was notfrom fossil fuel.HIV/AIDSHIV/AIDS poses a major threatin many places where weoperate, especially in highrisk countries such as SouthAfrica, India, Russia, Chinaand Thailand. Our globalHIV/AIDS policy provides atemplate to help fight thepandemic, and our associateshave joined in the fight. Forexample, in South Africa ourSimba associates serve as PeerEducators in the community.Contributions andCommunity ServiceThrough the PepsiCoFoundation, and our corporateand divisional contributions,we provide financial supportfor not-for-profit organizationsacross the globe. Focus areasinclude health and wellness,diversity and inclusion, theenvironment, employeecommunity engagement andhumanitarian aid in the eventof disaster. Groups looking forsupport can apply on-line atwww.pepsico.com.In-kind donations includefood and beverages donatedto food banks. Our communityoutreach programsinclude community serviceweeks. During our 2006Global Week of CommunityService, more than 1,000associates provided volunteerwork in their communities inthe United States, Mexico andSouth Africa. In Mexico City,for example, Sabritas associatesrepaired the “Casa de losNiños de Palo Solo,” a healthdevelopment center servingapproximately 260 children.Our associates are active intheir communities in innovativeways. In Brazil, an ElmaChips truck has been turnedinto a roving library forchildren. In Vietnam, throughthe Poor Patient’s Association,our associates help economicallydisadvantaged peoplereceive medical care. In Egyptand Lebanon, our businessessupport scholarships to helpyoung people continuetheir education.In India, we’re promotingseaweed farming as a localemployment opportunity forwomen in remote coastalcommunities, who wouldotherwise have to travelgreat distances to find work.Sustainability Time Line1999 Frito-Lay North Americabegins formal resourceconservation program.2001 PepsiCo Environmental TaskForce formed.2002 Carbonated beveragepackaging goal of 10%recycled content inPepsi-Cola NorthAmerica adopted.2003 Global Reporting InitiativeGuidelines adopted.2004 Sustainability TaskForce formed.2005 Environmental ManagementSystem developed.2006 Dow Jones SustainabilityIndex North America namesPepsiCo to list.Selected 2006 Communityand Sustainability Honors International CorporateCourage Award: AIDSResponsibility Project (ARP). Gamesa — Quaker, Mexico:Empresa SocialmenteResponsible. 100 Best CorporateCitizens from BusinessEthics magazine. America’s Most-AdmiredCompanies fromFORTUNE magazine. Dow Jones SustainabilityIndex North America.2006 Contribution SummaryPepsiCoFoundationCorporateContributionsDivisionsEstimated In-KindDonationsTotal$21.9 Million5.2 Million4.2 Million27.2 Million$58.5 Million20

267419_L01_P16_21.v2.qxd 3/4/07 12:16 AM Page 21Talent SustainabilityOur approximately 168,000 PepsiCo associates around theworld are the reason for our success. Recruiting, training andretaining our associates and building a culture of equality,diversity and inclusion allow us to achieve TalentSustainability and demonstrate to our associates that wecherish them.Associates like Israel Perez, a Frito-Lay route sales representative in theNew York City area, are the reason for PepsiCo’s success.AssociatesOur commitment to ourassociates is formalized in ourHuman Rights Policy whichwas introduced in 2006. Ourgoal is to make PepsiCo thecompany that hires, developsand retains the best people— irrespective of race,color, creed, gender orlifestyle orientation.There are many ways weare making this a reality —ranging from how we train,reward and compensate ourassociates to our robust andhistoric diversity and inclusionprograms. Company programshelp associates manage theircareers, train for advancement,increase their knowledge andskills, and participate in lifestyleand personal developmentopportunities. HealthRoads,offered in North America, is ahealth benefits program thatpromotes healthier lifestylesfor our associates and theirfamilies through information,online tools and personalizedwellness coaching. OurSharePower program providesstock options to associatesaround the world andencourages them to act likeowners of the company.Diversity and InclusionTo attract and retain the bestpeople, we seek to create adiverse and inclusive culturewhere everyone has equalopportunity to contributeand to succeed. We haveseveral initiatives to help usin this area. Our Diversity andInclusion Governance Council,formed in 2005, is a crossdivisional,cross-functionalgroup composed of internaland external thought leaders.Its mission is to raise the baron diversity and inclusion.Our Ethnic Advisory Boardsprovide counsel and adviceon business issues rangingfrom marketing our brands tosupporting our employees.Outside North Americawe have a growing numberSpending with U.S.minority–owned andwomen–owned supplierssurpassed $1 billion forthe first time.of programs to promotediversity and inclusion andsupport employees. In theUnited Kingdom and IrelandTimes, for example, we wererated as one of the ”Top 50Places Where Women Wantto Work.“Our focus on diversity isequally strong in our procurementprocesses. We haveteams dedicated to increasingthe diversity of our supplierbase. In 2006, for thefirst time, we surpassed$1 billion in purchases fromU.S. minority-owned andwomen-owned suppliers.For more information, read oursustainability report, visit theCorporate Citizenship section andsee our environmental programsin action at www.pepsico.com.Selected 2006 Diversity and Inclusion Honors America’s Top Corporations for Women’s Business Enterprises:Women’s Business Enterprise National Council (WBENC). Top 50 Companies for Diversity: Diversity, Inc. 40 Best Companies for Diversity: Black Enterprise. National Association of Asian American ProfessionalsConvention: NAAAP Convention Excellence award. Latina Style magazine: The 50 Best Companies for Latinas toWork for in the U.S. Hispanic Business magazine: Top 50 Companies for Hispanics. United Kingdom and Ireland Times: Top 50 Places Where WomenWant to Work. PepsiCo scores 100% on the Corporate Equality Index.U.S. Diversity and Inclusion StatisticsTotal Women % Minority %Board of Directors 14 3 21 4 29Senior Executives 23 4 17 6 26Executives 2,165 696 32 422 19All Managers 12,903 3,919 30 2,903 22All Employees 62,251 15,169 24 18,573 30At year-end we had approximately 168,000 associates worldwide.Our Board of Directors is pictured on page 23. Our Senior Executivesinclude Corporate and Division Officers based in the United States.The list appears on page 22. Beginning this year, we are includingProfessionals in the All Managers category to better capture ourexecutive talent pool.21

267419_L01_P22_26.v3.qxd 3/5/07 11:09 PM Page 22Corporate Officers and Principal Divisions22Executive Offices PepsiCo, Inc.700 Anderson Hill RoadPurchase, NY 10577914-253-2000Co–founder of PepsiCoDonald M. KendallOver 55 years of PepsiCo experience.Corporate OfficersSteven S ReinemundExecutive Chairman and Chairman of the Board of Directors58. 22 years.Indra K. NooyiChairman Elect and Chief Executive Officer51. 13 years.Mitch AdamekSenior Vice President and ChiefProcurement Officer45. 17 years.Peter A. BridgmanSenior Vice President andController54. 21 years.Richard GoodmanChief Financial Officer58. 13 years.Wahid HamidSenior Vice President, CorporateStrategy and Development48. Less than one year.Hugh F. JohnstonExecutive Vice President,Operations45. 19 years.Antonio LucioChief Health and WellnessInnovation Officer47. 11 years.Tod J. MacKenzieSenior Vice President,Corporate Communications49. 19 years.Matthew M. McKennaSenior Vice President, Finance56. 13 years.Margaret D. MooreSenior Vice President,Human Resources59. 33 years.Lionel L. Nowell IIISenior Vice Presidentand Treasurer52. 15 years.Ronald C. ParkerSenior Vice President,Human Resources,PepsiCo North Americaand Senior Vice President,Global Diversity, PepsiCo53. 24 years.Clay G. SmallSenior Vice President,Managing Attorney57. 25 years.Larry D. ThompsonSenior Vice President,Government AffairsGeneral Counsel and Secretary61. 2 years.Cynthia M. TrudellSenior Vice President and ChiefPersonnel Officer53. Less than one year.Michael D. WhiteChief Executive Officer,PepsiCo Internationaland Vice Chairman, PepsiCo55. 17 years.PepsiCo North America700 Anderson Hill RoadPurchase, NY 10577914-253-2000John C. ComptonChief Executive Officer45. 23 years.Division OfficersFrito-Lay North America7701 Legacy DrivePlano, TX 75024972-334-7000Albert P. CareyPresident and Chief Executive Officer55. 25 years.Pepsi-Cola North America700 Anderson Hill RoadPurchase, NY 10577914-253-2000Dawn HudsonPresident and Chief Executive Officer49. 10 years.PepsiCo International700 Anderson Hill RoadPurchase, NY 10577914-253-2000Michael D. WhiteChief Executive Officer, PepsiCo International and Vice Chairman, PepsiCoDivision OfficersPepsiCo Asia20th FloorCaroline Center28 Yun Ping RoadCauseway BayHong Kong852-2839-0288Ron McEachernPresident54. 22 years.PepsiCo Europe50, rue du RhôneCH – 124 GenevaSwitzerland41-22-818-6900Zein AbdallaPresident47. 11 years.PepsiCo Latin AmericaRegion Foods &BeveragesAv. Lázaro Cárdenas 2404 Pte.Col. Residencial San AgustínGarza García, NL66270Mexico52-81-8399-5151Salvador AlvaPresident56. 23 years.PepsiCo MiddleEast & AfricaKhalid Ibn Al Waleed RoadBank of Fujairah Building,3rd FloorPO Box 11330DubaiUnited Arab Emirates971-4-397-1666Saad Abdul–LatifPresident53. 25 years.QTG (Quaker Foods/Tropicana/Gatorade)QTG Plaza555 West Monroe StreetChicago, IL 60661312-821-1000Charles I. ManiscalcoPresident and Chief Executive Officer53. 26 years.PepsiCo Sales700 Anderson Hill RoadPurchase, NY 10577914-253-2000Tom GrecoPresident,Sales48. 20 years.Sabritas & GatoradeBosques de Duraznos No. 67Col. Bosques de las Lomas11700 Mexico D.F.Mexico52-55-2582-3000Pedro PadiernaPresident56. 19 years.PepsiCo UnitedKingdom1600 Arlington Business ParkTheale, ReadingBerkshireRG7 4SA UK44-118-930-6666Salman AminPresident47. 11 years.PepsiCo InternationalCommercial700 Anderson Hill RoadPurchase, NY 10577914-253-2000Massimo d’AmoreExecutive Vice President51. 12 years.

267419_L01_P22_26.v3.qxd 3/5/07 11:07 PM Page 23PepsiCo Board of DirectorsBack row, left to right: Robert E. Allen, John F. Akers, Victor J. Dzau, M. D., Sharon Percy Rockefeller, Daniel Vasella.Second row, left to right: Franklin A. Thomas, Alberto Ibargüen, Michael D. White, Ray L. Hunt, Arthur C. Martinez.Front row, left to right: Steven S Reinemund, Dina Dublon, James J. Schiro, Indra K. Nooyi.PepsiCo Board of DirectorsJohn F. AkersFormer Chairman of the Board andChief Executive Officer,International Business MachinesCorporation72. Elected 1991.Robert E. AllenFormer Chairman of the Board andChief Executive Officer,AT&T Corp.72. Elected 1990.Dina DublonConsultant,Former Executive Vice President andChief Financial Officer,JPMorgan Chase & Co.53. Elected 2005.Victor J. Dzau, M.D.Chancellor for Health Affairs, DukeUniversity and President & CEO, DukeUniversity Health Systems61. Elected 2005.Ray L. HuntChief Executive Officer,Hunt Oil Company, andChairman, Chief Executive Officerand PresidentHunt Consolidated, Inc.63. Elected 1996.Alberto IbargüenPresident and ChiefExecutive Officer,John S. and James L. KnightFoundation63. Elected 2005.Arthur C. MartinezFormer Chairman of the Board,President and Chief Executive Officer,Sears, Roebuck and Co.67. Elected 1999.Indra K. NooyiChairman Elect andChief Executive Officer,PepsiCo51. Elected 2001.Steven S ReinemundExecutive Chairman,and Chairman of the Boardof Directors,PepsiCo58. Elected 1996.Sharon Percy RockefellerPresident and ChiefExecutive Officer,WETA Public Stations62. Elected 1986.James J. SchiroChief Executive Officer,Zurich Financial Services61. Elected 2003.Franklin A. ThomasConsultant,The Study Group72. Elected 1994.Daniel VasellaChairman of the Board andChief Executive Officer,Novartis AG53. Elected 2002.Michael D. WhiteChief Executive Officer,PepsiCo Internationaland Vice Chairman of PepsiCo55. Elected 2006.PepsiCo announced on Feb. 5, 2007, the election of Indra K. Nooyi as Chairman of theBoard, effective when current Chairman Steven S Reinemund retires on May 2, 2007.Listings include age and year elected a PepsiCo director.23

267419_L01_P22_26.v4.qxd 3/6/07 8:54 AM Page 24Ethnic Advisory BoardsOur Ethnic Advisory Boards provide management with external viewpoints on issues related todiversity and inclusion, especially in the marketplace.Board membership is established for external individualsbased on their diverse backgrounds, experiences and points ofview. These boards provide counsel and advice on a range ofbusiness areas including:• Marketing to targeted communities.• Building alliances with retailers.• Creating products for a more diverse consumer base.• Developing a more diverse supplier base and otherbusiness relationships.Back row, left to right: Kweisi Mfume, Keith Clinkscales, Roderick D. Gillum, Reverend Al Sharpton, Earl G. Graves, Jr., Robert Holland,Jerri DeVard, Warren M. Thompson.Front row, left to right: Darlene Williamson, Ph.D., Ray M. Robinson, Reverend Dr. W. Franklyn Richardson, Glenda McNeal, Amy Hilliard,Earl G. Graves, Sr., Dawn Hudson, Benaree Pratt Wiley, Johnny F. Johnson, Clarence Avant.African American Advisory BoardClarence AvantChairman,Interior MusicJoined 1999.Keith ClinkscalesSenior Vice President andGeneral Manager,ESPN PublishingJoined 1999.Jerri DeVardFormer Senior Vice President, BrandManagement and MarketingCommunications,Verizon CommunicationsJoined 2002.Roderick D. GillumVice President, CorporateResponsibility and Diversity,General MotorsJoined 2005.Earl G. Graves, Sr.Chairman and Publisher,Earl G. Graves Ltd.Black Enterprise MagazineJoined 1999.Chairman of the Advisory BoardEarl G. Graves, Jr.President andChief Executive Officer,Black Enterprise MagazineJoined 2006.Amy HilliardPresident and ChiefExecutive Officer,The Hilliard Group &The ComfortCake Co.Joined 1999.Robert HollandPartner,Williams CapitalJoined 1999.Dawn HudsonPresident andChief Executive Officer,Pepsi-Cola North AmericaJoined 1999.Johnny F. JohnsonChief Executive Officer,KA ManagementJoined 1999.Glenda McNealSenior Vice President GlobalPartnerships, American ExpressJoined 1999.Kweisi MfumeFormer President andChief Executive Officer,National Association for theAdvancement of ColoredPeople (NAACP)Joined 2005.Reverend Dr. W. FranklynRichardsonSenior Minister,Grace Baptist ChurchJoined 1999.Ray M. RobinsonPresident,East Lake GolfJoined 1999.Reverend Al SharptonPresident,National Action NetworkJoined 1999.Warren M. ThompsonChairman andChief Executive Officer,Thompson HospitalityCorporation, Inc.Joined 2002.Benaree Pratt WileyRetired President andChief Executive Officer,The PartnershipJoined 2002.Darlene Williamson, Ph.D.Former President andChief Executive Officer,Performax Consulting ServicesJoined 1999.24

267419_L01_P22_26.v2.qxd 3/4/07 12:26 AM Page 25• Promoting PepsiCo’s diversity and inclusion efforts.• Recommending diverse talent for open positions.• Encouraging the expansion of diversity representationamong PepsiCo employees.• Providing a perspective on diversity and inclusionissues or questions.Our African American Advisory Board was formed in 1999. TheLatino/Hispanic Advisory Board was established in 2000. OurCanada business convened an Asian Advisory Council in 2006.We welcome Earl Graves, Jr. to the African AmericanAdvisory Board. We regret the passing of our esteemedmember, Darwin Davis, Sr., who served the board since 1999.To our Latino/Hispanic Advisory Board, we welcomeCid Wilson.Left to right: Isabel Valdés, Cid Wilson, Carlos H. Arce, Ph.D., Deborah Rosado Shaw, Raúl Yzaguirre, Albert P. Carey, Raquel Malo,Douglas X. Patiño, Ph.D., Maria Contreras-Sweet, Carlos A. Saladrigas, Victor Arias, Jr., Ricardo R. Fernández, Ph.D., Gilbert AranzaLatino/Hispanic Advisory BoardGilbert AranzaPresident,Star ConcessionsThe MultiRestaurant GroupJoined 2000.Carlos H. Arce, Ph.D.President and Founder,NuStatsJoined 2000.Victor Arias, Jr.Partner,Heidrick & StrugglesJoined 2000.Albert P. CareyPresident and Chief Executive Officer,Frito-Lay North AmericaJoined 2006.Ricardo R. Fernández, Ph.D.President,Lehman College,The City University of New YorkJoined 2003.Raquel MaloSenior Vice President,High Performance Nutrition,Human Performance InstituteJoined 2004.Douglas X. Patiño, Ph.D.Vice Chancellor Emeritus andProfessor,California State UniversityJoined 2000.Carlos A. SaladrigasChairman,Premier American BankJoined 2003.Deborah Rosado ShawPartner,Multi-ethnic Success Ventures, LLCJoined 2000.Maria Contreras-SweetChairwoman,Proamerica BankJoined 2005.Isabel ValdésConsultant, Author, Public SpeakerJoined 2001.Cid WilsonDirector of Equity Research,Kevin Dann and Partners, LLCJoined 2006.Raúl YzaguirrePresidential Professor,Center for Community Developmentand Civil RightsArizona State UniversityJoined 2000.Chairman of the Advisory Board25

267419_L01_P22_26.v3.qxd 3/5/07 11:03 PM Page 26Blue Ribbon Health and Wellness Advisory BoardPepsiCo’s Blue Ribbon Health and Wellness Advisory Board provides advice and expertiseon a variety of health and wellness initiatives.The initiatives include:• Improving the healthfulness of our existing products.• Evaluating our efforts to develop new better-for-you andgood-for-you products.• Providing access to resources that promote health andencourage active lifestyles.• Identifying emerging opportunities in the area of healthand wellness.• Connecting us to thought leaders and policy makers inthe area of health and wellness.Some of our international businesses are seeking advice in asimilar manner. For example, our Brazilian business hascreated the PepsiCo Panel of Experts. We welcome Dr. WilliamSears to our Board this year.Front row, left to right: Brock H. Leach, Kristy F. Woods, M.D., M.P.H., James O. Hill, Ph.D., Gro Harlem Brundtland, M.D., Susan Love, M.D.Second row, left to right: David Heber, M.D., Ph.D., Pamela Peeke, M.D., M.P. H., Antonio Lucio (PepsiCo), Antonia Demas, Ph.D.,Mario Maranhão, M.D., Janet Taylor, M.D.Back row, left to right: Kenneth Cooper, M.D., M.P.H., Fernando M. Treviño, Ph.D., M.P.H., James B. Hunt, Jr., Dean Ornish, M.D.Ambassador Thomas Foley, David A. Kessler, M.D., J.D., Samuel Ward Casscells, M.D., William Sears, M.D.Gro Harlem Brundtland, M.D.Former Director-GeneralWorld Health Organization,United NationsFormer Prime Minister, NorwayJoined 2004.Ambassador Thomas FoleyAkin Gump Strauss Hauer & Feld, LLPFormer Speaker of the U.S. House ofRepresentatives and Former U.S.Ambassador to JapanJoined 2003.Brock H. LeachSeminary Student &Community VolunteerPepsiCo Chief Innovation and Health &Wellness Officer, RetiredJoined 2003.William Sears, M.D.Associate Clinical Professorof PediatricsUniversity of California, Irvine,School of MedicineJoined 2006.Samuel Ward Casscells, M.D.John Edward Tyson DistinguishedProfessor of Medicine & Public Healthand Vice President for BiotechnologyThe University of Texas Health &Science Center at HoustonJoined 2003.Kenneth H. Cooper, M.D.,M.P.H.President & FounderThe Cooper Aerobics CenterJoined 2003.Antonia Demas, Ph.D.DirectorFood Studies InstituteJoined 2003.David Heber, M.D., Ph.D.Professor of Medicine & Public HealthDirector, UCLA Center forHuman NutritionJoined 2003.James O. Hill, Ph.D.Professor of Pediatrics & MedicineUniversity of Colorado HealthSciences CenterFounder, America On the MoveJoined 2003.Governor James B. Hunt, Jr.Former Governor of North CarolinaJoined 2003.David A. Kessler, M.D., J.D.Dean, School of MedicineVice Chancellor for Medical AffairsUniversity of California, San FranciscoJoined 2003.Susan Love, M.D.President and Medical DirectorDr. Susan Love Research FoundationJoined 2003.Mario Maranhão, M.D.Former PresidentWorld Heart FederationJoined 2004.Dean Ornish, M.D.Founder & DirectorPreventive Medicine ResearchInstitute (PMRI)Joined 2003.Chairman of the Advisory BoardPamela Peeke, M.D., M.P.H.Assistant Professor of MedicineUniversity of Maryland Schoolof MedicineJoined 2003.Janet E. Taylor, M.D.Clinical Instructor of PsychiatryColumbia UniversityJoined 2004.Fernando M. Treviño, Ph.D.,M.P.H.Professor and Founding Dean of theSchool of Public HealthUniversity of North TexasJoined 2004.Kristy F. Woods, M.D.,M.P.H.Former Director, Maya Angelou CenterWake Forest UniversityJoined 2005.26

267419_L01_P27_81.v2.qxd 2/28/07 4:07 PM Page 27Management’s Discussion and AnalysisOUR BUSINESSOur Operations.................................................................... 28Our Customers ..................................................................... 29Our Distribution Network ................................................... 30Our Competition.................................................................. 30Other Relationships ............................................................. 30Our Business Risks................................................................ 31OUR CRITICAL ACCOUNTING POLICIESRevenue Recognition .......................................................... 37Brand and Goodwill Valuations .......................................... 38Income Tax Expense and Accruals....................................... 39Stock-Based Compensation Expense................................... 40Pension and Retiree Medical Plans ..................................... 42OUR FINANCIAL RESULTSItems Affecting Comparability............................................ 44Results of Continuing Operations —Consolidated Review........................................................ 45Results of Continuing Operations — Division Review........ 47Frito-Lay North America .................................................. 48PepsiCo Beverages North America................................... 49PepsiCo International....................................................... 50Quaker Foods North America.......................................... 51Our Liquidity and Capital Resources................................... 52CONSOLIDATED STATEMENT OF INCOME .......................... 54CONSOLIDATED STATEMENT OF CASH FLOWS.................. 55CONSOLIDATED BALANCE SHEET....................................... 56CONSOLIDATED STATEMENT OF COMMONSHAREHOLDERS’ EQUITY ................................................ 57NOTES TO CONSOLIDATED FINANCIAL STATEMENTSNote 1 — Basis of Presentation and Our Divisions........... 58Note 2 — Our Significant Accounting Policies ................. 60Note 3 — Restructuring and Impairment Charges ........... 62Note 4 — Property, Plant and Equipment andIntangible Assets ............................................ 62Note 5 — Income Taxes ..................................................... 64Note 6 — Stock-Based Compensation .............................. 65Note 7 — Pension, Retiree Medical and Savings Plans..... 67Note 8 — Noncontrolled Bottling Affiliates..................... 71Note 9 — Debt Obligations and Commitments................ 72Note 10 — Risk Management ............................................. 73Note 11 — Net Income per Common Share fromContinuing Operations .................................. 75Note 12 — Preferred and Common Stock .......................... 76Note 13 — Accumulated Other Comprehensive Loss......... 76Note 14 — Supplemental Financial Information................ 77MANAGEMENT’S RESPONSIBILITY FORFINANCIAL REPORTING .................................................... 78MANAGEMENT’S REPORT ON INTERNAL CONTROLOVER FINANCIAL REPORTING.......................................... 79REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM.......................................................... 80SELECTED FINANCIAL DATA ................................................ 81RECONCILIATION OF GAAP AND NON-GAAPINFORMATION.................................................................. 82GLOSSARY ........................................................................... 8227

267419_L01_P27_81.v4.qxd 3/5/07 10:11 PM Page 29Our CustomersOur customers include authorizedbottlers and independent distributors,including foodservice distributors, andretailers. We normally grant our bottlersexclusive contracts to sell andmanufacture certain beverage productsbearing our trademarks within a specificgeographic area. Thesearrangements specify the amount to bepaid by our bottlers for concentrate,finished goods and Aquafina royalties,as well as the manufacturing processrequired for product quality.Since we do not sell directly to theconsumer, we rely on and providefinancial incentives to our customers toassist in the distribution and promotionof our products. For our independentdistributors and retailers, these incentivesinclude volume-based rebates,product placement fees, promotionsand displays. For our bottlers, theseincentives are referred to as bottlerfunding and are negotiated annuallywith each bottler to support a variety oftrade and consumer programs, such asconsumer incentives, advertising support,new product support, andvending and cooler equipment placement.Consumer incentives includecoupons, pricing discounts and promotions,such as sweepstakes and otherpromotional offers. Advertising supportis directed at advertising programs andsupporting bottler media. New productsupport includes targeted consumerand retailer incentives and direct marketplacesupport, such aspoint-of-purchase materials, productplacement fees, media and advertising.Vending and cooler equipment placementprograms support the acquisitionand placement of vending machinesand cooler equipment. The nature andtype of programs vary annually. Thelevel of bottler funding is at ourdiscretion because these incentivesare not required by the terms of ourbottling contracts.Since we do not sell directly tothe consumer, we rely on andprovide financial incentives toour customers to assist in thedistribution and promotion ofour products.Retail consolidation continues toincrease the importance of major customers.In 2006, sales to Wal-Martrepresented approximately 9% of ourtotal net revenue; and our top five retailcustomers represented approximately26% of our 2006 North American netrevenue, with Wal-Mart representingapproximately 13%. These percentagesinclude concentrate sales to our bottlerswhich are used in finished goods soldby them to these retailers. In addition,sales to The Pepsi Bottling Group (PBG)represented approximately 10% of ourtotal net revenue. See “Our RelatedParty Bottlers” and Note 8 for moreinformation on our anchor bottlers.Our Related Party BottlersWe have ownership interests in certainof our bottlers. Our ownership is lessthan 50%, and since we do not controlthese bottlers, we do not consolidatetheir results. We include our share oftheir net income based on our percentageof economic ownership in ourincome statement as bottling equityincome. We have designated threerelated party bottlers, PBG,PepsiAmericas, Inc. (PAS) and PepsiBottling Ventures LLC (PBV), as ouranchor bottlers. Our anchor bottlersdistribute approximately 60% of ourNorth American beverage volume andapproximately 18% of our internationalbeverage volume. Our anchor bottlersparticipate in the bottler funding programsdescribed above. Approximately8% of our total 2006 sales incentives arerelated to these bottlers. See Note 8 foradditional information on these relatedparties and related party commitmentsand guarantees.29

267419_L01_P27_81.v2.qxd 2/28/07 4:08 PM Page 34from adverse changes in commodityprices, affecting the cost of our rawmaterials and energy. The raw materialsand energy which we use for the productionof our products are largelycommodities that are subject to pricevolatility and fluctuations in availabilitycaused by changes in global supply anddemand, weather conditions, agriculturaluncertainty or governmentalcontrols. We purchase these materialsand energy mainly in the open market.If commodity price changes result inunexpected increases in raw materialsand energy costs, we may not be ableto increase our prices to offset theseincreased costs without sufferingreduced volume, revenue and operatingincome.Our profitability may also beadversely impacted due to waterscarcity and regulation. Water is a limitedresource in many parts of theworld. As demand for water continuesto increase, we and our business partnersmay face disruption of supply orincreased costs to obtain the waterneeded to produce our products.Our business could suffer if we areunable to compete effectively.Our businesses operate in highly competitivemarkets. We compete againstglobal, regional and private labelmanufacturers on the basis of price,quality, product variety and effectivedistribution. Increased competitionand anticipated actions by our competitorscould lead to downward pressureon prices and/or a decline in our marketshare, either of which couldadversely affect our results. See “OurCompetition” for more informationabout our competitors.Forward-Looking and CautionaryStatementsWe discuss expectations regardingour future performance, such as ourbusiness outlook, in our annual andquarterly reports, press releases, andother written and oral statements.These “forward-looking statements”are based on currently availablecompetitive, financial and economicdata and our operating plans. Theyare inherently uncertain, and investorsmust recognize that events could turnout to be significantly different fromour expectations. We undertake noobligation to update any forward-lookingstatement. The above discussion ofrisks is by no means all inclusive but isdesigned to highlight what we believeare important factors to consider whenevaluating our trends and future results.Market RisksWe are exposed to the market risks arising from adverse changes in:• commodity prices, affecting the cost of our raw materialsand energy,• foreign exchange rates,• interest rates,• stock prices, and• discount rates affecting the measurement of our pensionand retiree medical liabilities.In the normal course of business, wemanage these risks through a variety ofstrategies, including productivity initiatives,global purchasing programs andhedging strategies. Ongoing productivityinitiatives involve the identificationand effective implementation of meaningfulcost saving opportunities orefficiencies. Our global purchasing programsinclude fixed-price purchaseorders and pricing agreements. Ourhedging strategies include the use ofderivatives. Certain derivatives are designatedas either cash flow or fair valuehedges and qualify for hedge accountingtreatment, while others do notqualify and are marked to marketthrough earnings. We do not use derivativeinstruments for trading orspeculative purposes, and we limit ourexposure to individual counterparties tomanage credit risk. The fair value of ourderivatives fluctuates based on marketrates and prices. The sensitivity of ourderivatives to these market fluctuationsis discussed below. See Note 10 for furtherdiscussion of these derivatives andour hedging policies. See “Our CriticalAccounting Policies” for a discussion ofthe exposure of our pension plan assetsand pension and retiree medical liabilitiesto risks related to stock prices anddiscount rates.Inflationary, deflationary andrecessionary conditions impacting thesemarket risks also impact the demandfor and pricing of our products.Commodity PricesOur open commodity derivativecontracts that qualify for hedgeaccounting had a face value of$55 million at December 30, 2006 and$89 million at December 31, 2005. Theopen derivative contracts that qualifyfor hedge accounting resulted in netunrealized gains of less than $1 millionat December 30, 2006 and $39 millionat December 31, 2005. We estimate thata 10% decline in commodity priceswould have reduced our unrealizedgains on open contracts to $2 million ofunrealized losses in 2006 and $35 millionof unrealized gains in 2005.34

267419_L01_P27_81.v4.qxd 3/5/07 10:20 PM Page 35Our open commodity derivative contractsthat do not qualify for hedgeaccounting had a face value of$196 million at December 30, 2006 and$129 million at December 31, 2005. Theopen derivative contracts that do notqualify for hedge accounting resulted innet losses of $28 million in 2006 and$3 million in 2005. We estimate that a10% decline in commodity prices wouldhave increased our net losses on opencontracts to $31 million in 2006 and$4 million in 2005.We expect to be able to continue toreduce the impact of increases in ourraw material and energy costs throughour hedging strategies and ongoingproductivity initiatives.Foreign ExchangeFinancial statements of foreignsubsidiaries are translated into U.S. dollarsusing period-end exchange rates forassets and liabilities and weighted-averageexchange rates for revenues andexpenses. Adjustments resulting fromtranslating net assets are reported as aseparate component of accumulatedother comprehensive loss within shareholders’equity under the captioncurrency translation adjustment.Our operations outside of the U.S.generate approximately 40% of our netrevenue, with Mexico, the UnitedKingdom and Canada comprisingapproximately 20% of our net revenue.As a result, we are exposed to foreigncurrency risks, including unforeseeneconomic changes and political unrest.During 2006, net favorable foreign currency,primarily due to appreciation inthe Canadian dollar and Brazilian real,We do not use derivativeinstruments for trading orspeculative purposes.contributed almost 1 percentage pointto net revenue growth. Currencydeclines which are not offset couldadversely impact our future results.Exchange rate gains or losses relatedto foreign currency transactions are recognizedas transaction gains or losses inour income statement as incurred. Wemay enter into derivatives to manageour exposure to foreign currency transactionrisk. Our foreign currencyderivatives had a total face value of$1.0 billion at December 30, 2006 and$1.1 billion at December 31, 2005. Thecontracts that qualify for hedgeaccounting resulted in net unrealizedlosses of $6 million at December 30,2006 and $9 million at December 31,2005. We estimate that an unfavorable10% change in the exchange rateswould have resulted in unrealized lossesof $86 million in 2006 and $81 million in2005. The contracts not meeting thecriteria for hedge accounting resultedin net losses of $10 million in 2006 andnet gains of $14 million in 2005. Alllosses and gains were offset by changesin the underlying hedged items, resultingin no net impact on earnings.Interest RatesWe centrally manage our debt andinvestment portfolios consideringinvestment opportunities and risks, taxconsequences and overall financingstrategies. We may use interest rate andcross currency interest rate swaps tomanage our overall interest expenseand foreign exchange risk. These instrumentseffectively change the interestrate and currency of specific debtissuances. These swaps are entered intoconcurrently with the issuance of thedebt that they are intended to modify.The notional amount, interest paymentand maturity date of the swaps matchthe principal, interest payment andmaturity date of the related debt. Ourcounterparty credit risk is consideredlow because these swaps are enteredinto only with strong creditworthycounterparties, are generally settled ona net basis and are of relatively shortduration.Assuming year-end 2006 and 2005variable rate debt and investment levels,a 1-percentage-point increase ininterest rates would have decreased netinterest expense by $10 million in 2006and $8 million in 2005.Stock PricesA portion of our deferred compensationliability is tied to certain marketindices and our stock price. We managethese market risks with mutual fundinvestments and prepaid forward contractsfor the purchase of our stock. Thecombined gains or losses on theseinvestments are substantially offset bychanges in our deferred compensationliability.Our Approach to Managing RisksThe achievement of our strategic andoperating objectives will necessarilyinvolve taking risks. Our risk managementprocess is intended to ensure thatrisks are taken knowingly and purposefully.As such, we leverage anintegrated risk managementframework to identify, assess, prioritize,manage, monitor and communicaterisks across the Company. This frameworkincludes:• the PepsiCo Executive Risk Council(PERC), comprised of a crossfunctional,geographically diverse,senior management group whichidentifies, assesses, prioritizes andaddresses strategic and reputationalrisks;• Division Risk Committees (DRCs),comprised of cross-functional seniormanagement teams which meet regularlyeach year to identify, assess,prioritize and address division-specificoperating risks;• PepsiCo’s Risk Management Office,which manages the overall risk managementprocess, provides ongoingguidance, tools and analytical supportto the PERC and the DRCs, identifiesand assesses potential risks, and facilitatesongoing communicationbetween the parties, as well as toPepsiCo’s Audit Committee and Boardof Directors; and• PepsiCo Corporate Audit, which confirmsthe ongoing effectiveness of therisk management framework throughperiodic audit and review procedures.In 2006, we continued to focus ourmitigation efforts where it was determinedthat actions were necessary andappropriate to further reduce PepsiCo’sexposure to risks, integrating thoseefforts in our businesses’ operatingplans and budgets, where accountabil-35

267419_L01_P27_81.v2.qxd 2/28/07 4:08 PM Page 36ity is assigned and performance measured.Some highlights include:• To address certain risks related to thedemand for our products, such asconsumer health concerns aboutproduct attributes and ingredients,we continued to focus on the developmentof products that respond toconsumer trends, including formulatingproducts to lower sugar, fats, andsodium and adding ingredients andnew products that can deliver nutritionalbenefits. For example, at FLNAwe introduced a new portion controlline of 100-calorie offerings, and wealso switched to NuSun sunflower oil,an oil containing 90% mono- andpolyunsaturated fats and lesssaturated fat than most other cookingoils, for our Lay’s and Rufflespotato chips. Internationally, wereduced the amount of saturated fatsin our Walkers crisps in the UnitedKingdom by 70% and the amount ofsalt by 25%. Beyond providing morenutritious product choices, and in aneffort to help address the growingconcerns regarding childhood obesitytrends in the U.S., we joined with theAlliance for a Healthier Generation —a joint initiative of the William J.Clinton Foundation and the AmericanHeart Association — to set voluntarybeverage guidelines for U.S. schoolsthat limit portion sizes and establishvoluntary guidelines for snacks andside items in U.S. schools.• To help ensure that we maintain ourreputation for providing safe convenientfoods and beverages, weenhanced the coordination of ourdivision-led product integrity effortsthrough the PepsiCo Product IntegrityCouncil (PPIC), a cross-functionalforum to share leading practices andconfer about areas of potential risk.Through the PPIC, we completed athird-party review of our food safetyand food security programs whichhelped identify opportunities to betterleverage internal best practicesacross all of our businesses.Furthermore, we enhanced our productsampling and testing protocols.• We continued to enhance our informationtechnology infrastructure andapplication systems by upgrading ournetworks and updating or retiringolder infrastructure and systems. Wesigned a multi-year managed servicescontract to consolidate PI’s technologyinfrastructure into three datacenters and another multi-year servicescontract to provide and managePI’s data network. The data centerservices will provide full system anddata protection and backup andrecovery capabilities, and the datanetwork services will enhancesecurity and provide 24x7x365monitoring and response capabilities.We expect to fully implement both ofthese service contracts over the nextthree years.We continued to focus onleveraging diversity andinclusion, ensuring we have thetalent base necessary to leadour growing businesses.• With respect to our BPT initiative, wecontinue to build on our learningsand incorporate these into the metricsused to monitor the project.Specific actions taken this yearinclude revising the overall projectstructure, project resources and timelines.We also continue to invest inprocess and control resources to builda more automated control environmentthat remains compliant with theSarbanes-Oxley Act.• To address supply chain risks, wecontinued to assess our capability tomitigate potential businessdisruptions and increased the coordinationof our efforts across IT disasterrecovery, crisis management and businesscontinuity. Having recognizedthe potentially significant impact of apandemic such as avian influenza onour employees and our business, weformed a cross-functional, cross-divisionalPandemic Planning Team thatworked to develop strategies andtactics to mitigate that impact.• Against a challenging trade environment,we continued to work toensure consistent and equitable tradepractices across our customers, todeliver value-added product innovationand differentiation, to achievethe most effective trade spend acrosscustomers and channels through productivityprograms, and to moreeffectively communicate to our customersthe economic advantages ofour direct-store-delivery (DSD) system.• To address risks relating to legal andregulatory issues, we have launchedan enhanced PepsiCo Code ofConduct training program in multiplelanguages. We also improved thefunctionality of our employee hotlineto better enable reporting of complianceand ethics concerns andenhanced our process for handlingreported incidents and ensuringappropriate corrective action.Furthermore, we completed environmentaland health & safety auditsthat will help focus our mitigationefforts in these areas going forward.• As part of our ongoing efforts tomaintain a talented workforce, wecontinued to focus on leveragingdiversity and inclusion, designing theright organizational model to meetour business needs and ensuring wehave the talent base necessary to leadour growing businesses. Tactically, weworked to expand the breadth anddepth of our succession plans andreinforced our focus on managingour people through an increasedemphasis on people development aspart of our performance managementprocess.• To manage our risks related to rawmaterials, we continued to reduceour input cost volatility across ourtotal portfolio by employing varioushedging strategies where appropriateand as market opportunities arose.We also continued to utilize our scaleto achieve maximum value across ourcommodity portfolio and to ensureadequate supply. In addition, we havedeveloped strategic global suppliersolutions to help minimize volatility.36

267419_L01_P27_81.v2.qxd 2/28/07 4:08 PM Page 37Our Critical Accounting PoliciesAn appreciation of our critical accounting policies isnecessary to understand our financial results. Thesepolicies may require management to make difficultand subjective judgments regarding uncertainties,and as a result, such estimates may significantly impactour financial results. The precision of these estimates andthe likelihood of future changes depend on a number ofunderlying variables and a range of possible outcomes.Other than our accounting for pension plans, our criticalaccounting policies do not involve the choice betweenalternative methods of accounting. We applied ourOur critical accounting policies arise inconjunction with the following:• revenue recognition,• brand and goodwill valuations,• income tax expense and accruals,• stock-based compensation expense, and• pension and retiree medical plans.critical accounting policies and estimation methods consistently in all material respects, and for all periodspresented, and have discussed these policies with our Audit Committee.In connection with our ongoing BPT initiative, we aligned certain accounting policies across our divisionsin 2005. We conformed our methodology for calculating our bad debt reserves and modified our policy forrecognizing revenue for products shipped to customers by third–party carriers. Additionally, we conformedour method of accounting for certain costs, primarily warehouse and freight. These changes reduced our netrevenue by $36 million and our operating profit by $60 million in 2005.Revenue RecognitionOur products are sold for cash or oncredit terms. Our credit terms, whichare established in accordance with localand industry practices, typically requirepayment within 30 days of delivery inthe U.S., and generally within 30 to 90days internationally, and may allow discountsfor early payment. We recognizerevenue upon shipment or delivery toour customers based on written salesterms that do not allow for a right ofreturn. However, our policy for DSD andchilled products is to remove andreplace damaged and out-of-date productsfrom store shelves to ensure thatconsumers receive the product qualityand freshness they expect. Similarly,our policy for warehouse-distributedproducts is to replace damaged andout-of-date products. Based on our historicalexperience with this practice, wehave reserved for anticipated damagedand out-of-date products. Our bottlershave a similar replacement policyand are responsible for the productsthey distribute.Our policy is to provide customerswith product when needed. In fact, ourcommitment to freshness and productdating serves to regulate the quantity ofproduct shipped or delivered. In addition,DSD products are placed on the shelf byour employees with customer shelfspace limiting the quantity of product.For product delivered through ourother distribution networks, customerinventory levels are monitored.Our credit terms typicallyrequire payment within 30 daysof delivery in the U.S., andgenerally within 30 to 90 daysinternationally.As discussed in “Our Customers,” weoffer sales incentives and discountsthrough various programs to customersand consumers. Sales incentives and discountsare accounted for as a reductionof revenue and totaled $10.1 billion in2006, $8.9 billion in 2005 and $7.8 billionin 2004. Sales incentives includepayments to customers for performingmerchandising activities on our behalf,such as payments for in-store displays,payments to gain distribution of newproducts, payments for shelf space anddiscounts to promote lower retail prices.A number of our sales incentives, such asbottler funding and customer volumerebates, are based on annual targets,and accruals are established during theyear for the expected payout. Theseaccruals are based on contract terms andour historical experience with similarprograms and require managementjudgment with respect to estimatingcustomer participation and performancelevels. Differences between estimatedexpense and actual incentive costs arenormally insignificant and arerecognized in earnings in the periodsuch differences are determined. Theterms of most of our incentive arrangementsdo not exceed a year, andtherefore do not require highly uncer-37

267419_L01_P27_81.v4.qxd 3/5/07 11:14 PM Page 38tain long-term estimates. For interimreporting, we estimate total annualsales incentives for most of our programsand record a pro rata share inproportion to revenue. Certain arrangements,such as fountain pouring rights,may extend beyond one year. The costsincurred to obtain incentive arrangementsare recognized over no longerthan the contract period as a reductionof revenue, and the remaining balancesof $297 million at year-end 2006 and$321 million at year-end 2005 areincluded in current assets and otherassets on our balance sheet.We estimate and reserve for our baddebt exposure based on our experiencewith past due accounts. In 2005, ourmethod of determining the reserveswas conformed across our divisions inconnection with our BPT initiative, asdiscussed above. Bad debt expense isclassified within selling, generaland administrative expenses in ourincome statement.Brand and Goodwill ValuationsWe sell products under a number ofbrand names, many of which weredeveloped by us. The brand developmentcosts are expensed as incurred.We also purchase brands and goodwillin acquisitions. Upon acquisition, thepurchase price is first allocated to identifiableassets and liabilities, includingbrands, based on estimated fair value,with any remaining purchase pricerecorded as goodwill.We believe that a brand has anindefinite life if it has significant marketshare in a stable macroeconomic environmentand a history of strongrevenue and cash flow performancethat we expect to continue for the foreseeablefuture. If these perpetual brandcriteria are not met, brands are amortizedover their expected useful lives,which generally range from five to 40years. Determining the expected life ofa brand requires considerable managementjudgment and is based on anevaluation of a number of factors,including the competitive environment,market share, brand history and themacroeconomic environment of thecountries in which the brand is sold.Perpetual brands and goodwill,including the goodwill that is part ofour noncontrolled bottling investmentbalances, are not amortized. Perpetualbrands and goodwill are assessed forimpairment at least annually. If the carryingamount of a perpetual brandexceeds its fair value, as determinedby its discounted cash flows, animpairment loss is recognized in anamount equal to that excess. Goodwillis evaluated using a two-step impairmenttest at the reporting unit level. Areporting unit can be a division or businesswithin a division. The first stepcompares the book value of a reportingunit, including goodwill, with its fairvalue, as determined by its discountedcash flows. If the book value of areporting unit exceeds its fair value, wecomplete the second step to determinethe amount of goodwill impairmentloss that we should record. In the secondstep, we determine an implied fairWe did not recognize anyimpairment charges forperpetual brands or goodwill inthe years presented.value of the reporting unit’s goodwillby allocating the fair value of thereporting unit to all of the assets andliabilities other than goodwill (includingany unrecognized intangible assets).The amount of impairment loss is equalto the excess of the book value of thegoodwill over the implied fair value ofthat goodwill.Amortizable brands are only evaluatedfor impairment upon a significantchange in the operating or macroeconomicenvironment. If an evaluation ofthe undiscounted future cash flowsindicates impairment, the asset is writtendown to its estimated fair value,which is based on its discounted futurecash flows.Considerable management judgmentis necessary to evaluate the impact ofoperating and macroeconomic changesand to estimate future cash flows.Assumptions used in our impairmentevaluations, such as forecasted growthrates and our cost of capital, are basedon the best available market informationand are consistent with our internalforecasts and operating plans. Theseassumptions could be adverselyimpacted by certain of the risksdiscussed in “Our Business Risks.”We did not recognize anyimpairment charges for perpetualbrands or goodwill in the yearspresented. As of December 30, 2006, wehad $5.8 billion of perpetual brandsand goodwill, of which approximately65% related to Tropicana and Walkers.38

267419_L01_P27_81.v2.qxd 2/28/07 4:08 PM Page 39Income Tax Expense and AccrualsOur annual tax rate is based on ourincome, statutory tax rates and taxplanning opportunities available to usin the various jurisdictions in which weoperate. Significant judgment isrequired in determining our annual taxrate and in evaluating our tax positions.We establish reserves when, despite ourbelief that our tax return positions arefully supportable, we believe that certainpositions are subject to challengeand that we may not succeed. Weadjust these reserves, as well as therelated interest, in light of changingfacts and circumstances, such as theprogress of a tax audit. See Note 5 foradditional information regarding ourtax reserves.An estimated effective tax rate for ayear is applied to our quarterly operatingresults. In the event there is asignificant or unusual item recognizedin our quarterly operating results, thetax attributable to that item isseparately calculated and recorded atthe same time as that item. We considerthe tax benefits from the resolution ofprior year tax matters to be such items.In 2006, we recognized non-cash taxbenefits of $602 million (the “2006 TaxAdjustments”), substantially all ofwhich related to the Internal RevenueService’s (IRS) examination of our consolidatedincome tax returns for theyears 1998 through 2002. The IRS issueda Revenue Agent’s Report (RAR), andwe are in agreement with their conclusion,except for one matter which wecontinue to dispute. The agreed adjustmentsrelate to transfer pricing andvarious other transactions, includingcertain acquisitions, the public offeringof PBG, as well as the restructuring ofour international snack foodsoperations during that audit period.Tax law requires items to be includedin our tax returns at different times thanthe items are reflected in our financialstatements. As a result, our annual taxrate reflected in our financial statementsis different than that reported inour tax returns (our cash tax rate). Someof these differences are permanent,such as expenses that are not deductiblein our tax return, and some differencesreverse over time, such as depreciationexpense. These temporary differencescreate deferred tax assets and liabilities.Deferred tax assets generally representitems that can be used as a tax deductionor credit in our tax returns in futureyears for which we have alreadyrecorded the tax benefit in our incomestatement. We establish valuationallowances for our deferred tax assetswhen we believe expected future taxableincome is not likely to support theuse of a deduction or credit in that taxjurisdiction. Deferred tax liabilities generallyrepresent tax expense recognizedin our financial statements for whichpayment has been deferred, or expensefor which we have already taken adeduction in our tax return but have notyet recognized as expense in our financialstatements.The American Jobs Creation Act of2004 (AJCA) created a one-time incentivefor U.S. corporations to repatriateundistributed international earnings byproviding an 85% dividends receiveddeduction. In 2005, we repatriatedapproximately $7.5 billion in earningspreviously considered indefinitely reinvestedoutside the U.S. and recordedincome tax expense of $460 millionrelated to this repatriation. Other thanthe earnings repatriated, we intend tocontinue to reinvest earnings outsidethe U.S. for the foreseeable future and,therefore, have not recognized any U.S.tax expense on these earnings. AtDecember 30, 2006, we had approximately$10.8 billion of undistributedinternational earnings.In 2006, our annual tax rate was19.3% compared to 36.1% in 2005 asdiscussed in “Other ConsolidatedResults.” The tax rate in 2006 decreased16.8 percentage points primarily reflectingthe 2006 Tax Adjustments, theabsence of the 2005 AJCA tax chargeand the resolution of certain stateincome tax audits in the current year. In2007, our annual tax rate is expected tobe 27.7%, primarily reflecting theabsence of the 2006 Tax Adjustments.39

267419_L01_P27_81.v4.qxd 3/5/07 11:16 PM Page 40Stock–Based Compensation ExpenseWe believe that we will achieve ourbest results if our employees act and arerewarded as business owners. Therefore,we believe stock ownership andstock-based incentive awards are thebest way to align the interests ofemployees with those of our shareholders.A majority of our employeesparticipate in our stock-based compensationprograms. Stock option grantsare made at the current stock price,meaning each employee’s exercise priceis equivalent to our stock price on thedate of grant. Employees must generallyprovide three additional years ofservice to earn the grant, referred to asthe vesting period. Our options generallyhave a 10-year term, which meansour employees would have up to sevenyears after the vesting period to elect topay the exercise price to purchase oneshare of our stock for each option exercised.Employees benefit from stockoptions to the extent our stock priceappreciates above the exercise priceafter vesting and during the term ofthe grant. There have been no reductionsto the exercise price of previouslyissued awards, and any repricing ofawards would require approval ofour shareholders.Executives who are awarded longtermincentives based on theirperformance are offered the choice ofstock options or restricted stock units(RSUs). Executives who elect RSUsreceive one RSU for every four stockoptions that would have otherwisebeen granted. Senior officers do nothave a choice and are granted 50%stock options and 50% RSUs. RSUexpense is based on the fair value ofPepsiCo stock on the date of grant andis amortized over the vesting period,generally three years. Each RSU is settledin a share of our stock after thevesting period. Vesting of RSU awardsfor senior officers is contingent uponthe achievement of pre-established performancetargets.We also continued, as we have since1989, to grant an annual award of stockoptions to all eligible employees, basedon job level or classification, under ourbroad-based stock option program,SharePower. SharePower awards generallyhave a 10-year term and vest overthree years.Method of AccountingWe account for our employee stockoptions, which include grants underour executive program and broadbasedSharePower program, under thefair value method of accounting usinga Black-Scholes valuation model tomeasure stock option expense at thedate of grant. All stock grants have anexercise price equal to the fair marketvalue of our common stock on the dateof grant. The fair value of stock optiongrants is amortized to expense over thevesting period.On January 1, 2006, we adopted SFAS 123R,Share-Based Payment. Since we had previouslyaccounted for our stock-based compensationunder the fair value method, our adoption didnot significantly impact our financial position orour results of operations.On January 1, 2006, we adoptedStatement of Financial AccountingStandards (SFAS) 123R, Share-BasedPayment, under the modified prospectivemethod. Since we had previouslyaccounted for our stock-based compensationplans under the fair valueprovisions of SFAS 123, our adoption didnot significantly impact our financialposition or our results of operations.Under SFAS 123R, actual tax benefitsrecognized in excess of tax benefits previouslyestablished upon grant arereported as a financing cash inflow.Prior to adoption, such excess tax benefitswere reported as an operatingcash inflow.Our divisions are held accountablefor stock-based compensation expenseand, therefore, this expense is allocatedto our divisions as an incrementalemployee compensation cost. The allocationof stock-based compensationexpense in 2006 was approximately28% to FLNA, 19% to PBNA, 32% to PI,4% to QFNA and 17% to corporateunallocated expenses. The expenseallocated to our divisions excludes anyimpact of changes in our Black-Scholesassumptions during the year whichreflect market conditions over whichdivision management has no control.Therefore, any variances between allocatedexpense and our actual expenseare recognized in corporateunallocated expenses.40

267419_L01_P27_81.v2.qxd 2/28/07 4:08 PM Page 41Our AssumptionsOur Black-Scholes model estimates the expected value our employees willreceive from the options based on a number of assumptions, such as interestrates, employee exercises, our stock price and dividend yield. Our weightedaveragefair value assumptions include:Estimated 2007 2006 2005 2004Expected life 6 yrs. 6 yrs. 6 yrs. 6 yrs.Risk free interest rate 5.7% 4.5% 3.8% 3.3%Expected volatility 18% 18% 23% 26%Expected dividend yield 1.9% 1.9% 1.8% 1.8%The expected life is a significantassumption as it determines the periodfor which the risk free interest rate,volatility and dividend yield must beapplied. The expected life is the periodover which our employee groups areexpected to hold their options. It isbased on our historical experience withsimilar grants. The risk free interest rateis based on the expected U.S. Treasuryrate over the expected life. Volatilityreflects movements in our stock priceover the most recent historical periodequivalent to the expected life.Dividend yield is estimated over theexpected life based on our stated dividendpolicy and forecasts of net income,share repurchases and stock price.2007 Estimated Expense and Sensitivity of AssumptionsOur stock-based compensation expense, including RSUs, is as follows:Estimated 2007 2006 2005Stock-based compensation expense $271 $270 $311If we assumed a 100-basis-point change in the following assumptions, our estimated2007 stock-based compensation expense would increase/(decrease) as follows:100-Basis-Point Increase 100-Basis-Point DecreaseRisk free interest rate $6 $(6)Expected volatility $1 $(1)Expected dividend yield $(9) $10If the expected life were assumed tobe one year longer, our estimated 2007stock-based compensation expensewould increase by $7 million. If theexpected life were assumed to be oneyear shorter, our estimated 2007 stockbasedcompensation expense woulddecrease by $8 million. As noted, changingthe assumed expected life impactsall of the Black-Scholes valuationassumptions as the risk free interestrate, expected volatility and expecteddividend yield are estimated over theexpected life.41

267419_L01_P27_81.v2.qxd 2/28/07 4:08 PM Page 42Pension and Retiree Medical PlansOur pension plans cover full-timeemployees in the U.S. and certain internationalemployees. Benefits aredetermined based on either years ofservice or a combination of years of serviceand earnings. U.S. and Canadaretirees are also eligible for medical andlife insurance benefits (retiree medical)if they meet age and servicerequirements. Generally, our share ofretiree medical costs is capped at specifieddollar amounts that vary basedupon years of service, with retirees contributingthe remainder of the cost.On December 30, 2006, we adoptedSFAS 158, Employers’ Accounting forDefined Benefit Pension and OtherPostretirement Plans — an amendmentof FASB Statements No. 87, 88, 106, and132(R) (SFAS 158). SFAS 158 requiresthat we recognize the overfunded orunderfunded status of our pension andretiree medical plans (our Plans) as anasset or liability on our December 30,2006 balance sheet. Subsequentchanges in the funded status will berecognized in comprehensive income inthe year in which they occur. SFAS 158also requires that, beginning in 2008,our assumptions used to measure ourannual pension and retiree medicalexpenses be determined as of the balancesheet date, and all plan assets andliabilities be reported as of that date.Currently, the assumptions used to measureour annualpension and retireemedical expenses aredetermined as ofSeptember 30 (measurementdate) andall plan assets andliabilities are generallyreported as of that date. Inaccordance with SFAS 158, prior yearamounts have not been adjusted. Forfurther information regarding the impactof our adoption of SFAS 158, see Note 7.Our AssumptionsThe determination of pension andretiree medical plan obligations andrelated expenses requires the use ofassumptions to estimate the amount ofthe benefits that employees earn whileworking, as well as the present value ofthose benefits. Annual pension andretiree medical expense amounts areprincipally based on four components:1) the value of benefits earned byemployees for working during the year(service cost), 2) increase in the liabilitydue to the passage of time (interestcost), and 3) other gains and losses asdiscussed below, reduced by 4) expectedreturn on plan assets for ourfunded plans.Significant assumptions used to measureour annual pension and retireemedical expenses include:• the interest rate used to determinethe present value of liabilities(discount rate);• certain employee-related factors,such as turnover, retirement ageand mortality;• for pension expense, the expectedreturn on assets in our funded plansand the rate of salary increases forplans where benefits are based onearnings; and• for retiree medical expense, healthcare cost trend rates.Our assumptions reflect our historicalexperience and management’s bestjudgment regarding future expectations.Due to the significant managementSFAS 158 requires that we recognize theoverfunded or underfunded status of our pensionand retiree medical plans as an asset or liabilityon our December 30, 2006 balance sheet.judgment involved, our assumptionscould have a material impact on themeasurement of our pension andretiree medical benefit expensesand obligations.At each measurement date, the discountrate is based on interest rates forhigh-quality, long-term corporate debtsecurities with maturities comparable tothose of our liabilities. In the U.S., weuse the Moody’s Aa Corporate Indexyield and adjust for differencesbetween the average duration of thebonds in this Index and the averageduration of our benefit liabilities, basedupon a published index.The expected return on pension planassets is based on our historical experience,our pension plan investmentstrategy and our expectations for longtermrates of return. Our pension planinvestment strategy is reviewed annuallyand is established based upon planliabilities, an evaluation of market conditions,tolerance for risk, and cashrequirements for benefit payments. Weuse a third-party advisor to assist us indetermining our investment allocationand modeling our long-term rate ofreturn assumptions. Our current investmentallocation target for our U.S.plans is 60% in equity securities, withthe balance in fixed income securities.Our expected long-term rate of returnon U.S. plan assets is 7.8%, reflectingestimated long-term rates of return of9.3% from equity securities and 5.8%from fixed income securities. We use amarket-related value method that recognizeseach year’s asset gain or lossover a five-year period. Therefore, ittakes five years for the gain or loss fromany one year to be fully included in theother gains and losses calculationdescribed below.Other gains and losses resulting fromactual experience differing from ourassumptions and from changes in ourassumptions are also determined ateach measurement date. If this netaccumulated gain or loss exceeds 10%of the greater of plan assets or liabilities,a portion of the net gain or loss isincluded in expense for the followingyear. The cost or benefit of planchanges that increase or decrease benefitsfor prior employee service (priorservice cost/(credit)) is included in earningson a straight-line basis over theaverage remaining service period ofthose employees expected to benefit,which is approximately 11 years forpension expense and approximately13 years for retiree medical.42

267419_L01_P27_81.v5.qxd 3/6/07 2:55 PM Page 43Weighted-average assumptions for pension and retiree medical expenses areas follows:2007 2006 2005PensionExpense discount rate 5.7% 5.6% 6.1%Expected rate of return on plan assets 7.7% 7.7% 7.8%Expected rate of salary increases 4.5% 4.4% 4.3%Retiree medicalExpense discount rate 5.8% 5.7% 6.1%Current health care cost trend rate 9.0% 10.0% 11.0%Future ExpenseThe estimated changes in pension and retiree medical expense are as follows:Pension Retiree Medical2006 expense $417 $127Increase in discount rate (15) (2)(Decrease)/Increase in experience loss amortization (1) 1Impact of contributions (2) –Other (3) 42007 estimated expense $396 $130Pension and retiree medical servicecosts, measured at a fixed discount ratebut including the effect of demographicassumption changes, as well as theeffects of gains and losses due to demographics,are reflected in division resultsfor North American employees. Divisionresults also include interest costs, measuredat a fixed discount rate, forretiree medical plans. Interest costs forthe pension plans, measured at a fixeddiscount rate, and the effect of changesin discount rates, gains and losses otherthan those due to demographics, pensionasset returns and the impact ofpension funding are all reflected in corporateunallocated expenses.Based on our current assumptions,which reflect our prior experience, currentplan provisions and expectations forfuture experience, we expect our pensionexpense to decrease slightly in 2008,declining to approximately $360 millionby 2012 as unrealized losses are amortized.If our assumptions and our planprovisions for retiree medical costsremain unchanged and our experiencemirrors these assumptions, we expect ourannual retiree medical expense beyond2007 to approximate $130 million.Sensitivity of AssumptionsA decrease in the discount rate or in theexpected rate of return assumptionswould increase pension expense. Theestimated impact of a 25-basis-pointdecrease in the discount rate on 2007pension expense is an increase ofapproximately $37 million. Theestimated impact on 2007 pensionexpense of a 25-basis-point decrease inthe expected rate of return is anincrease of approximately $16 million.See Note 7 regarding the sensitivityof our retiree medical cost assumptions.Future FundingWe make contributions to pensiontrusts maintained to provide plan benefitsfor certain pension plans. Thesecontributions are made in accordancewith applicable tax regulations thatprovide for current tax deductions forour contributions, and taxation to theemployee only upon receipt of planbenefits. Generally, we do not fund ourpension plans when our contributionswould not be currently deductible.Our pension contributions for 2006were $59 million, all of which werenon-discretionary. In 2007, we expect tomake contributions of up to $150 millionwith up to $75 million expected tobe discretionary. Our cash payments forretiree medical are estimated to beapproximately $85 million in 2007. Asour retiree medical plans are notsubject to regulatory funding requirements,we fund these plans on apay-as-you-go basis. For estimatedfuture benefit payments, including ourpay-as-you-go payments as well asthose from trusts, see Note 7.Recent Accounting PronouncementsIn September 2006, the SEC issued StaffAccounting Bulletin No. 108, Consideringthe Effects of Prior Year Misstatementswhen Quantifying Misstatements inCurrent Year Financial Statements (SAB108), to address diversity in practice inquantifying financial statementmisstatements. SAB 108 requires thatwe quantify misstatements based ontheir impact on each of our financialstatements and related disclosures. OnDecember 30, 2006, we adopted SAB108. Our adoption of SAB 108 did notimpact our financial statements.In July 2006, the Financial AccountingStandards Board (FASB) issued FASBInterpretation No. 48, Accounting forUncertainty in Income Taxes—an interpretationof FASB Statement No. 109(FIN 48), which clarifies the accountingfor uncertainty in tax positions. FIN 48requires that we recognize in our financialstatements, the impact of a taxposition, if that position is more likelythan not of being sustained on audit,based on the technical merits of theposition. The provisions of FIN 48 areeffective as of the beginning of our2007 fiscal year, with the cumulativeeffect of the change in accounting principlerecorded as an adjustment toopening retained earnings. We do notexpect our adoption of FIN 48 to materiallyimpact our financial statements.In September 2006, the FASB issuedSFAS 157, Fair Value Measurements(SFAS 157), which defines fair value,establishes a framework for measuringfair value, and expands disclosures aboutfair value measurements. The provisionsof SFAS 157 are effective as of the beginningof our 2008 fiscal year. We arecurrently evaluating the impactof adopting SFAS 157 on ourfinancial statements.43

267419_L01_P27_81.v2.qxd 2/28/07 4:08 PM Page 44Our Financial ResultsItems Affecting ComparabilityThe year-over-year comparisons of our financial results are affected by the following items:2006 2005Net revenue53rd week........................................................................................................................................ – $418Operating profit2006 restructuring and impairment charges................................................................................. $(67) –53rd week........................................................................................................................................ – $752005 restructuring charges............................................................................................................. – $(83)Net income2006 restructuring and impairment charges................................................................................. $(43) –2006 Tax Adjustments..................................................................................................................... $602 –PepsiCo share of PBG tax settlement............................................................................................. $18 –AJCA tax charge .............................................................................................................................. – $(460)53rd week........................................................................................................................................ – $572005 restructuring charges............................................................................................................. – $(55)Net income per common share — diluted2006 restructuring and impairment charges................................................................................. $(0.03) –2006 Tax Adjustments..................................................................................................................... $0.36 –PepsiCo share of PBG tax settlement............................................................................................. $0.01 –AJCA tax charge .............................................................................................................................. – $(0.27)53rd week........................................................................................................................................ – $0.032005 restructuring charges............................................................................................................. – $(0.03)For the items affecting our 2004 results, see Notes 3 and 5, as well as our 2005 Annual Report.53rd weekIn 2005, we had an additional week ofresults (53rd week). Our fiscal year endson the last Saturday of each December,resulting in an additional week ofresults every five or six years.2006 Restructuring andImpairment ChargesIn 2006, we incurred a charge of$67 million in conjunction with consolidatingthe manufacturing network atFLNA by closing two plants in the U.S.,and rationalizing other assets, toincrease manufacturing productivityand supply chain efficiencies.2005 Restructuring ChargesIn 2005, we incurred restructuringcharges of $83 million to reduce costs inour operations, principally throughheadcount reductions.2006 Tax AdjustmentsIn 2006, we recognized non-cash taxbenefits of $602 million, substantiallyall of which related to the IRS’s examinationof our consolidated tax returnsfor the years 1998 through 2002.PepsiCo Share of PBG Tax SettlementIn 2006, the IRS concluded its examinationof PBG’s consolidated income taxreturns for the years 1999 through 2000(PBG’s Tax Settlement). Consequently, anon-cash benefit of $21 million wasincluded in bottling equity income aspart of recording our share of PBG’sfinancial results.AJCA Tax ChargeIn 2005, we repatriated approximately$7.5 billion in earnings previously consideredindefinitely reinvested outsidethe U.S. in connection with the AJCAand recorded income tax expense of$460 million related to this repatriation.44

267419_L01_P27_81.v4.qxd 3/6/07 7:13 AM Page 45Results of Continuing Operations — Consolidated ReviewIn the discussions of net revenue andoperating profit below, effective netpricing reflects the year–over–yearimpact of discrete pricing actions,sales incentive activities and mixresulting from selling varyingproducts in different package sizesand in different countries.ServingsSince our divisions each use differentmeasures of physical unit volume (i.e.,kilos, gallons, pounds and case sales), acommon servings metric is necessary toreflect our consolidated physical unitvolume. Our divisions’ physical volumemeasures are converted into servingsbased on U.S. Food and DrugAdministration guidelines for singleservingsizes of our products.In 2006, total servings increased5.5% over the prior year, as servings forbeverages worldwide grew over 6%and servings for snacks worldwide grew5%. All of our divisions positively contributedto the total servings growth. In2005, total servings increased 7% comparedto 2004, as servings for beveragesworldwide grew over 7% and servingsfor snacks worldwide grew 6%.Net Revenue and Operating Profit2006Net revenue increased 8% primarilyreflecting higher volume and positiveeffective net pricing across all divisions.The volume gains and the effective netpricing each contributed 3 percentagepoints to net revenue growth. Acquisitionscontributed 1 percentage pointand foreign exchange contributedalmost 1 percentage point to net revenuegrowth. The absence of the prioryear’s additional week reduced net revenueby over 1 percentage point andreduced volume growth by almost1 percentage point.Total operating profit increased 9%and margin increased 0.1 percentagepoints. The operating profit gains reflectthe net revenue growth, partially offsetby the impact of higher raw materialand energy costs across all divisions. Theabsence of the prior year’s additionalweek reduced operating profit growthby over 1 percentage point.2005Net revenue increased 11% reflecting,across all divisions, increased volume,favorable effective net pricing and netfavorable foreign currency movements.The volume gains contributed 6 percentagepoints, the effective net pricingcontributed 3 percentage points andthe net favorable foreign currencymovements contributed over 1 percentagepoint. The 53rd week contributedover 1 percentage point to revenuegrowth and almost 1 percentage pointto volume growth.Total operating profit increased 13%and margin increased 0.2 percentagepoints. The operating profit gains primarilyreflect leverage from the revenuegrowth, partially offset by higher sellingand distribution (S&D) expenses andincreased cost of sales, largely due tohigher raw materials, energy and S&Dlabor costs, as well as higher advertisingand marketing expenses. Total operatingprofit margin also benefited from afavorable comparison to prior yearrestructuring and impairment charges.The additional week in 2005 contributedover 1 percentage point to total operatingprofit growth.Corporate Unallocated ExpensesCorporate unallocated expenses includethe costs of our corporate headquarters,centrally-managed initiatives, suchChange2006 2005 2004 2006 2005Total net revenue $35,137 $32,562 $29,261 8% 11%Operating profitFLNA $2,615 $2,529 $2,389 3% 6%PBNA 2,055 2,037 1,911 1% 7%PI 1,948 1,607 1,323 21% 21%QFNA 554 537 475 3% 13%Corporate unallocated (733) (788) (689) (7)% 14%Restructuring andimpairment charges – – (150)Total operating profit $6,439 $5,922 $5,259 9% 13%Total operatingprofit margin 18.3% 18.2% 18.0% 0.1 0.2as our BPT initiative in North America,unallocated insurance and benefit programs,foreign exchange transactiongains and losses, and certain commodityderivative gains and losses, as well asprofit-in-inventory elimination adjustmentsfor our noncontrolled bottlingaffiliates and certain other items.In 2006, corporate unallocatedexpenses decreased $55 million primarilyreflecting the absence of anon-recurring charge of $55 million inthe prior year to conform our methodof accounting across all divisions, primarilyfor warehouse and freight costs.Higher costs associated with our BPTinitiative of $35 million, as well as theunfavorable comparison to the prioryear’s $25 million gain in connectionwith the settlement of a class action45

267419_L01_P27_81.v3.qxd 3/2/07 4:35 PM Page 46lawsuit related to our purchases of highfructose corn syrup from 1991 to 1995,were offset by the favorable impact ofcertain other corporate items.In 2005, corporate unallocatedexpenses increased 14%. This increaseprimarily reflects higher costs associatedwith our BPT initiative whichcontributed 7 percentage points,increased support behind health andwellness and innovation initiativeswhich contributed 5 percentage points,and Corporate departmental expensesand restructuring charges which eachcontributed 2 percentage points to theincrease. In 2005, items of a non-recurringnature included charges of$55 million to conform our method ofaccounting across all divisions, primarilyfor warehouse and freight costs, and again of $25 million in connection withthe settlement of a class action lawsuitrelated to our purchases of high fructosecorn syrup from 1991 to 1995. In2004, we recorded a charge of $50 millionfor the settlement of a contractualdispute with a former business partner.Other Consolidated ResultsBottling equity income includes ourshare of the net income or loss of ournoncontrolled bottling affiliates asdescribed in “Our Customers.” Ourinterest in these bottling investmentsmay change from time to time. Anygains or losses from these changes, aswell as other transactions related to ourbottling investments, are also includedon a pre-tax basis. We continue to sellshares of PBG stock to reduce our ownershipto the level at the time of PBG’sinitial public offering, since our ownershiphas increased as a result of PBG’sshare repurchase program. We sold10.0 million and 7.5 million shares ofPBG stock in 2006 and 2005,respectively. The resulting lower ownershippercentage reduces the equityincome from PBG that we recognize.2006Bottling equity income increased 11%primarily reflecting a $186 million pretaxgain on our sale of PBG stock, whichcompared favorably to a $126 millionpre-tax gain in the prior year. The noncashgain of $21 million from our shareof PBG’s Tax Settlement was fully offsetby lower equity income from ouranchor bottlers in the current year,primarily resulting from the impact oftheir respective adoptions of SFAS 123Rin 2006.Net interest expense decreased 33%primarily reflecting higher averagerates on our investments and lowerdebt balances, partially offset by lowerinvestment balances and the impact ofhigher average rates on our borrowings.The tax rate decreased 16.8 percentagepoints compared to prior yearprimarily reflecting the 2006 TaxAdjustments, the absence of the 2005AJCA tax charge and the resolution ofcertain state income tax audits in thecurrent year.Net income increased 38% and therelated net income per share increased40%. These increases primarily reflectthe 2006 Tax Settlement, the absence ofthe AJCA tax charge and our solid operatingprofit growth.2005Bottling equity income increased 46%reflecting $126 million of pre-tax gainson our sales of PBG stock, as well asstronger bottler results.Net interest expense increased 4%reflecting the impact of higher debtlevels, substantially offset by higherinvestment rates and cash balances.The tax rate increased 11.4 percentagepoints reflecting the $460 millionAJCA tax charge, as well as the absenceChange2006 2005 2004 2006 2005Bottling equity income $616 $557 $380 11% 46%Interest expense, net $(66) $(97) $(93) (33)% 4%Annual tax rate 19.3% 36.1% 24.7%Net income — continuingoperations $5,642 $4,078 $4,174 38% (2)%Net income per commonshare — continuingoperations — diluted $3.34 $2.39 $2.41 40% (1)%of income tax benefits of $266 millionrecorded in 2004 related to a reductionin foreign tax accruals following theresolution of certain open tax itemswith foreign tax authorities and arefund claim related to prior U.S. taxsettlements. This increase was partiallyoffset by increased international profitwhich is taxed at a lower rate.Net income from continuing operationsdecreased 2% and the related netincome per common share from continuingoperations decreased 1%. Thesedecreases reflect the impact of the taxitems discussed above, partially offsetby our operating profit growth,increased bottling equity income, whichincludes the gain on our PBG stock sale,the impact of the 53rd week, a favorablecomparison to prior yearrestructuring and impairment charges,and for net income per share, theimpact of our share repurchases.46

267419_L01_P27_81.v4.qxd 3/6/07 7:19 AM Page 47Results of Continuing Operations — Division ReviewThe results and discussions below are based on how our Chief Executive Officer monitors the performanceof our divisions. For additional information on these items and our divisions, see Note 1.FLNA PBNA PI QFNA TotalNet Revenue, 2006 ............................................................ $10,844 $9,565 $12,959 $1,769 $35,137Net Revenue, 2005............................................................. $10,322 $9,146 $11,376 $1,718 $32,562% Impact of:Volume ............................................................................... 1% 3% (a) 6% (a) 1% 3%Effective net pricing .......................................................... 3 1 4 2 3Foreign exchange .............................................................. 0.5 – 1 1 1Acquisitions/divestitures.................................................... 0.5 – 3 – 1% Change (b) ........................................................................ 5% 5% 14% 3% 8%FLNA PBNA PI QFNA TotalNet Revenue, 2005............................................................. $10,322 $9,146 $11,376 $1,718 $32,562Net Revenue, 2004............................................................. $9,560 $8,313 $9,862 $1,526 $29,261% Impact of:Volume ............................................................................... 4.5% 4% (a) 8% (a) 9% 6%Effective net pricing .......................................................... 3 5 2.5 3 3Foreign exchange .............................................................. 0.5 – 3 1 1Acquisitions/divestitures.................................................... – – 2 – 0.5% Change (b) ........................................................................ 8% 10% 15% 13% 11%(a) For beverages sold to our bottlers, volume growth is based on our concentrate shipments and equivalents.(b) Amounts may not sum due to rounding.47

267419_L01_P27_81.v4.qxd 3/5/07 11:26 PM Page 48Frito–Lay North America% Change2006 2005 2004 2006 2005Net revenue $10,844 $10,322 $9,560 5 8Operating profit $2,615 $2,529 $2,389 3 62006Net revenue grew 5% reflecting volumegrowth of 1% and positive effective netpricing due to salty snack pricingactions and favorable mix. Pound volumegrew primarily due to double-digitgrowth in SunChips, Multipack andQuaker Rice Cakes. These volume gainsIn 2006, FLNA volume grewprimarily due to double-digitgrowth in SunChips, Multipackand Quaker Rice Cakes.were partially offset by low-single-digitdeclines in trademark Lay’s and Doritos.Overall, salty snacks revenue grew 5%with volume growth of 1%, and othermacro snacks revenue grew 9% withvolume growth of 6%. The Stacy’s PitaChip Company acquisition contributedapproximately 0.5 percentage points toboth revenue and volume growth. Theabsence of the prior year’s additionalweek reduced volume and net revenuegrowth by 2 percentage points.Operating profit grew 3% reflectingthe net revenue growth. This growthwas partially offset by higher commoditycosts, primarily cooking oil andenergy. Operating profit was also negativelyimpacted by almost 3 percentagepoints as a result of a fourth quartercharge for the consolidation of themanufacturing network, including theclosure of two plants and rationalizationof other manufacturing assets. Theabsence of the prior year’s additionalweek, which reduced operating profitgrowth by 2 percentage points, waslargely offset by the impact of restructuringcharges in the prior year toreduce costs in our operations, principallythrough headcount reductions.Smart Spot eligible products representedapproximately 15% of netrevenue. These products experienceddouble-digit revenue growth, while thebalance of the portfolio had low-singledigitrevenue growth.2005Net revenue grew 8%reflecting volumegrowth of 4.5% andpositive effective netpricing driven by saltysnack pricing actions and favorable mixon both salty and convenience foodsproducts. Pound volume grew primarilydue to mid-single-digit growth in trademarkLay’s potato chips,high-single-digit growth in salty trademarkTostitos, double-digit growth inSantitas, mid-single-digit growth intrademark Cheetos, high-single-digitgrowth in Dips and Fritos, and doubledigitgrowth in SunChips. These gainswere partially offset by the discontinuanceof Toastables and Doritos Rollitos.Overall, salty snacks revenue grew 8%with volume growth of 5%, and othermacro snacks revenue grew 13% withvolume growth of 1%. Other macrosnacks products revenue benefited fromfavorable mix. The additional weekcontributed 2 percentage points to volumeand net revenue growth.Operating profit grew 6% reflectingpositive effective net pricing actions andvolume growth. This growth was offsetby higher S&D costs resulting fromincreased labor and benefit charges andfuel costs; higher cost of sales, driven byraw materials, natural gas and freight;and increased advertising and marketingcosts. Operating profit was alsoFLNA’s Smart Spot eligible productsexperienced double-digit revenue growth inboth 2006 and 2005.negatively impacted by more than1 percentage point as a result of fourthquarter charges to reduce costs in ouroperations, principally through headcountreductions. The additional weekcontributed 2 percentage points tooperating profit growth.Smart Spot eligible products representedapproximately 13% of netrevenue. These products experienceddouble-digit revenue growth, whilethe balance of the portfolio had highsingle-digitrevenue growth.48

267419_L01_P27_81.v2.qxd 2/28/07 4:08 PM Page 49PepsiCo Beverages North America% Change2006 2005 2004 2006 2005Net revenue $9,565 $9,146 $8,313 5 10Operating profit $2,055 $2,037 $1,911 1 72006Bottler case sales (BCS) volume grew4%. The volume increase was driven bya 14% increase in non-carbonated beverages,partially offset by a 2% declinein CSDs. The non-carbonated portfolioperformance was driven by double-digitgrowth in trademark Aquafina,Gatorade, Lipton ready-to-drink teas,Tropicana juice drinks and Propel.Tropicana Pure Premium experienced alow-single-digit decline in volume. Thedecline in CSDs reflects a low-singledigitdecline in trademark Pepsi,partially offset by a mid-single-digitIn 2006, Smart Spot eligibleproducts grew to over 70% ofPBNA’s total net revenue.increase in trademark Sierra Mist and alow-single-digit increase in trademarkMountain Dew. Across the brands, regularCSDs experienced a low-single-digitdecline and diet CSDs declined slightly.The additional week in 2005 had no significantimpact on volume growth asbottler volume is reported based on acalendar month.Net revenue grew 5%. Positive mixcontributed to the revenue growth,reflecting the strength of non-carbonatedbeverages. Price increases taken in2006, primarily on concentrate,Tropicana Pure Premium and fountain,were offset by overall higher tradespending. The absence of the prioryear’s additional week reduced net revenuegrowth by 1 percentage point.Operating profit increased 1% primarilyreflecting the net revenuegrowth and lower advertising and marketingexpenses. Higher raw materialcosts, primarily oranges, increased supplychain costs in Gatorade and higherenergy costs substantially offset theoperating profit increase. Total marketplacespending for the year increased,reflecting a shift from advertising andmarketing spending to trade spending.Additionally, the impact of more-favorablesettlements of trade spendingaccruals in 2005 was mostly offset by afavorable insurance settlement of$29 million in 2006. The absence of theprior year’s additional week, whichreduced operating profit growth by1 percentage point, was fully offset bythe impact of charges taken in thefourth quarter of 2005 to reduce costsin our operations, principally throughheadcount reductions.Smart Spot eligible products representedover 70% of net revenue. Theseproducts experienced high-single-digitrevenue growth, while the balance ofthe portfolio declined in the low-singledigitrange.2005Net revenue grew 10% and BCS volumegrew 4%. The volume increase wasdriven by a 16% increase in non-carbonatedbeverages, partially offset by a 1%decline in CSDs. Within non-carbonatedbeverages, Gatorade, trademarkAquafina, Tropicana juice drinks, Propeland SoBe all experienced double-digitgrowth. Above averagesummer temperaturesacross the country, as wellas the launch of new productssuch as AquafinaFlavorSplash and GatoradeLemonade earlier in theyear, drove Gatorade andtrademark Aquafina growth. TropicanaPure Premium experienced a low-singledigitdecline resulting from priceincreases taken in the first quarter. Thedecline in CSDs reflects low-single-digitdeclines in trademark Pepsi and trademarkMountain Dew, slightly offset bylow-single-digit growth in Sierra Mist.Across the brands, a low-single-digitdecline in regular CSDs was partiallyoffset by low-single-digit growth in dietCSDs. The additional week in 2005 hadno significant impact on volume growthas bottler volume is reported based ona calendar month.Net revenue also benefited from5 percentage points of favorableeffective net pricing, reflecting the continuedmigration from CSDs tonon-carbonated beverages and priceincreases taken in the first quarter,primarily on concentrate and TropicanaPure Premium, partially offset byincreased trade spending in 2005. Theadditional week in 2005 contributed1 percentage point to net revenuegrowth.Operating profit increased nearly7%, primarily reflecting net revenuegrowth. This increase was partially offsetby higher raw material, energy andtransportation costs, as well asincreased advertising and marketingexpenses. The additional week in 2005contributed 1 percentage point to operatingprofit growth and was fully offsetby a 1-percentage-point decline relatedto charges taken in 2005 to reduce costsin our operations, principally throughheadcount reductions.Aquafina, Gatorade, Tropicana juice drinksand Propel all experienced double-digitvolume growth in both 2006 and 2005.Smart Spot eligible products representedalmost 70% of net revenue.These products experienced doubledigitrevenue growth, while thebalance of the portfolio grew in the lowsingle-digitrange.49

267419_L01_P27_81.v4.qxd 3/5/07 11:29 PM Page 50PepsiCo International% Change2006 2005 2004 2006 2005Net revenue $12,959 $11,376 $9,862 14 15Operating profit $1,948 $1,607 $1,323 21 21502006International snacks volume grew 9%,reflecting double-digit growth in Russia,Turkey, Egypt and India, and single-digitgrowth at Sabritas in Mexico. Overall, theEurope, Middle East & Africa region grew17%, the Latin America region grew2.5% and the Asia Pacific region grew12%. Acquisitions of two businesses inEurope in 2006 increased the Europe,Middle East & Africa region volumegrowth by nearly 6 percentage points.The acquisition of a business in Australiaincreased the Asia Pacific region volumegrowth by 1 percentage point. Inaggregate, acquisitions contributed2 percentage points to the reported totalPepsiCo International snack volumegrowth rate. The absence of the prioryear’s additional week reduced thegrowth rate by 1 percentage point.Beverage volume grew 9%, reflectingbroad-based increases led by doubledigitgrowth in the Middle East, China,Argentina, Russia and Venezuela. TheInternational snack volume andbeverage volume each grew 9%in 2006.Europe, Middle East & Africa region grew11%, the Asia Pacific region grew 9%and the Latin America region grew 7%.Acquisitions contributed 1 percentagepoint to the Europe, Middle East & Africaregion volume growth rate andcontributed slightly to the reported totalPepsiCo International beverage volumegrowth rate. CSDs grew at a high-singledigitrate while non-carbonatedbeverages grew at a double-digit rate.Net revenue grew 14%, primarily as aresult of the broad-based volume growthand favorable effective net pricing. Thenet impact of acquisitions anddivestitures contributed nearly 3 percentagepoints to net revenue growth.Foreign currency contributed 1 percentagepoint of growth. The absence of theprior year’s additional week reduced netrevenue growth by 1 percentage point.Operating profit grew 21%, drivenprimarily by the net revenue growth,partially offset by increased raw materialand energy costs. The net impact ofacquisitions and divestitures had noimpact on the growth rate. Foreigncurrency contributed 1 percentage pointof growth. The absence of the prioryear's additional week, which reducedthe operating profit growth rate by1 percentage point, was fully offset bythe impact of charges taken in 2005 toreduce costs in our operations andrationalize capacity.2005International snacks volume grew 7%,reflecting growth of 11% in the Europe,Middle East & Africa region, 5% in theLatin America region and 6% in the AsiaPacific region. Acquisition and divestitureactivity, principally the divestiture in 2004of our interest in a South Korea joint venture,reduced Asia Pacific region volumeby 11 percentage points. The acquisitionof a business in Romania late in 2004increased the Europe, Middle East &Africa region volume growth by 3 percentagepoints. Cumulatively, ourdivestiture and acquisition activities didnot impact the reported total PepsiCoInternational snack volume growth rate.The overall gains reflected mid-singledigitgrowth at Sabritas in Mexico,double-digit growth in India, Turkey,Russia, Australia and China, partially offsetby a low-single-digit decline atWalkers in the United Kingdom. Thedecline at Walkers is due principally tomarketplace pressures. The additionalweek contributed 1 percentage point tointernational snack volume growth.Beverage volume grew 11%, reflectinggrowth of 14% in the Europe, MiddleEast & Africa region, 11% in the AsiaPacific region and 6% in the LatinAmerica region. Acquisitions had no significantimpact on the reported totalPepsiCo International beverage volumegrowth rate. Broad-based increases wereled by double-digit growth in the MiddleEast, China, Argentina, Venezuela andRussia. Carbonated soft drinks and noncarbonatedbeverages both grew at adouble-digit rate. The additional weekhad no impact on beverage volumegrowth as volume is reported based on acalendar month.Net revenue grew 15%, primarily as aresult of the broad-based volume growthand favorable effective net pricing.Foreign currency contributed almost3 percentage points of growth reflectingthe favorable Mexican peso and Brazilianreal, partially offset by the unfavorableBritish pound. Acquisitions and divestiturescontributed almost 2 percentagepoints of growth. The additional weekcontributed 1 percentage point to revenuegrowth. Cumulatively, the impact offoreign currency, acquisitions and divestitures,and the additional week on netrevenue was 5 percentage points.Operating profit grew 21% drivenlargely by the broad-based volumegrowth and favorable effective net pricing,partially offset by increased energyand raw material costs. Foreign currencycontributed 4 percentage points ofgrowth based on the favorable Mexicanpeso and Brazilian real. The net favorableimpact from acquisition and divestitureactivity, primarily the acquisition ofGeneral Mills’ minority interest in SnackVentures Europe in the first quarter of2005, contributed 2 percentage points ofgrowth. The additional week contributed1 percentage point to operating profitgrowth which was fully offset by a 1-percentage-pointdecline in operating profitgrowth related to fourth quarter chargesto reduce costs in our operations andrationalize capacity.

267419_L01_P27_81.v5.qxd 3/6/07 2:55 PM Page 51Quaker Foods North America% Change2006 2005 2004 2006 2005Net revenue $1,769 $1,718 $1,526 3 13Operating profit $554 $537 $475 3 132006Net revenue grew 3% and volumeincreased 1%. The volume increasereflects mid-single-digit growth inOatmeal, high-single-digit growth inLife cereal and low-single-digit growthin Cap’n Crunch cereal. These increaseswere partially offset by a low-singledigitdecline in Aunt Jemima syrup andmix and a mid-single-digit decline inRice-A-Roni. Net revenue growth wasalso driven by favorable effective netpricing, which contributed almost 2 percentagepoints to net revenue growth,and favorable Canadian foreignexchange rates which contributedalmost 1 percentage point. The absenceof the prior year’s additional weekreduced both net revenue andvolume growth by approximately2 percentage points.Operating profit increased 3%primarily reflecting the net revenuegrowth. Increased cost of sales, primarilydriven by higher raw material andenergy costs, were largely offset bylower advertising and marketingexpenses. The absence of the prior year’sadditional week reduced operatingprofit growth by approximately 2 points.Smart Spot eligible products representedapproximately 55% of netrevenue and had mid-single-digit netrevenue growth. The balance of theportfolio experienced a low-single-digitdecline. The absence of the prior year’sadditional week negatively impactedthese results.2005Net revenueincreased 13% andvolume increased9%. The volumeincrease reflectsdouble-digitgrowth in Oatmeal, Aunt Jemima syrupand mix, Rice-A-Roni and Pasta Roni, aswell as high-single-digit growth inCap’n Crunch cereal and mid-singledigitgrowth in Life cereal. Highereffective net pricing contributed nearly3 percentage points of growth reflectingfavorable product mix, thesettlement of prior year trade spendingaccruals and price increases on ready-toeatcereals taken in the third quarter of2004. Favorable Canadian exchangerates contributed nearly 1 percentagepoint to net revenue growth. The additionalweek in 2005 contributedapproximately 2 percentage points toboth net revenue and volume growth.Operating profit increased 13%reflecting the net revenue growth. Thisgrowth was partially offset by higheradvertising and marketing costs behindprograms for core brands and innovation,as well as an unfavorable cost ofsales comparison primarily due toIn 2006 and 2005, Smart Spot eligible productsrepresented over half of QFNA’s total net revenue.higher energy and raw material costs inthe latter part of 2005. The additionalweek in 2005 contributed approximately2 percentage points to operatingprofit growth.Smart Spot eligible productsreprsented approximately half of netrevenue and had double-digit revenuegrowth. The balance of the portfolioalso experienced double-digitrevenue growth.51

267419_L01_P27_81.v2.qxd 2/28/07 8:19 PM Page 52Our Liquidity and Capital ResourcesOur strong cash–generating capability and financialcondition give us ready access to capital marketsthroughout the world. Our principal source of liquidityis our operating cash flow. This cash–generatingcapability is one of our fundamental strengths andprovides us with substantial financial flexibility inmeeting operating, investing and financing needs. Inaddition, we have revolving credit facilities that arefurther discussed in Note 9. Our cash provided fromoperating activities is somewhat impacted byseasonality. Working capital needs are impacted byweekly sales, which are generally highest in the thirdquarter due to seasonal and holiday–related salespatterns, and generally lowest in the first quarter.2006 Cash UtilizationOther, net$223Short-term investments$2,017Cash proceedsfrom sale of PBG stock$318Stock option exercises$1,194Operating activities$6,084Long-term debt$106Acquisitions$522Dividends$1,854Capital spending$2,068Share repurchases$3,010Short-term borrowings$2,341Source of CashUse of Cash52Operating ActivitiesIn 2006, our operations provided$6.1 billion of cash compared to$5.9 billion in the prior year. Theincrease primarily reflects our solid businessresults. Our operating cash flow in2006 also reflects increased net taxpayments over the prior year of$897 million, which included $420 millionrelated to our repatriation ofinternational cash in 2005 in connectionwith the AJCA, substantially offset byreductions in pension plancontributions over the prior year of$744 million.Investing ActivitiesIn 2006, we used $194 million for ourinvesting activities. Capital spending of$2.1 billion and acquisitions of $522 millionwere mostly offset by net sales ofshort-term investments of $2.0 billionand proceeds from our sale of PBGstock of $318 million. The increase incapital spending over the prior year primarilyreflects increased investments atPI and in our North American Gatoradebusiness, as well as increased supportbehind our ongoing BPT initiative. In2005, we used $3.5 billion, primarilyreflecting capital spending of $1.7 billion,acquisitions of $1.1 billion,primarily the $750 million acquisition ofGeneral Mills’ minority interest in SnackVentures Europe, and net purchases ofshort-term investments of $1.0 billion.These amounts were partially offset bythe proceeds from our sale of PBG stockof $214 million.In the first quarter of 2007, we completedour acquisition of Naked JuiceCompany which was funded with existingdomestic cash. This acquisition willbe included in the first quarter of 2007as an investing activity in ourCondensed Consolidated Statement ofCash Flows.We anticipate net capital spending ofapproximately $2.6 billion in 2007, whichis expected to be within our net capitalspending target of approximately 5%to 7% of net revenue in each of thenext few years. Planned capital spendingin 2007 includes increasedinvestments at PI, particularly in thedeveloping and emerging markets, andadditional investments in manufacturingcapacity to support our NorthAmerican Gatorade business as well asother non-carbonated beverage businesses.New capital projects areevaluated on a case-by-case basis andmust meet certain payback and internalrate of return targets.Financing ActivitiesIn 2006, we used $6.0 billion for ourfinancing activities, primarily reflectingthe return of operating cash flow to ourshareholders through common sharerepurchases of $3.0 billion and dividendpayments of $1.9 billion. Net repaymentsof short-term borrowings of$2.3 billion were partially offset by stockoption proceeds of $1.2 billion. In 2005,we used $1.9 billion for our financingactivities, primarily reflecting sharerepurchases of $3.0 billion and dividendpayments of $1.6 billion, partially offsetby net proceeds from short-term borrowingsof $1.8 billion and stock optionproceeds of $1.1 billion.On May 3, 2006, our Board ofDirectors authorized and publiclyannounced our new $8.5 billion repurchaseprogram, which expires on June30, 2009. Since inception of the newprogram, we have repurchased $1.1 billionof shares, leaving $7.4 billion ofremaining authorization. We have historicallyrepurchased significantly moreshares each year than we have issuedunder our stock-based compensationplans, with average net annual repurchasesof 1.4% of outstanding sharesfor the last five years. We target anannual dividend payout of approximately45% of prior year’s net incomefrom continuing operations. Annually,we review our capital structure with ourBoard, including our dividend policyand share repurchase activity.

267419_L01_P27_81.v2.qxd 2/28/07 8:19 PM Page 532005 Cash Utilization 2004 Cash UtilizationShort-term borrowings$1,848Cash proceedsfrom sale of PBG stock$214Stock option exercises$1,099Other, net$70 Long-term debt$152Operating activities$5,852Acquisitions$1,095Dividends$1,642Short-term investments$991Capital spending$1,736Share repurchases$3,031Other, net$69Stock option exercises$965Short-term borrowings$1,112Operating activities$5,054Short-terminvestments$969Dividends$1,329Capital spending$1,387Share repurchases$3,055Source of CashUse of CashSource of CashUse of Cash2006 2005 2004Net cash provided by operating activities $ 6,084 $ 5,852 $ 5,054Capital spending (2,068) (1,736) (1,387)Sales of property, plant and equipment 49 88 38Management operating cash flow $ 4,065 $ 4,204 $ 3,705Management Operating Cash FlowWe focus on management operatingcash flow as a key element in achievingmaximum shareholder value, and it isthe primary measure we use to monitorcash flow performance. However, it isnot a measure provided by accountingprinciples generally accepted in the U.S.Since net capital spending is essential toour product innovation initiatives andmaintaining our operational capabilities,we believe that it is a recurring andnecessary use of cash. As such, webelieve investors should also considernet capital spending when evaluatingour cash from operating activities. Thetable above reconciles the net cash providedby operating activities asreflected in our Consolidated Statementof Cash Flows to our management operatingcash flow. Managementoperating cash flow was used primarilyto repurchase shares and pay dividends.We expect to continue to returnapproximately all of our managementoperating cash flow to our shareholdersthrough dividends and sharerepurchases. However, see “OurBusiness Risks” for certain factors thatmay impact our operating cash flows.Credit RatingsOur debt ratings of Aa3 from Moody’sand A+ from Standard & Poor’scontribute to our ability to access globalcapital markets. We have maintainedstrong investment grade ratings forover a decade. Each rating is consideredstrong investment grade and is in thefirst quartile of their respective rankingsystems. These ratings also reflect theimpact of our anchor bottlers’ cashflows and debt.Credit Facilities and Long-TermContractual CommitmentsSee Note 9 for a description of ourcredit facilities and long-term contractualcommitments.Off-Balance-Sheet ArrangementsIt is not our business practice to enterinto off-balance-sheet arrangements,other than in the normal course ofbusiness, nor is it our policy to issueguarantees to our bottlers, noncontrolledaffiliates or third parties.However, certain guarantees were necessaryto facilitate the separation of ourbottling and restaurant operationsfrom us. At year-end 2006, we believe itis remote that these guarantees wouldrequire any cash payment. We do notenter into off-balance-sheet transactionsspecifically structured to provideincome or tax benefits or to avoidrecognizing or disclosing assets orliabilities. See Note 9 for a descriptionof our off-balance-sheet arrangements.53

267419_L01_P27_81.v2.qxd 2/28/07 4:08 PM Page 54Consolidated Statement of IncomePepsiCo, Inc. and SubsidiariesFiscal years ended December 30, 2006, December 31, 2005 and December 25, 2004(in millions except per share amounts) 2006 2005 2004Net Revenue.................................................................................................................. $35,137 $32,562 $29,261Cost of sales................................................................................................................... 15,762 14,176 12,674Selling, general and administrative expenses ............................................................. 12,774 12,314 11,031Amortization of intangible assets................................................................................ 162 150 147Restructuring and impairment charges ....................................................................... – – 150Operating Profit............................................................................................................ 6,439 5,922 5,259Bottling equity income ................................................................................................. 616 557 380Interest expense............................................................................................................ (239) (256) (167)Interest income ............................................................................................................. 173 159 74Income from Continuing Operations before Income Taxes....................................... 6,989 6,382 5,546Provision for Income Taxes .......................................................................................... 1,347 2,304 1,372Income from Continuing Operations .......................................................................... 5,642 4,078 4,174Tax Benefit from Discontinued Operations ................................................................ – – 38Net Income .................................................................................................................... $ 5,642 $ 4,078 $ 4,212Net Income per Common Share — BasicContinuing operations............................................................................................. $3.42 $2.43 $2.45Discontinued operations.......................................................................................... – – 0.02Total .......................................................................................................................... $3.42 $2.43 $2.47Net Income per Common Share — DilutedContinuing operations............................................................................................. $3.34 $2.39 $2.41Discontinued operations.......................................................................................... – – 0.02Total .......................................................................................................................... $3.34 $2.39 $2.44** Based on unrounded amounts.See accompanying notes to consolidated financial statements.Net RevenueOperating Profit$29,261$32,562$35,137$5,259$5,922$6,4392004 2005 20062004 2005 2006Income from Continuing Operations$4,174 $4,078$5,642Net Income per Common Share — Continuing Operations$2.41 $2.39$3.342004 2005 20062004 2005 200654

267419_L01_P27_81.v4.qxd 3/6/07 9:18 AM Page 55Consolidated Statement of Cash FlowsPepsiCo, Inc. and SubsidiariesFiscal years ended December 30, 2006, December 31, 2005 and December 25, 2004(in millions) 2006 2005 2004Operating ActivitiesNet income .................................................................................................................... $ 5,642 $ 4,078 $ 4,212Depreciation and amortization.................................................................................... 1,406 1,308 1,264Stock-based compensation expense ............................................................................ 270 311 368Excess tax benefits from share-based payment arrangements .................................. (134) – –Restructuring and impairment charges ....................................................................... – – 150Cash payments for merger-related costs and restructuring charges ......................... – (22) (92)Tax benefit from discontinued operations.................................................................. – – (38)Pension and retiree medical plan contributions ......................................................... (131) (877) (534)Pension and retiree medical plan expenses ................................................................ 544 464 395Bottling equity income, net of dividends.................................................................... (479) (411) (297)Deferred income taxes and other tax charges and credits......................................... (510) 440 (203)Other non-cash charges and credits, net..................................................................... 32 145 166Change in accounts and notes receivable ................................................................... (330) (272) (130)Change in inventories................................................................................................... (186) (132) (100)Change in prepaid expenses and other current assets ............................................... (37) (56) (31)Change in accounts payable and other current liabilities.......................................... 223 188 216Change in income taxes payable ................................................................................. (295) 609 (268)Other, net ..................................................................................................................... 69 79 (24)Net Cash Provided by Operating Activities ................................................................ 6,084 5,852 5,054Investing ActivitiesSnack Ventures Europe (SVE) minority interest acquisition ....................................... – (750) –Capital spending ........................................................................................................... (2,068) (1,736) (1,387)Sales of property, plant and equipment...................................................................... 49 88 38Investment in finance assets......................................................................................... (25) – –Other acquisitions and investments in noncontrolled affiliates ................................ (522) (345) (64)Cash proceeds from sale of PBG stock ......................................................................... 318 214 –Divestitures.................................................................................................................... 37 3 52Short-term investments, by original maturityMore than three months — purchases ................................................................... (29) (83) (44)More than three months — maturities................................................................... 25 84 38Three months or less, net......................................................................................... 2,021 (992) (963)Net Cash Used for Investing Activities........................................................................ (194) (3,517) (2,330)Financing ActivitiesProceeds from issuances of long-term debt ................................................................ 51 25 504Payments of long-term debt ........................................................................................ (157) (177) (512)Short-term borrowings, by original maturityMore than three months — proceeds..................................................................... 185 332 153More than three months — payments.................................................................... (358) (85) (160)Three months or less, net......................................................................................... (2,168) 1,601 1,119Cash dividends paid ...................................................................................................... (1,854) (1,642) (1,329)Share repurchases — common ..................................................................................... (3,000) (3,012) (3,028)Share repurchases — preferred.................................................................................... (10) (19) (27)Proceeds from exercises of stock options .................................................................... 1,194 1,099 965Excess tax benefits from share-based payment arrangements .................................. 134 – –Net Cash Used for Financing Activities ....................................................................... (5,983) (1,878) (2,315)Effect of exchange rate changes on cash and cash equivalents ................................ 28 (21) 51Net (Decrease)/Increase in Cash and Cash Equivalents.............................................. (65) 436 460Cash and Cash Equivalents, Beginning of Year .......................................................... 1,716 1,280 820Cash and Cash Equivalents, End of Year..................................................................... $ 1,651 $ 1,716 $ 1,280See accompanying notes to consolidated financial statements.55

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 56Consolidated Balance SheetPepsiCo, Inc. and SubsidiariesDecember 30, 2006 and December 31, 2005(in millions except per share amounts) 2006 2005ASSETSCurrent AssetsCash and cash equivalents ................................................................................................................. $ 1,651 $ 1,716Short-term investments...................................................................................................................... 1,171 3,166Accounts and notes receivable, net................................................................................................... 3,725 3,261Inventories .......................................................................................................................................... 1,926 1,693Prepaid expenses and other current assets....................................................................................... 657 618Total Current Assets....................................................................................................................... 9,130 10,454Property, Plant and Equipment, net.................................................................................................. 9,687 8,681Amortizable Intangible Assets, net................................................................................................... 637 530Goodwill.............................................................................................................................................. 4,594 4,088Other nonamortizable intangible assets........................................................................................... 1,212 1,086Nonamortizable Intangible Assets ............................................................................................... 5,806 5,174Investments in Noncontrolled Affiliates........................................................................................... 3,690 3,485Other Assets ....................................................................................................................................... 980 3,403Total Assets................................................................................................................................ $29,930 $31,727LIABILITIES AND SHAREHOLDERS’ EQUITYCurrent LiabilitiesShort-term obligations ....................................................................................................................... $ 274 $ 2,889Accounts payable and other current liabilities................................................................................. 6,496 5,971Income taxes payable ......................................................................................................................... 90 546Total Current Liabilities ................................................................................................................. 6,860 9,406Long-Term Debt Obligations ............................................................................................................. 2,550 2,313Other Liabilities .................................................................................................................................. 4,624 4,323Deferred Income Taxes....................................................................................................................... 528 1,434Total Liabilities ............................................................................................................................... 14,562 17,476Commitments and ContingenciesPreferred Stock, no par value ............................................................................................................ 41 41Repurchased Preferred Stock............................................................................................................. (120) (110)Common Shareholders’ EquityCommon stock, par value 1 2/3¢ per share (issued 1,782 shares) .................................................... 30 30Capital in excess of par value............................................................................................................. 584 614Retained earnings............................................................................................................................... 24,837 21,116Accumulated other comprehensive loss............................................................................................ (2,246) (1,053)23,205 20,707Less: repurchased common stock, at cost (144 and 126 shares, respectively)................................. (7,758) (6,387)Total Common Shareholders’ Equity ............................................................................................ 15,447 14,320Total Liabilities and Shareholders’ Equity ............................................................................... $29,930 $31,727See accompanying notes to consolidated financial statements.56

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 57Consolidated Statement ofCommon Shareholders’ EquityPepsiCo, Inc. and SubsidiariesFiscal years ended December 30, 2006, December 31, 2005 and December 25, 20042006 2005 2004(in millions) Shares Amount Shares Amount Shares AmountCommon Stock ................................................................. 1,782 $ 30 1,782 $ 30 1,782 $ 30Capital in Excess of Par ValueBalance, beginning of year ......................................... 614 618 548Stock-based compensation expense........................... 270 311 368Stock option exercises (a) .............................................. (300) (315) (298)Balance, end of year.................................................... 584 614 618Retained EarningsBalance, beginning of year ......................................... 21,116 18,730 15,961Net income................................................................... 5,642 4,078 4,212Cash dividends declared — common.......................... (1,912) (1,684) (1,438)Cash dividends declared — preferred ........................ (1) (3) (3)Cash dividends declared — RSUs ................................ (8) (5) (2)Balance, end of year.................................................... 24,837 21,116 18,730Accumulated Other Comprehensive LossBalance, beginning of year ......................................... (1,053) (886) (1,267)Currency translation adjustment ................................ 465 (251) 401Cash flow hedges, net of tax:Net derivative (losses)/gains ................................... (18) 54 (16)Reclassification of (gains)/losses to net income .... (5) (8) 9Unamortized pension and retiree medical, net of tax.. (1,782) – –Minimum pension liability adjustment, net of tax.... 138 16 (19)Unrealized gain on securities, net of tax ................... 9 24 6Other ............................................................................ – (2) –Balance, end of year.................................................... (2,246) (1,053) (886)Repurchased Common StockBalance, beginning of year ......................................... (126) (6,387) (103) (4,920) (77) (3,376)Share repurchases........................................................ (49) (3,000) (54) (2,995) (58) (2,994)Stock option exercises ................................................. 31 1,619 31 1,523 32 1,434Other ............................................................................ – 10 – 5 – 16Balance, end of year.................................................... (144) (7,758) (126) (6,387) (103) (4,920)Total Common Shareholders’ Equity .............................. $15,447 $14,320 $13,5722006 2005 2004Comprehensive IncomeNet income................................................................... $5,642 $4,078 $4,212Currency translation adjustment ................................ 465 (251) 401Cash flow hedges, net of tax ...................................... (23) 46 (7)Minimum pension liability adjustment, net of tax....... 5 16 (19)Unrealized gain on securities, net of tax ................... 9 24 6Other ............................................................................ – (2) –Total Comprehensive Income .......................................... $6,098 $3,911 $4,593(a) Includes total tax benefits of $130 million in 2006, $125 million in 2005 and $183 million in 2004.See accompanying notes to consolidated financial statements.57

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 58Notes to Consolidated Financial StatementsNote 1 — Basis of Presentation and Our DivisionsBasis of PresentationOur financial statements include theconsolidated accounts of PepsiCo, Inc.and the affiliates that we control. Inaddition, we include our share of theresults of certain other affiliates basedon our economic ownership interest. Wedo not control these other affiliates, asour ownership in these other affiliates isgenerally less than 50%. Our share ofthe net income of noncontrolled bottlingaffiliates is reported in our incomestatement as bottling equity income.Bottling equity income also includes anychanges in our ownership interests ofthese affiliates. Bottling equity incomeincludes $186 million and $126 millionof pre-tax gains on our sales of PBGstock in 2006 and 2005, respectively. SeeNote 8 for additional information onour significant noncontrolled bottlingaffiliates. Intercompany balances andtransactions are eliminated. In 2005, wehad an additional week of results (53rdweek). Our fiscal year ends on the lastSaturday of each December, resulting inan additional week of results every fiveor six years.In connection with our ongoing BPTinitiative, we aligned certain accountingpolicies across our divisions in 2005.We conformed our methodology forcalculating our bad debt reserves andmodified our policy for recognizing revenuefor products shipped to customersby third-party carriers. Additionally, weconformed our method of accountingfor certain costs, primarily warehouseand freight. These changes reduced ournet revenue by $36 million and ouroperating profit by $60 million in 2005.Raw materials, direct labor and plantoverhead, as well as purchasing andreceiving costs, costs directly related toproduction planning, inspection costsand raw material handling facilities, areincluded in cost of sales. The costs ofmoving, storing and delivering finishedproduct are included in selling, generaland administrative expenses.The preparation of our consolidatedfinancial statements in conformity withgenerally accepted accounting principlesrequires us to make estimates andassumptions that affect reportedamounts of assets, liabilities, revenues,expenses and disclosure of contingentassets and liabilities. Estimates are usedin determining, among other items, salesincentives accruals, tax reserves, stockbasedcompensation, pension andretiree medical accruals, useful lives forintangible assets, and future cash flowsassociated with impairment testing forperpetual brands, goodwill and otherlong-lived assets. Actual results coulddiffer from these estimates.See “Our Divisions” below and foradditional unaudited information onitems affecting the comparability of ourconsolidated results, see “ItemsAffecting Comparability” inManagement’s Discussion and Analysis.Tabular dollars are in millions, exceptper share amounts. All per shareamounts reflect common per shareamounts, assume dilution unless noted,and are based on unrounded amounts.Certain reclassifications were made toprior years’ amounts to conform to the2006 presentation.Our DivisionsWe manufacture or use contract manufacturers,market and sell a variety ofsalty, sweet and grain-based snacks, carbonatedand non-carbonatedbeverages, and foods through ourNorth American and international businessdivisions. Our North Americandivisions include the United States andCanada. The accounting policies for thedivisions are the same as thosedescribed in Note 2, except for certainallocation methodologies for stockbasedcompensation expense andpension and retiree medical expenses,as described in the unaudited informationin “Our Critical AccountingPolicies.” Additionally, beginning in thefourth quarter of 2005, we began centrallymanaging commodity derivativeson behalf of our divisions. Certain ofthe commodity derivatives, primarilythose related to the purchase of energyfor use by our divisions, do not qualifyfor hedge accounting treatment. Thesederivatives hedge underlying commodityprice risk and were not entered intofor speculative purposes. Such derivativesare marked to market with theresulting gains and losses recognized incorporate unallocated expenses. Thesegains and losses are subsequentlyreflected in division results when thedivisions take delivery of the underlyingcommodity. Therefore, division resultsreflect the contract purchase price ofthe energy or other commodities.Division results are based on how ourPresident and Chief Executive Officerassesses the performance of and reallocatesresources to our divisions. Divisionresults exclude certain Corporate-initiatedrestructuring and impairmentcharges. For additional unaudited informationon our divisions, see “OurOperations” in Management’sDiscussion and Analysis.58

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 59Frito-LayNorth America(FLNA)PepsiCoBeveragesNorth America(PBNA)PepsiCoInternational(PI)Quaker FoodsNorth America(QFNA)Net RevenueOperating Profit2006 2005 2004 2006 2005 2004FLNA $10,844 $10,322 $ 9,560 $2,615 $2,529 $2,389PBNA 9,565 9,146 8,313 2,055 2,037 1,911PI 12,959 11,376 9,862 1,948 1,607 1,323QFNA 1,769 1,718 1,526 554 537 475Total division 35,137 32,562 29,261 7,172 6,710 6,098Corporate – – – (733) (788) (689)35,137 32,562 29,261 6,439 5,922 5,409Restructuring and impairment charges – – – – – (150)Total $35,137 $32,562 $29,261 $6,439 $5,922 $5,259Net RevenuePI37%QFNA5%PBNA27%FLNA31%Division Operating ProfitPI27%QFNA8%PBNA29%FLNA36%CorporateCorporate includes costs of our corporateheadquarters, centrally-managedinitiatives, such as our BPT initiative inNorth America, unallocated insuranceand benefit programs, foreignexchange transaction gains and losses,and certain commodity derivative gainsand losses, as well as profit-in-inventoryelimination adjustments for our noncontrolledbottling affiliates and certainother items.Restructuring and ImpairmentCharges — See Note 3.Other Division InformationTotal AssetsCapital Spending2006 2005 2004 2006 2005 2004FLNA $ 5,969 $ 5,948 $ 5,476 $ 499 $ 512 $ 469PBNA 6,567 6,316 6,048 492 320 265PI 11,274 9,983 8,921 835 667 537QFNA 1,003 989 978 31 31 33Total division 24,813 23,236 21,423 1,857 1,530 1,304Corporate (a) 1,739 5,331 3,569 211 206 83Investments in bottling affiliates 3,378 3,160 2,995 – – –$29,930 $31,727 $27,987 $2,068 $1,736 $1,387(a) Corporate assets consist principally of cash and cash equivalents, short-term investments, and property, plant and equipment.59

267419_L01_P27_81.v9.qxd 3/8/07 11:17 AM Page 60Total AssetsCapital SpendingNet RevenueQFNA3%Other17%FLNA20%QFNA2%Corporate10%FLNA24%Other22%PI38%PBNA22%PI40%PBNA24%UnitedKingdom5%Canada5%Mexico9%United States59%Amortization ofDepreciation andIntangible AssetsOther Amortization2006 2005 2004 2006 2005 2004Long-Lived AssetsFLNA $ 9 $ 3 $ 3 $ 432 $ 419 $ 420PBNA 77 76 75 282 264 258PI 76 71 68 478 420 382QFNA – – 1 33 34 36Total division 162 150 147 1,225 1,137 1,096Corporate – – – 19 21 21$162 $150 $147 $1,244 $1,158 $1,117Canada3%UnitedKingdom10%Mexico5%Other24%United States58%Net Revenue (a)Long-Lived Assets (b)2006 2005 2004 2006 2005 2004U.S. $20,788 $19,937 $18,329 $11,515 $10,723 $10,212Mexico 3,228 3,095 2,724 996 902 878United Kingdom 1,839 1,821 1,692 1,995 1,715 1,896Canada 1,702 1,509 1,309 589 582 548All other countries 7,580 6,200 5,207 4,725 3,948 3,339$35,137 $32,562 $29,261 $19,820 $17,870 $16,873(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 reportedin the country where they are primarily used.Note 2 — Our Significant Accounting Policies60Revenue RecognitionWe recognize revenue upon shipmentor delivery to our customers based onwritten sales terms that do not allowfor a right of return. However, our policyfor DSD and chilled products is toremove and replace damaged and outof-dateproducts from store shelves toensure that our consumers receive theproduct quality and freshness that theyexpect. Similarly, our policy for warehouse-distributedproducts is to replacedamaged and out-of-date products.Based on our historical experience withthis practice, we have reserved foranticipated damaged and out-of-dateproducts. For additional unauditedinformation on our revenue recognitionand related policies, including our policyon bad debts, see “Our CriticalAccounting Policies” in Management’sDiscussion and Analysis. We are exposedto concentration of credit risk by ourcustomers, Wal-Mart and PBG. In 2006,Wal-Mart represented approximately9% of our total net revenue, includingconcentrate sales to our bottlers whichare used in finished goods sold by themto Wal-Mart; and PBG representedapproximately 10%. We havenot experienced credit issues withthese customers.

267419_L01_P27_81.v4.qxd 3/6/07 9:19 AM Page 61Sales Incentives and OtherMarketplace SpendingWe offer sales incentives and discountsthrough various programs to our customersand consumers. Sales incentivesand discounts are accounted for as areduction of revenue and totaled$10.1 billion in 2006, $8.9 billion in 2005and $7.8 billion in 2004. While most ofthese incentive arrangements haveterms of no more than one year, certainarrangements, such as fountain pouringrights, extend beyond one year. Costsincurred to obtain these arrangementsare recognized over no longer than thecontract period and the remaining balancesof $297 million at December 30,2006 and $321 million at December 31,2005 are included in current assets andother assets on our balance sheet. Foradditional unaudited information onour sales incentives, see “Our CriticalAccounting Policies” in Management’sDiscussion and Analysis.Other marketplace spending includesthe costs of advertising and other marketingactivities and is reported asselling, general and administrativeexpenses. Advertising expenses were$1.7 billion in 2006, $1.8 billion in 2005and $1.7 billion in 2004. Deferredadvertising costs are not expensed untilthe year first used and consist of:• media and personal serviceprepayments,• promotional materials in inventory, and• production costs of future mediaadvertising.Deferred advertising costs of$171 million and $202 million at yearend2006 and 2005, respectively, areclassified as prepaid expenses on ourbalance sheet.Distribution CostsDistribution costs, including the costs ofshipping and handling activities, arereported as selling, general and administrativeexpenses. Shipping and handlingexpenses were $4.6 billion in 2006,$4.1 billion in 2005 and $3.9 billionin 2004.Cash EquivalentsCash equivalents are investments withoriginal maturities of three months orless which we do not intend to rolloverbeyond three months.Software CostsWe capitalize certain computersoftware and software developmentcosts incurred in connection with developingor obtaining computer softwarefor internal use. Capitalized softwarecosts are included in property, plantand equipment on our balance sheetand amortized on a straight-linebasis when placed into service over theestimated useful lives of the software,which approximate five to sevenyears. Net capitalized software anddevelopment costs were $537 millionat December 30, 2006 and $327 millionat December 31, 2005.Commitments and ContingenciesWe are subject to various claims andcontingencies related to lawsuits, taxesand environmental matters, as well ascommitments under contractual andother commercial obligations. We recognizeliabilities for contingencies andcommitments when a loss is probableand estimable. For additional informationon our commitments, see Note 9.Research and DevelopmentWe engage in a variety of research anddevelopment activities. These activitiesprincipally involve the development ofnew products, improvement in thequality of existing products, improvementand modernization of productionprocesses, and the development andimplementation of new technologies toenhance the quality and value of bothcurrent and proposed product lines.Research and development costs were$344 million in 2006 and $340 million in2005 and are reported as selling, generaland administrative expenses.Other Significant Accounting PoliciesOur other significant accounting policiesare disclosed as follows:• Property, Plant and Equipment andIntangible Assets — Note 4 and, foradditional unaudited information onbrands and goodwill, see “Our CriticalAccounting Policies” in Management’sDiscussion and Analysis.• Income Taxes — Note 5 and, for additionalunaudited information, see“Our Critical Accounting Policies” inManagement’s Discussion and Analysis.• Stock-Based Compensation Expense —Note 6 and, for additional unauditedinformation, see “Our CriticalAccounting Policies” in Management’sDiscussion and Analysis.• Pension, Retiree Medical and SavingsPlans — Note 7 and, for additionalunaudited information, see “OurCritical Accounting Policies” inManagement’s Discussion and Analysis.• Risk Management — Note 10 and, foradditional unaudited information, see“Our Business Risks” in Management’sDiscussion and Analysis.Recent Accounting PronouncementsAs further discussed in Note 6, weadopted SFAS 123R on January 1, 2006.As further discussed in Note 7, weadopted SFAS 158 on December 30, 2006.In September 2006, the SEC issuedSAB 108 to address diversity in practicein quantifying financial statement misstatements.SAB 108 requires that wequantify misstatements based on theirimpact on each of our financial statementsand related disclosures. OnDecember 30, 2006, we adopted SAB108. Our adoption of SAB 108 did notimpact our financial statements.In July 2006, the FASB issued FIN 48which clarifies the accounting for uncertaintyin tax positions. FIN 48 requiresthat we recognize in our financial statements,the impact of a tax position, ifthat position is more likely than not ofbeing sustained on audit, based on thetechnical merits of the position. Theprovisions of FIN 48 are effective as ofthe beginning of our 2007 fiscal year,with the cumulative effect of thechange in accounting principlerecorded as an adjustment to openingretained earnings. We do not expectour adoption of FIN 48 to materiallyimpact our financial statements.In September 2006, the FASB issuedSFAS 157 which defines fair value,establishes a framework for measuringfair value, and expands disclosuresabout fair value measurements. Theprovisions of SFAS 157 are effectiveas of the beginning of our 2008 fiscalyear. We are currently evaluating theimpact of adopting SFAS 157 on ourfinancial statements.61

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 62Note 3 — Restructuring and Impairment Charges2006 Restructuring andImpairment ChargesIn 2006, we incurred a charge of $67 million($43 million after-tax or $0.03 pershare) in conjunction with consolidatingthe manufacturing network at FLNA byclosing two plants in the U.S., and rationalizingother assets, to increasemanufacturing productivity and supplychain efficiencies. The charge was comprisedof $43 million of assetimpairments, $14 million of severanceand other employee costs and $10 millionof other costs. Employee-related costsprimarily reflect the termination costs forapproximately 380 employees. We expectall of the cash payments related to thischarge to be paid by the end of 2007.2005 Restructuring ChargesIn 2005, we incurred a charge of $83 million($55 million after-tax or $0.03 pershare) in conjunction with actions takento reduce costs in our operations, principallythrough headcount reductions. Ofthis charge, $34 million related to FLNA,$21 million to PBNA, $16 million to PIand $12 million to Corporate. Most ofthis charge related to the terminationof approximately 700 employees. As ofDecember 30, 2006, all terminationshad occurred and substantially noaccrual remains.2004 Restructuring andImpairment ChargesIn 2004, we incurred a charge of $150million ($96 million after-tax or $0.06 pershare) in conjunction with the consolidationof FLNA’s manufacturing network aspart of its ongoing productivityprogram. Of this charge, $93 millionrelated to asset impairments, primarilyreflecting the closure of four U.S. plants.Production from these plants was redeployedto other FLNA facilities in the U.S.The remaining $57 million includedemployee-related costs of $29 million,contract termination costs of $8 millionand other exit costs of $20 million.Employee-related costs primarily reflectthe termination costs for approximately700 employees. As of December 30,2006, all terminations had occurred andsubstantially no accrual remains.Note 4 — Property, Plant and Equipment and Intangible AssetsAverage Useful Life 2006 2005 2004Property, plant and equipment, netLand and improvements 10 – 30 yrs. $ 756 $ 685Buildings and improvements 20 – 44 4,095 3,736Machinery and equipment, including fleet and software 5 – 15 12,768 11,658Construction in progress 1,439 1,06619,058 17,145Accumulated depreciation (9,371) (8,464)$ 9,687 $ 8,681Depreciation expense $1,182 $1,103 $1,062Amortizable intangible assets, netBrands 5 – 40 $1,288 $1,054Other identifiable intangibles 3 – 15 290 2571,578 1,311Accumulated amortization (941) (781)$ 637 $ 530Amortization expense $162 $150 $14762

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 63Depreciation and amortization arerecognized on a straight-line basis overan asset’s estimated useful life. Land isnot depreciated and construction inprogress is not depreciated until readyfor service. Amortization of intangibleassets for each of the next five years,based on average 2006 foreignexchange rates, is expected to be$49 million in 2007, $49 million in 2008,$47 million in 2009, $46 million in 2010and $44 million in 2011.Depreciable and amortizable assetsare only evaluated for impairmentupon a significant change in the operatingor macroeconomic environment. Inthese circumstances, if an evaluation ofthe undiscounted cash flows indicatesimpairment, the asset is written downto its estimated fair value, which isbased on discounted future cash flows.Useful lives are periodically evaluatedto determine whether events or circumstanceshave occurred which indicatethe need for revision. For additionalunaudited information on our amortizablebrand policies, see “Our CriticalAccounting Policies” in Management’sDiscussion and Analysis.Nonamortizable Intangible AssetsPerpetual brands and goodwill areassessed for impairment at least annually.If the carrying amount of aperpetual brand exceeds its fair value,as determined by its discounted cashflows, an impairment loss is recognizedin an amount equal to that excess.Goodwill is evaluated using a two-stepimpairment test at the reporting unitlevel. A reporting unit can be a divisionor business within a division. The firststep compares the book value of areporting unit, including goodwill, withits fair value, as determined by its discountedcash flows. If the book value ofa reporting unit exceeds its fair value,we complete the second step to determinethe amount of goodwillimpairment loss that we should record.In the second step, we determine animplied fair value of the reporting unit’sgoodwill by allocating the fair value ofthe reporting unit to all of the assetsand liabilities other than goodwill(including any unrecognized intangibleassets). The amount of impairment lossis equal to the excess of the book valueof the goodwill over the implied fairvalue of that goodwill. No impairmentcharges resulted from the requiredimpairment evaluations. The change inthe book value of nonamortizableintangible assets is as follows:Balance, Translation Balance, Translation Balance,Beginning 2005 Acquisitions and Other End of 2005 Acquisitions and Other End of 2006Frito-Lay North AmericaGoodwill $ 138 $ – $ 7 $ 145 $139 $ – $ 284PepsiCo BeveragesNorth AmericaGoodwill 2,161 – 3 2,164 39 – 2,203Brands 59 – – 59 – – 592,220 – 3 2,223 39 – 2,262PepsiCo InternationalGoodwill 1,435 278 (109) 1,604 183 145 1,932Brands 869 263 (106) 1,026 – 127 1,1532,304 541 (215) 2,630 183 272 3,085Quaker FoodsNorth AmericaGoodwill 175 – – 175 – – 175CorporatePension intangible 5 – (4) 1 – (1) –Total goodwill 3,909 278 (99) 4,088 361 145 4,594Total brands 928 263 (106) 1,085 – 127 1,212Total pension intangible 5 – (4) 1 – (1) –$4,842 $541 $(209) $5,174 $361 $271 $5,80663

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 64Note 5 — Income Taxes2006 2005 2004Income before income taxes — continuing operationsU.S. ............................................................................................................................. $3,844 $3,175 $2,946Foreign ....................................................................................................................... 3,145 3,207 2,600$6,989 $6,382 $5,546Provision for income taxes — continuing operationsCurrent: U.S. Federal.............................................................................................. $ 776 $1,638 $1,030Foreign..................................................................................................... 569 426 256State ......................................................................................................... 56 118 691,401 2,182 1,355Deferred: U.S. Federal.............................................................................................. (31) 137 11Foreign..................................................................................................... (16) (26) 5State ......................................................................................................... (7) 11 1(54) 122 17$1,347 $2,304 $1,372Tax rate reconciliation — continuing operationsU.S. Federal statutory tax rate .................................................................................. 35.0% 35.0% 35.0%State income tax, net of U.S. Federal tax benefit.................................................... 0.5 1.4 0.8Taxes on AJCA repatriation....................................................................................... – 7.0 –Lower taxes on foreign results.................................................................................. (6.5) (6.5) (5.4)Settlement of prior years’ audit................................................................................ – – (4.8)2006 Tax Adjustments................................................................................................ (8.6) – –Other, net ................................................................................................................... (1.1) (0.8) (0.9)Annual tax rate .......................................................................................................... 19.3% 36.1% 24.7%Deferred tax liabilitiesInvestments in noncontrolled affiliates.................................................................... $1,103 $ 993Property, plant and equipment................................................................................. 784 772Pension benefits......................................................................................................... – 863Intangible assets other than nondeductible goodwill ............................................ 169 135Zero coupon notes..................................................................................................... 27 35Other .......................................................................................................................... 221 169Gross deferred tax liabilities ..................................................................................... 2,304 2,967Deferred tax assetsNet carryforwards ...................................................................................................... 667 608Stock-based compensation........................................................................................ 443 426Retiree medical benefits............................................................................................ 541 400Other employee-related benefits ............................................................................. 342 342Pension benefits......................................................................................................... 38 –Other .......................................................................................................................... 592 520Gross deferred tax assets........................................................................................... 2,623 2,296Valuation allowances................................................................................................. (624) (532)Deferred tax assets, net............................................................................................. 1,999 1,764Net deferred tax liabilities ........................................................................................ $ 305 $1,203Deferred taxes included within:Assets:Prepaid expenses and other current assets........................................................... $223 $231Liabilities:Deferred income taxes ........................................................................................... $528 $1,434Analysis of valuation allowancesBalance, beginning of year ....................................................................................... $532 $564 $438Provision/(benefit) .................................................................................................. 71 (28) 118Other additions/(deductions)................................................................................. 21 (4) 8Balance, end of year .................................................................................................. $624 $532 $56464

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 65For additional unaudited informationon our income tax policies, includingour reserves for income taxes, see “OurCritical Accounting Policies” inManagement’s Discussion and Analysis.Carryforwards, Credits andAllowancesOperating loss carryforwards totaling$6.1 billion at year-end 2006 are beingcarried forward in a number of foreignand state jurisdictions where we arepermitted to use tax operating lossesfrom prior periods to reduce future taxableincome. These operating losses willexpire as follows: $0.2 billion in 2007,$5.0 billion between 2008 and 2026 and$0.9 billion may be carried forwardindefinitely. In addition, certain taxcredits generated in prior periods ofapproximately $33.9 million are availableto reduce certain foreign taxliabilities through 2011. We establishvaluation allowances for our deferredtax assets when the amount ofexpected future taxable income is notlikely to support the use of the deductionor credit.Undistributed International EarningsThe AJCA created a one-time incentivefor U.S. corporations to repatriateundistributed international earnings byproviding an 85% dividends receiveddeduction. In 2005, we repatriatedapproximately $7.5 billion in earningspreviously considered indefinitely reinvestedoutside the U.S. and recordedincome tax expense of $460 millionrelated to this repatriation. Other thanthe earnings repatriated, we intend tocontinue to reinvest earnings outsidethe U.S. for the foreseeable future and,therefore, have not recognized any U.S.tax expense on these earnings. AtDecember 30, 2006, we had approximately$10.8 billion of undistributedinternational earnings.ReservesA number of years may elapse before aparticular matter, for which we haveestablished a reserve, is audited andfinally resolved. The number of yearswith open tax audits varies dependingon the tax jurisdiction. In 2006, we recognizednon-cash tax benefits of$602 million, substantially all of whichrelated to the IRS’s examination of ourconsolidated income tax returns for theyears 1998 through 2002. The IRS issueda Revenue Agent’s Report (RAR), andwe are in agreement with their conclusion,except for one matter which wecontinue to dispute. The agreed adjustmentsrelate to transfer pricing andvarious other transactions, includingcertain acquisitions, the public offeringof PBG, as well as the restructuring ofour international snack foodsoperations during that audit period.During 2004, we recognized $266 millionof tax benefits related to thefavorable resolution of certain previouslyopen tax issues. In addition, in2004, we recognized a tax benefit of$38 million upon agreement with theIRS on a previously open issue related toour discontinued restaurant operations.The IRS has initiated their audits ofour tax returns for the years 2003through 2005. While it is often difficultto predict the final outcome or the timingof resolution of any particular taxmatter, we believe that our reservesreflect the probable outcome of knowntax contingencies. We adjust thesereserves, as well as the related interest,in light of changing facts and circumstances.Settlement of any particularissue would usually require the use ofcash. Favorable resolution would be recognizedas a reduction to our annualtax rate in the year of resolution. Ourtax reserves, covering all federal, stateand foreign jurisdictions, are presentedon our balance sheet within other liabilities(see Note 14), except for anyamounts relating to items we expect topay in the coming year which areincluded in current income taxespayable. For further unaudited informationon the impact of the resolutionof open tax issues, see “OtherConsolidated Results.”As further discussed in Note 2, wewill adopt FIN 48 as of the beginning ofour 2007 fiscal year.Note 6 — Stock–Based CompensationOur stock-based compensation programis a broad-based program designed toattract and retain employees while alsoaligning employees’ interests with theinterests of our shareholders. A majorityof our employees participate in ourstock-based compensation programs. Inaddition, members of our Board ofDirectors participate in our stock-basedcompensation program in connectionwith their service on our Board. Stockoptions and RSUs are granted toemployees under the shareholderapproved2003 Long-Term IncentivePlan (LTIP), our only active stock-basedplan. Stock-based compensationexpense was $270 million in 2006,$311 million in 2005 and $368 million in2004. Related income tax benefits recognizedin earnings were $80 million in2006, $87 million in 2005 and $103 millionin 2004. Stock-based compensationcost capitalized in connection with ourBPT initiative was $3 million in 2006,$4 million in 2005 and none in 2004. Atyear-end 2006, 36 million shares wereavailable for future stock-based compensationgrants. For additionalunaudited information on our stockbasedcompensation program, see “OurCritical Accounting Policies” inManagement’s Discussion and Analysis.Method of Accounting andOur AssumptionsWe account for our employee stockoptions, which include grants under ourexecutive program and broad-basedSharePower program, under the fairvalue method of accounting using aBlack-Scholes valuation model to measurestock option expense at the date ofgrant. All stock option grants have anexercise price equal to the fair marketvalue of our common stock on the dateof grant and generally have a 10-yearterm. The fair value of stock optiongrants is amortized to expense over thevesting period, generally three years.65

267419_L01_P27_81.v4.qxd 3/6/07 9:20 AM Page 66Executives who are awarded long-termincentives based on their performanceare offered the choice of stock options orRSUs. Executives who elect RSUs receiveone RSU for every four stock options thatwould have otherwise been granted.Senior officers do not have a choice andare granted 50% stock options and 50%RSUs. RSU expense is based on the fairvalue of PepsiCo stock on the date ofgrant and is amortized over the vestingperiod, generally three years. Each RSU issettled in a share of our stock after thevesting period. Vesting of RSU awards forsenior officers is contingent upon theachievement of pre-established performancetargets. There have been noreductions to the exercise price of previouslyissued awards, and any repricing ofawards would require approval of ourshareholders.On January 1, 2006, we adopted SFAS123R under the modified prospectivemethod. Since we had previouslyaccounted for our stock-based compensationplans under the fair value provisionsof SFAS 123, our adoption did not significantlyimpact our financial position orour results of operations. Under SFAS123R, actual tax benefits recognized inexcess of tax benefits previously establishedupon grant are reported as afinancing cash inflow. Prior to adoption,such excess tax benefits were reported asan operating cash inflow.Our weighted-average Black-Scholes fair value assumptions are as follows:2006 2005 2004Expected life 6 yrs. 6 yrs. 6 yrs.Risk free interest rate 4.5% 3.8% 3.3%Expected volatility 18% 23% 26%Expected dividend yield 1.9% 1.8% 1.8%A summary of our stock-based compensation activity for the year ended December 30, 2006 is presented below:Average AggregateAverage Life IntrinsicOur Stock Option Activity Options (a) Price (b) (years) (c) Value (d)Outstanding at January 1, 2006 150,149 $42.03Granted 12,519 57.72Exercised (31,056) 38.61Forfeited/expired (3,863) 49.06Outstanding at December 30, 2006 127,749 $44.24 5.46 $2,339,562Exercisable at December 30, 2006 91,381 $41.02 4.42 $1,967,843(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.Average Average AggregateIntrinsic Life IntrinsicOur RSU Activity RSUs (a) Value (b) (years) (c) Value (d)Outstanding at January 1, 2006 5,669 $50.70Granted 2,992 58.22Converted (183) 50.00Forfeited/expired (593) 53.17Outstanding at December 30, 2006 7,885 $53.38 1.38 $493,201(a) RSUs are in thousands.(b) Weighted-average intrinsic value at grant date.(c) Weighted-average contractual life remaining.(d) In thousands.66

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 67Other Stock-Based Compensation Data 2006 2005 2004Stock OptionsWeighted-average fair value of options granted $12.81 $13.45 $12.04Total intrinsic value of options exercised (a) $686,242 $632,603 $667,001RSUsTotal number of RSUs granted (a) 2,992 3,097 3,077Weighted-average intrinsic value of RSUs granted $58.22 $53.83 $47.28Total intrinsic value of RSUs converted (a) $10,934 $4,974 $914(a) In thousands.At December 30, 2006, there was $301 million of total unrecognized compensation cost related to nonvested share-based compensationgrants. This unrecognized compensation is expected to be recognized over a weighted-average period of 1.5 years.Note 7 — Pension, Retiree Medical and Savings PlansOur pension plans cover full-timeemployees in the U.S. and certain internationalemployees. Benefits aredetermined based on either years ofservice or a combination of years of serviceand earnings. U.S. and Canadaretirees are also eligible for medical andlife insurance benefits (retiree medical)if they meet age and servicerequirements. Generally, our share ofretiree medical costs is capped at specifieddollar amounts, which vary basedupon years of service, with retirees contributingthe remainder of the costs.We use a September 30 measurementdate and all plan assets and liabilitiesare generally reported as of that date.Other gains and losses resulting fromactual experience differing from ourassumptions and from changes in ourassumptions are also determined ateach measurement date. If this netaccumulated gain or loss exceeds 10%of the greater of plan assets or liabilities,a portion of the net gain or loss isincluded in expense for the followingyear. The cost or benefit of planchanges that increase or decreasebenefits for prior employee service(prior service cost/(credit)) is included inearnings on a straight-line basis overthe average remaining service period ofthose expected to benefit, which isapproximately 11 years for pensionexpense and approximately 13 years forretiree medical.On December 30, 2006, we adoptedSFAS 158 which requires that we recognizethe overfunded or underfundedstatus of our Plans as an asset or liabilityon our December 30, 2006 balancesheet. Subsequent changes in thefunded status will be recognizedthrough comprehensive income in theyear in which they occur. SFAS 158 alsorequires that, beginning in 2008, ourassumptions used to measure ourannual pension and retiree medicalexpenses be determined as of the balancesheet date, and all plan assets andliabilities be reported as of that date. Inaccordance with SFAS 158, prior yearamounts have not been adjusted.The following illustrates the incrementaleffect of applying SFAS 158 onindividual line items on our balancesheet as of December 30, 2006:BeforeAfterApplicationApplicationof SFAS 158 Adjustments of SFAS 158Other nonamortizable intangible assets $1,229 $(17) $1,212Other assets $2,979 $(1,999) $980Total assets $31,946 $(2,016) $29,930Accounts payable and other current liabilities $6,475 $21 $6,496Other liabilities $4,127 $497 $4,624Deferred income taxes $1,419 $(891) $528Total liabilities $14,935 $(373) $14,562Accumulated other comprehensive loss $603 $1,643 $2,246Total common shareholders’ equity $17,090 $(1,643) $15,44767

267419_L01_P27_81.v8.qxd 3/8/07 12:13 AM Page 68PensionRetiree Medical2006 2005 2006 2005 2006 2005U.S.InternationalChange in projected benefit liabilityLiability at beginning of year $5,771 $4,968 $1,263 $ 952 $1,312 $1,319Service cost 245 213 52 32 46 40Interest cost 319 296 68 55 72 78Plan amendments 11 – 8 3 – (8)Participant contributions – – 12 10 – –Experience (gain)/loss (163) 517 20 203 (34) (45)Benefit payments (233) (241) (38) (28) (75) (74)Settlement/curtailment loss (7) – (6) – – –Special termination benefits 4 21 – – 1 2Foreign currency adjustment – – 126 (68) – –Other – (3) 6 104 48 –Liability at end of year $5,947 $5,771 $1,511 $1,263 $1,370 $1,312Change in fair value of plan assetsFair value at beginning of year $5,086 $4,152 $1,099 $ 838 $ – $ –Actual return on plan assets 513 477 112 142 – –Employer contributions/funding 19 699 30 104 75 74Participant contributions – – 12 10 – –Benefit payments (233) (241) (38) (28) (75) (74)Settlement/curtailment loss (7) – – – – –Foreign currency adjustment – – 116 (61) – –Other – (1) (1) 94 – –Fair value at end of year $5,378 $5,086 $1,330 $1,099 $ – $ –Reconciliation of funded statusFunded status $(569) $ (685) $(181) $(164) $(1,370) $(1,312)Adjustment for fourth quarter contributions 6 5 13 4 16 19Unrecognized prior service cost/(credit) – 5 – 17 – (113)Unrecognized experience loss – 2,288 – 474 – 402Net amount recognized $(563) $1,613 $(168) $ 331 $(1,354) $(1,004)Amounts recognizedOther assets $ 185 $2,068 $ 6 $367 $ – $ –Intangible assets – – – 1 – –Other current liabilities (19) – (2) – (84) –Other liabilities (729) (479) (172) (41) (1,270) (1,004)Minimum pension liability – 24 – 4 – –Net amount recognized $ (563) $1,613 $(168) $331 $(1,354) $(1,004)Amounts included in accumulated other comprehensive loss (pre-tax)Net loss $1,836 $ – $475 $– $ 364 $–Prior service cost/(credit) 13 – 24 – (101) –Minimum pension liability – 24 – 4 – –Total $1,849 $24 $499 $4 $ 263 $–Components of the (decrease)/increase in net lossChange in discount rate $ (123) $ 365 $ 2 $194 $ (30) $ 61Employee-related assumption changes (45) 57 6 2 – –Liability-related experience differentfrom assumptions 5 95 6 7 (4) (54)Actual asset return different fromexpected return (122) (133) (30) (73) – –Amortization of losses (164) (106) (29) (15) (21) (26)Other, including foreign currency adjustmentsand 2003 Medicare Act (3) (3) 46 (22) 17 (52)Total $ (452) $(275) $ 1 $ 93 $ (38) $ (71)Liability at end of year for service to date $4,998 $4,783 $1,239 $1,04768

267419_L01_P27_81.v4.qxd 3/6/07 9:20 AM Page 69Components of benefit expense are as follows:PensionRetiree Medical2006 2005 2004 2006 2005 2004 2006 2005 2004U.S.InternationalComponents of benefit expenseService cost $ 245 $ 213 $ 193 $52 $32 $27 $ 46 $ 40 $ 38Interest cost 319 296 271 68 55 47 72 78 72Expected return on plan assets (391) (344) (325) (81) (69) (65) – – –Amortization of prior service cost/(credit) 3 3 6 2 1 1 (13) (11) (8)Amortization of net loss 164 106 81 29 15 9 21 26 19340 274 226 70 34 19 126 133 121Settlement/curtailment loss 3 – 4 – – 1 – – –Special termination benefits 4 21 19 – – 1 1 2 4Total $ 347 $ 295 $ 249 $70 $34 $21 $127 $135 $125The estimated amounts to be amortized from accumulated other comprehensive loss into benefit expense in 2007 for ourpension and retiree medical plans are as follows:PensionRetiree MedicalU.S.InternationalNet loss $136 $29 $ 18Prior service cost/(credit) 5 3 (13)Total $141 $32 $ 5The following table provides the weighted-average assumptions used to determine projected benefit liability and benefitexpense for our pension and retiree medical plans:PensionRetiree Medical2006 2005 2004 2006 2005 2004 2006 2005 2004U.S.InternationalWeighted average assumptionsLiability discount rate 5.8% 5.7% 6.1% 5.2% 5.1% 6.1% 5.8% 5.7% 6.1%Expense discount rate 5.7% 6.1% 6.1% 5.1% 6.1% 6.1% 5.7% 6.1% 6.1%Expected return on plan assets 7.8% 7.8% 7.8% 7.3% 8.0% 8.0% – – –Rate of salary increases 4.5% 4.4% 4.5% 3.9% 4.1% 3.9% – – –The following table provides selected information about plans with liability for service to date and total benefit liability inexcess of plan assets:PensionRetiree Medical2006 2005 2006 2005 2006 2005U.S.InternationalSelected information for plans with liabilityfor service to date in excess of plan assetsLiability for service to date $(387) $(374) $(286) $(65)Fair value of plan assets $1 $8 $237 $33Selected information for plans withbenefit liability in excess of plan assetsBenefit liability $(754) $(2,690) $(1,387) $(1,158) $(1,370) $(1,312)Fair value of plan assets $1 $1,758 $1,200 $985 – –Of the total projected pension benefit liability at year-end 2006, $701 million relates to plans that we do not fundbecause the funding of such plans does not receive favorable tax treatment.69

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 70Future Benefit Payments and FundingOur estimated future benefit payments are as follows:2007 2008 2009 2010 2011 2012-16Pension $265 $285 $310 $345 $375 $2,490Retiree medical* $90 $95 $100 $100 $105 $595*Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the Medicare Act.Subsidies are expected to be approximately $5 million for each of the years from 2007 through 2011 and approximately $40 million for 2012 through 2016.These future benefits to beneficiariesinclude payments from both fundedand unfunded pension plans.In 2007, we expect to make pensioncontributions of up to $150 million withup to $75 million expected to be discretionary.Our cash payments for retireemedical are estimated to be approximately$85 million in 2007.Pension AssetsThe expected return on pension planassets is based on our historical experience,our pension plan investmentstrategy and our expectations for longtermrates of return. We use amarket-related value method thatrecognizes each year’s asset gain or lossover a five-year period. Therefore, ittakes five years for the gain or loss fromany one year to be fully included in thevalue of pension plan assets that is usedto calculate the expected return. Ourpension plan investment strategy isreviewed annually and is establishedbased upon plan liabilities, an evaluationof market conditions, tolerance forrisk, and cash requirements for benefitpayments. Our investment objective isto ensure that funds are available tomeet the plans’ benefit obligationswhen they are due. Our investmentstrategy is to prudently invest planassets in high-quality and diversifiedequity and debt securities to achieveour long-term return expectation. Ourinvestment policy also permits the useof derivative instruments to enhancethe overall return of the portfolio. Weuse a third-party advisor to assist us indetermining our investment allocationand modeling our long-term rate ofreturn assumptions. Our expected longtermrate of return on U.S. plan assets is7.8%, reflecting estimated long-termrates of return of 9.3% from equitysecurities and 5.8% from fixed incomesecurities. Our target allocation andactual pension plan asset allocations forthe plan years 2006 and 2005 areas follows:Actual AllocationAsset Category Target Allocation 2006 2005Equity securities 60% 61% 60%Debt securities 40% 39% 39%Other, primarily cash – – 1%Total 100% 100% 100%Pension assets include 5.5 millionshares of PepsiCo common stock with amarket value of $358 million in 2006,and 5.5 million shares with a marketvalue of $311 million in 2005. Our investmentpolicy limits the investment inPepsiCo stock at the time of investmentto 10% of the fair value of plan assets.Retiree Medical Cost Trend RatesAn average increase of 9% in the costof covered retiree medical benefits isassumed for 2007. This average increaseis then projected to decline gradually to5% in 2011 and thereafter. Theseassumed health care cost trend rateshave an impact on the retiree medicalplan expense and liability. However,the cap on our share of retiree medicalcosts limits the impact. A 1-percentagepointchange in the assumed healthcare trend rate would have thefollowing effects:1% Increase 1% Decrease2006 service and interest cost components $4 $(3)2006 benefit liability $42 $(36)Savings PlanOur U.S. employees are eligible to participatein 401(k) savings plans, which arevoluntary defined contribution plans.The plans are designed to help employeesaccumulate additional savings forretirement. We make matching contributionson a portion of eligible pay basedon years of service. In 2006 and 2005, ourmatching contributions were $56 millionand $52 million, respectively.For additional unaudited informationon our pension and retiree medical plansand related accounting policies andassumptions, see “Our CriticalAccounting Policies” in Management’sDiscussion and Analysis.70

267419_L01_P27_81.v5.qxd 3/6/07 2:57 PM Page 71Note 8 — Noncontrolled Bottling AffiliatesOur most significant noncontrolled bottlingaffiliates are PBG and PAS.Approximately 10% of our total netrevenue in 2006, 2005 and 2004 reflectssales to PBG.The Pepsi Bottling GroupIn addition to approximately 38% and41% of PBG’s outstanding commonstock that we own at year-end 2006 and2005, respectively, we own 100% ofPBG’s class B common stock and approximately7% of the equity of BottlingGroup, LLC, PBG’s principal operatingsubsidiary. This gives us economic ownershipof approximately 43% and 45%of PBG’s combined operations at yearend2006 and 2005, respectively.Bottling equity income includes$186 million and $126 million of pretaxgains on our sales of PBG stock in2006 and 2005, respectively.PBG’s summarized financial information is as follows:2006 2005 2004Current assets $ 2,749 $ 2,412Noncurrent assets 9,178 9,112Total assets $11,927 $11,524Current liabilities $2,051 $2,598Noncurrent liabilities 7,252 6,387Minority interest 540 496Total liabilities $9,843 $9,481Our investment $1,842 $1,738Net revenue $12,730 $11,885 $10,906Gross profit $5,920 $5,632 $5,250Operating profit $1,017 $1,023 $976Net income $522 $466 $457Our investment in PBG, whichincludes the related goodwill, was$500 million and $400 million higherthan our ownership interest in theirnet assets at year-end 2006 and 2005,respectively. Based upon the quotedclosing price of PBG shares at year-end2006 and 2005, the calculated marketvalue of our shares in PBG, excludingour investment in Bottling Group, LLC,exceeded our investment balance byapproximately $1.4 billion and$1.5 billion, respectively.PepsiAmericasAt year-end 2006 and 2005, we owned approximately 44% and 43% ofPepsiAmericas, respectively, and their summarized financial information is as follows:2006 2005 2004Current assets $ 675 $ 598Noncurrent assets 3,532 3,456Total assets $4,207 $4,054Current liabilities $ 694 $ 722Noncurrent liabilities 1,909 1,763Total liabilities $2,603 $2,485Our investment $1,028 $968Net revenue $3,972 $3,726 $3,345Gross profit $1,608 $1,562 $1,423Operating profit $356 $393 $340Net income $158 $195 $182Our investment in PAS, whichincludes the related goodwill, was$316 million and $292 million higherthan our ownership interest in their netassets at year-end 2006 and 2005,respectively. Based upon the quotedclosing price of PAS shares at year-end2006 and 2005, the calculated marketvalue of our shares in PepsiAmericasexceeded our investment balance byapproximately $173 million and$364 million, respectively.In January 2005, PAS acquired aregional bottler, Central InvestmentCorporation. The table includes theresults of Central InvestmentCorporation from the transactiondate forward.Related Party TransactionsOur significant related party transactionsinvolve our noncontrolled bottling affiliates.We sell concentrate to theseaffiliates, which they use in the productionof CSDs and non-carbonated beverages.We also sell certain finished goodsto these affiliates and we receive royaltiesfor the use of our trademarks forcertain products. Sales of concentrateand finished goods are reported net ofbottler funding. For further unauditedinformation on these bottlers, see “OurCustomers” in Management’s Discussionand Analysis.71

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 72These transactions with our bottling affiliates are reflected in our consolidatedfinancial statements as follows:Such amounts are settled on termsconsistent with other trade receivablesand payables. See Note 9 regarding ourguarantee of certain PBG debt.2006 2005 2004Net revenue $4,837 $4,633 $4,170Selling, general and administrative expenses $87 $143 $114Accounts and notes receivable $175 $178Accounts payable and other current liabilities $62 $117In addition, we coordinate, on anaggregate basis, the negotiation andpurchase of sweeteners and other rawmaterials requirements for certain ofour bottlers with suppliers. Once wehave negotiated the contracts, the bottlersorder and take delivery directlyfrom the supplier and pay the suppliersdirectly. Consequently, thesetransactions are not reflected in ourconsolidated financial statements. Asthe contracting party, we could be liableto these suppliers in the event of anynonpayment by our bottlers, but weconsider this exposure to be remote.Note 9 — Debt Obligations and CommitmentsIn the second quarter of 2006, weentered into a new unsecured revolvingcredit agreement which enables us toborrow up to $1.5 billion subject to customaryterms and conditions. Fundsborrowed under this agreement may beused for general corporate purposes,including supporting our outstandingcommercial paper issuances. The agreementterminates in May 2011 andreplaces our previous $2.1 billion ofcredit facilities. As of December 30,2006, we have reclassified $1.5 billion ofshort-term debt to long-term based onour intent and ability to refinance on along-term basis.In addition, $394 million of our debtrelated to borrowings from various linesof credit maintained for our internationaldivisions. These lines of credit are subjectto normal banking terms and conditions2006 2005Short-term debt obligationsCurrent maturities of long-term debt $ 605 $ 143Commercial paper (5.3% and 3.3%) 792 3,140Other borrowings (7.3% and 7.4%) 377 356Amounts reclassified to long-term debt (1,500) (750)$ 274 $2,889Long-term debt obligationsShort-term borrowings, reclassified $1,500 $ 750Notes due 2007-2026 (6.0% and 5.4%) 1,148 1,161Zero coupon notes, $425 million due 2007-2012 (13.4%) 299 312Other, due 2007-2016 (6.1% and 6.3%) 208 233$3,155 2,456Less: current maturities of long-term debt obligations (605) (143)$2,550 $2,313The interest rates in the above table reflect weighted-average rates at year-end.and are fully committed to the extentof our borrowings.In the third quarter of 2006, weentered into a U.S. $2.5 billion euromedium term note program. Under theprogram, we may issue unsecured notesunder mutually agreed upon terms withthe purchasers of the notes. Proceedsfrom any issuance of notes may be usedfor general corporate purposes, exceptas otherwise specified in the relatedprospectus. As of December 30, 2006,we have no outstanding notes underthe program.Interest Rate SwapsWe entered into interest rate swaps in2004 to effectively convert the interestrate of a specific debt issuance from afixed rate of 3.2% to a variable rate.The variable weighted-average interestrate that we pay is linked to LIBOR andis subject to change. The notionalamount of the interest rate swaps outstandingat December 30, 2006 andDecember 31, 2005 was $500 million.The terms of the interest rate swapsmatch the terms of the debt they modify.The swaps mature in May 2007.At December 30, 2006, approximately63% of total debt, after theimpact of the related interest rateswaps, was exposed to variable interestrates, compared to 78% at December31, 2005. In addition to variable ratelong-term debt, all debt with maturitiesof less than one year is categorized asvariable for purposes of this measure.Cross Currency Interest Rate SwapsIn 2004, we entered into a crosscurrency interest rate swap to hedgethe currency exposure on U.S. dollardenominated debt of $50 million heldby a foreign affiliate. The terms of thisswap match the terms of the debt itmodifies. The swap matures in 2008.The unrealized gain related to this swapwas less than $1 million at December30, 2006 and December 31, 2005,resulting in a U.S. dollar liability of$50 million. We have also entered intocross currency interest rate swaps tohedge the currency exposure on U.S.dollar denominated intercompany debtof $95 million at December 30, 2006and $125 million at December 31, 2005.The terms of the swaps match the termsof the debt they modify. The swapsmature in 2007. The net unrealized lossrelated to these swaps was less than$1 million at December 30, 2006 andthe net unrealized gain related tothese swaps was $5 million atDecember 31, 2005.72

267419_L01_P27_81.v3.qxd 3/2/07 4:36 PM Page 73Long-Term Contractual CommitmentsPayments Due by Period Total 2007 2008-2009 2010-2011 2012 and beyondLong-term debt obligations (a) $1,050 $ – $ 583 $ 125 $ 342Interest on debt obligations (b) 295 50 57 43 145Operating leases 922 231 302 176 213Purchasing commitments 5,205 1,357 2,216 871 761Marketing commitments 1,199 287 453 332 127Other commitments 279 229 43 5 2$8,950 $2,154 $3,654 $1,552 $1,590(a) Excludes current maturities of long-term debt of $605 million which are classified within current liabilities, as well as short-term borrowings reclassifiedas long-term debt of $1,500 million.(b) Interest payments on floating-rate debt are estimated using interest rates effective as of December 30, 2006.The above table reflects non-cancelable commitments as of December 30, 2006 based on year-end foreign exchange rates.Most long-term contractual commitments,except for our long-term debtobligations, are not recorded on ourbalance sheet. Non-cancelable operatingleases primarily represent building leases.Non-cancelable purchasing commitmentsare primarily for oranges andorange juice, cooking oil and packagingmaterials. Non-cancelable marketingcommitments primarily are for sportsmarketing. Bottler funding is notreflected in our long-term contractualcommitments as it is negotiated on anannual basis. See Note 7 regardingour pension and retiree medical obligationsand discussion below regardingour commitments to noncontrolledbottling affiliates and former restaurantoperations.Off-Balance-Sheet ArrangementsIt is not our business practice to enterinto off-balance-sheet arrangements,other than in the normal course ofbusiness, nor is it our policy to issueguarantees to our bottlers, noncontrolledaffiliates or third parties.However, certain guarantees were necessaryto facilitate the separation ofour bottling and restaurant operationsfrom us. In connection with thesetransactions, we have guaranteed$2.3 billion of Bottling Group, LLC’slong-term debt through 2012 and$23 million of YUM! Brands, Inc.’s(YUM) outstanding obligations, primarilyproperty leases, through 2020. Theterms of our Bottling Group, LLC debtguarantee are intended to preserve thestructure of PBG’s separation from usand our payment obligation would betriggered if Bottling Group, LLC failedto perform under these debtobligations or the structure significantlychanged. Our guarantees of certainobligations ensured YUM’s continueduse of certain properties. These guaranteeswould require our cash payment ifYUM failed to perform under theselease obligations.See “Our Liquidity and CapitalResources” in Management’s Discussionand Analysis for further unauditedinformation on our borrowings.Note 10 — Risk ManagementWe are exposed to the risk of lossarising from adverse changes in:• commodity prices, affecting the costof our raw materials and energy,• foreign exchange risks,• interest rates,• stock prices, and• discount rates affecting the measurementof our pension and retireemedical liabilities.In the normal course of business, wemanage these risks through a variety ofstrategies, including the use of derivatives.Certain derivatives are designatedas either cash flow or fair value hedgesand qualify for hedge accounting treatment,while others do not qualify andare marked to market throughearnings. See “Our Business Risks” inManagement’s Discussion and Analysisfor further unaudited information onour business risks.For cash flow hedges, changes in fairvalue are deferred in accumulated othercomprehensive loss within shareholders’equity until the underlying hedgeditem is recognized in net income. Forfair value hedges, changes in fair valueare recognized immediately in earnings,consistent with the underlying hedgeditem. Hedging transactions are limitedto an underlying exposure. As a result,any change in the value of our derivativeinstruments would be substantially offsetby an opposite change in the value ofthe underlying hedged items. Hedgingineffectiveness and a net earningsimpact occur when the change in thevalue of the hedge does not offset thechange in the value of the underlyinghedged item. If the derivative instrumentis terminated, we continue todefer the related gain or loss and includeit as a component of the cost of theunderlying hedged item. Upon determinationthat the underlying hedged itemwill not be part of an actual transaction,we recognize the related gain or loss innet income in that period.We also use derivatives that do notqualify for hedge accounting treatment.We account for such derivatives at marketvalue with the resulting gains andlosses reflected in our income statement.We do not use derivative instruments fortrading or speculative purposes, and we73

267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 74limit our exposure to individual counterpartiesto manage credit risk.Commodity PricesWe are subject to commodity price riskbecause our ability to recover increasedcosts through higher pricing may be limitedin the competitive environment inwhich we operate. This risk is managedthrough the use of fixed-price purchaseorders, pricing agreements, geographicdiversity and derivatives. We use derivatives,with terms of no more than twoyears, to economically hedge price fluctuationsrelated to a portion of ouranticipated commodity purchases, primarilyfor natural gas and diesel fuel. Forthose derivatives that qualify for hedgeaccounting, any ineffectiveness isrecorded immediately. However, suchcommodity cash flow hedges have nothad any significant ineffectiveness for allperiods presented. We classify both theearnings and cash flow impact fromthese derivatives consistent with theunderlying hedged item. During the next12 months, we expect to reclassify netgains of $1 million related to cash flowhedges from accumulated other comprehensiveloss into net income. Derivativesused to hedge commodity price risks thatdo not qualify for hedge accounting aremarked to market each period andreflected in our income statement.Foreign ExchangeOur operations outside of the U.S. generateapproximately 40% of our netrevenue, with Mexico, the UnitedKingdom and Canada comprisingapproximately 20% of our net revenue.As a result, we are exposed to foreigncurrency risks from unforeseen economicchanges and political unrest. Onoccasion, we enter into hedges, primarilyforward contracts with terms of no morethan two years, to reduce the effect offoreign exchange rates. Ineffectiveness ofthese hedges has not been material.Interest RatesWe centrally manage our debt andinvestment portfolios considering investmentopportunities and risks, taxconsequences and overall financingstrategies. We may use interest rate andcross currency interest rate swaps to manageour overall interest expense andforeign exchange risk. These instrumentseffectively change the interest rate andcurrency of specific debt issuances. Theseswaps are entered into concurrently withthe issuance of the debt that they areintended to modify. The notionalamount, interest payment and maturitydate of the swaps match the principal,interest payment and maturity date ofthe related debt. These swaps areentered into only with strong creditworthycounterparties, are settled on a netbasis and are of relatively short duration.Stock PricesThe portion of our deferred compensationliability that is based on certainmarket indices and on our stock price issubject to market risk. We hold mutualfund investments and prepaid forwardcontracts to manage this risk. Changes inthe fair value of these investments andcontracts are recognized immediately inearnings and are offset by changes inthe related compensation liability.Fair ValueAll derivative instruments arerecognized on our balance sheet at fairvalue. The fair value of our derivativeinstruments is generally based onquoted market prices. Book and fairvalues of our derivative and financialinstruments are as follows:742006 2005Book Value Fair Value Book Value Fair ValueAssetsCash and cash equivalents (a) $1,651 $1,651 $1,716 $1,716Short-term investments (b) $1,171 $1,171 $3,166 $3,166Forward exchange contracts (c) $8 $8 $19 $19Commodity contracts (d) $2 $2 $41 $41Prepaid forward contracts (e) $73 $73 $107 $107Cross currency interest rate swaps (f) $1 $1 $6 $6LiabilitiesForward exchange contracts (c) $24 $24 $15 $15Commodity contracts (d) $29 $29 $3 $3Debt obligations $2,824 $2,955 $5,202 $5,378Interest rate swaps (g) $4 $4 $9 $9The above items are included on our balance sheet under the captions noted or as indicated below. In addition, derivatives qualify for hedge accounting unlessotherwise noted below.(a) Book value approximates fair value due to the short maturity.(b) Principally short-term time deposits and includes $145 million at December 30, 2006 and $124 million at December 31, 2005 of mutual fund investments usedto manage a portion of market risk arising from our deferred compensation liability.(c) The 2006 liability includes $10 million related to derivatives that do not qualify for hedge accounting and the 2005 asset includes $14 million related to derivatives thatdo 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 2006 liability includes $28 million related to derivatives that do not qualify for hedge accounting. The 2005 asset includes $2 million related to derivativesthat do not qualify for hedge accounting and the liability relates entirely to derivatives that do not qualify for hedge accounting. Assets are reported withincurrent 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 hada fair value of $35 million at December 30, 2006 and $47 million at December 31, 2005 based on a third-party estimate of the costto us of transferring the liability to an independent financial institution. See Note 9 for additional information on our guarantees.

267419_L01_P27_81.v4.qxd 3/6/07 9:20 AM Page 75Note 11 — Net Income per Common Share from Continuing OperationsBasic net income per common share isnet income available to common shareholdersdivided by the weightedaverage of common shares outstandingduring the period. Diluted net incomeper common share is calculated usingthe weighted average of commonshares outstanding adjusted to includethe effect that would occur if in-themoneyemployee stock options wereexercised and RSUs and preferredshares were converted into commonshares. Options to purchase 0.1 millionshares in 2006, 3.0 million shares in2005 and 7.0 million shares in 2004were not included in the calculation ofdiluted earnings per common sharebecause these options were out-of-themoney.Out-of-the-money options hadaverage exercise prices of $65.24 in2006, $53.77 in 2005 and $52.88 in 2004.The computations of basic and diluted net income per common share from continuing operations are as follows:2006 2005 2004Income Shares (a) Income Shares (a) Income Shares (a)Net income $5,642 $4,078 $4,174Preferred shares:Dividends (2) (2) (3)Redemption premium (9) (16) (22)Net income available forcommon shareholders $5,631 1,649 $4,060 1,669 $4,149 1,696Basic net income per common share $3.42 $2.43 $2.45Net income available forcommon shareholders $5,631 1,649 $4,060 1,669 $4,149 1,696Dilutive securities:Stock options and RSUs – 36 – 35 – 31ESOP convertible preferred stock 11 2 18 2 24 2Diluted $5,642 1,687 $4,078 1,706 $4,173 1,729Diluted net income per common share $3.34 $2.39 $2.41(a) Weighted-average common shares outstanding.75

267419_L01_P27_81.v5.qxd 3/6/07 2:57 PM Page 76Note 12 — Preferred and Common StockAs of December 30, 2006 and December31, 2005, there were 3.6 billion sharesof common stock and 3 million sharesof convertible preferred stock authorized.The preferred stock was issuedonly for an ESOP established by Quakerand these shares are redeemable forcommon stock by the ESOP participants.The preferred stock accrues dividends atan annual rate of $5.46 per share. Atyear-end 2006 and 2005, there were803,953 preferred shares issued and320,853 and 354,853 shares outstanding,respectively. The outstandingpreferred shares had a fair value of$100 million as of December 30, 2006and $104 million as of December 31,2005. Each share is convertible at theoption of the holder into 4.9625 sharesof common stock. The preferred sharesmay be called by us upon written noticeat $78 per share plus accrued andunpaid dividends. There were 17 millionshares of common stock held in theaccounts of ESOP participants as ofDecember 30, 2006 and December 31,2005. Quaker made the final award toits ESOP plan in June 2001.2006 2005 2004Shares Amount Shares Amount Shares AmountPreferred stock 0.8 $41 0.8 $41 0.8 $41Repurchased preferred stockBalance, beginning of year 0.5 $110 0.4 $ 90 0.3 $63Redemptions – 10 0.1 19 0.1 27Balance, end of year 0.5 $120 0.5 $110* 0.4 $90*Does not sum due to rounding.Note 13 — Accumulated Other Comprehensive LossComprehensive income is a measure ofincome which includes both net incomeand other comprehensive income orloss. Other comprehensive income orloss results from items deferred fromrecognition into our income statement.Accumulated other comprehensive lossis separately presented on our balancesheet as part of common shareholders’equity. Other comprehensive2006 2005 2004income/(loss) was $456 million in 2006,$(167) million in 2005 and $381 millionin 2004. The accumulated balances foreach component of other comprehensiveloss were as follows:Currency translation adjustment $ (506) $ (971) $(720)Cash flow hedges, net of tax (a) 4 27 (19)Unamortized pension and retireemedical, net of tax (b) (1,782) – –Minimum pension liability adjustment (c) – (138) (154)Unrealized gain on securities, net of tax 40 31 7Other (2) (2) –Accumulated other comprehensive loss $(2,246) $(1,053) $(886)(a) Includes $3 million gain in 2006, no impact in 2005 and $6 million gain in 2004 for our share of ourequity investees’ accumulated derivative activity.(b) Net of taxes of $964 million in 2006.(c) Net of taxes of $72 million in 2005 and $77 million in 2004. Also includes $120 million in 2005 and$121 million in 2004 for our share of our equity investees’ minimum pension liability adjustments.76

267419_L01_P27_81.v4.qxd 3/6/07 9:21 AM Page 77Note 14 — Supplemental Financial Information2006 2005 2004Accounts receivableTrade receivables $3,147 $2,718Other receivables 642 6183,789 3,336Allowance, beginning of year 75 97 $105Net amounts charged/(credited) to expense 10 (1) 18Deductions (a) (27) (22) (25)Other (b) 6 1 (1)Allowance, end of year 64 75 $ 97Net receivables $3,725 $3,261Inventories (c)Raw materials $ 860 $ 738Work-in-process 140 112Finished goods 926 843$1,926 $1,693(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 19% in 2006 and 17% in 2005 of theinventory cost was computed using the LIFO method. The differences between LIFO and FIFO methodsof valuing these inventories were not material.2006 2005 2004Other assetsNon-current notes and accounts receivable $149 $ 186Deferred marketplace spending 232 281Unallocated purchase price forrecent acquisitions 196 256Pension plans 197 2,440Other 206 240$980 $3,403Accounts payable and other current liabilitiesAccounts payable $2,102 $1,799Accrued marketplace spending 1,444 1,383Accrued compensation and benefits 1,143 1,062Dividends payable 492 431Other current liabilities 1,315 1,296$6,496 $5,971Other liabilitiesReserves for income taxes $1,435 $1,884Other 3,189 2,439$4,624 $4,323Other supplemental informationRent expense $291 $228 $245Interest paid $215 $213 $137Income taxes paid, net of refunds $2,155 $1,258 $1,833Acquisitions (a)Fair value of assets acquired $ 678 $ 1,089 $ 78Cash paid and debt issued (522) (1,096) (64)SVE minority interest eliminated – 216 –Liabilities assumed $ 156 $ 209 $ 14(a) In 2005, these amounts include the impact of our acquisition of General Mills, Inc.’s 40.5% ownershipinterest in SVE for $750 million. The excess of our purchase price over the fair value of net assetsacquired is $250 million and is included in goodwill. We also reacquired rights to distribute globalbrands for $263 million which is included in other nonamortizable intangible assets.77

267419_L01_P27_81.v2.qxd 2/28/07 2:57 PM Page 79Management’s Report on Internal Control over Financial ReportingTo Our Shareholders:Our management is responsible for establishing and maintainingadequate 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 ourmanagement, including our Chief Executive Officer andChief Financial Officer, we conducted an evaluation of theeffectiveness of our internal control over financial reportingbased upon the framework in Internal Control — IntegratedFramework issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on that evaluation,our management concluded that our internal controlover financial reporting is effective as of December 30, 2006.KPMG LLP, an independent registered public accountingfirm, has audited the consolidated financial statementsincluded in this Annual Report and, as part of their audit, hasissued their attestation report, included herein, (1) on ourmanagement’s assessment of the effectiveness of our internalcontrols over financial reporting and (2) on the effectivenessof our internal control over financial reporting.During our fourth fiscal quarter of 2006, we began migratingcertain of our financial processing systems to SAPsoftware. This software implementation is part of our ongoingBusiness Process Transformation initiative, and we plan tocontinue implementing such software throughout otherparts of our businesses over the course of the next few years.In connection with the SAP implementation, we are modifyingthe design and documentation of our internal controlprocesses and procedures relating to the new software.Except as described above, there were no changes in ourinternal control over financial reporting that have materiallyaffected, or are reasonably likely to materially affect, ourinternal control over financial reporting during our fourthfiscal quarter of 2006.Peter A. BridgmanSenior Vice President and ControllerRichard GoodmanChief Financial OfficerIndra K. NooyiPresident and Chief Executive Officer79

267419_L01_P27_81.v2.qxd 2/28/07 4:10 PM Page 80Report of Independent Registered Public Accounting FirmBoard of Directors and Shareholders PepsiCo, Inc.:We have audited the accompanying Consolidated BalanceSheet of PepsiCo, Inc. and Subsidiaries as of December 30,2006 and December 31, 2005 and the related ConsolidatedStatements of Income, Cash Flows and CommonShareholders’ Equity for each of the years in the three-yearperiod ended December 30, 2006. We have also audited management’sassessment, included in Management’s Report onInternal Control over Financial Reporting that PepsiCo, Inc.and Subsidiaries maintained effective internal control overfinancial reporting as of December 30, 2006, based on criteriaestablished in Internal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO). PepsiCo, Inc.’s management isresponsible for these consolidated financial statements, formaintaining effective internal control over financial reporting,and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is toexpress an opinion on these consolidated financialstatements, an opinion on management’s assessment, and anopinion on the effectiveness of PepsiCo, Inc.’s internal controlover financial reporting based on our audits.We conducted our audits in accordance with the standardsof the Public Company Accounting Oversight Board (UnitedStates). Those standards require that we plan and perform theaudits to obtain reasonable assurance about whether the consolidatedfinancial statements are free of materialmisstatement and whether effective internal control overfinancial reporting was maintained in all material respects.Our audit of the consolidated financial statements includedexamining, on a test basis, evidence supporting the amountsand disclosures in the consolidated financial statements,assessing the accounting principles used and significant estimatesmade by management, and evaluating the overallfinancial statement presentation. Our audit of internal controlover financial reporting included obtaining an understandingof internal control over financial reporting, evaluating management’sassessment, testing and evaluating the design andoperating effectiveness of internal control, and performingsuch other procedures as we considered necessary in the circumstances.We believe that our audits provide a reasonablebasis for our opinions.A company’s internal control over financial reporting is aprocess designed to provide reasonable assurance regardingthe reliability of financial reporting and the preparation offinancial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internalcontrol over financial reporting includes those policiesand procedures that (1) pertain to the maintenance ofrecords that, in reasonable detail, accurately and fairly reflectthe transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of thecompany are being made only in accordance with authorizationsof management and directors of the company; and(3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effecton the financial statements.Because of its inherent limitations, internal control overfinancial reporting may not prevent or detect misstatements.Also, projections of any evaluation of effectiveness to futureperiods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, thefinancial position of PepsiCo, Inc. and Subsidiaries as ofDecember 30, 2006 and December 31, 2005, and the results oftheir operations and their cash flows for each of the years inthe three-year period ended December 30, 2006, in conformitywith United States generally accepted accountingprinciples. Also, in our opinion, management’s assessmentthat PepsiCo, Inc. maintained effective internal control overfinancial reporting as of December 30, 2006, is fairly stated,in all material respects, based on criteria established inInternal Control — Integrated Framework issued by COSO.Furthermore, in our opinion, PepsiCo, Inc. maintained, in allmaterial respects, effective internal control over financialreporting as of December 30, 2006, based on criteria establishedin Internal Control — Integrated Framework issuedby COSO.As discussed in Note 7 to the consolidated financial statements,PepsiCo, Inc. and Subsidiaries adopted the provisionsof FASB Statement No. 158, “Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans —an amendment to FASB Statements No. 87, 88, 106 and132(R),” as of December 30, 2006.KPMG LLPNew York, New YorkFebruary 16, 200780

267419_L01_P27_81.v2.qxd 2/28/07 4:10 PM Page 81Selected Financial Data (in millions except per share amounts, unaudited)First Second Third FourthQuarterly Quarter Quarter Quarter QuarterNet revenue2006 $7,205 $8,599 $8,950 $10,3832005 $6,585 $7,697 $8,184 $10,096Gross profit2006 $4,026 $4,790 $4,920 $5,6392005 $3,715 $4,383 $4,669 $5,6192006 restructuring and impairment charges (a)2006 – – – $672005 restructuring charges (a)2005 – – – $832006 Tax Adjustments (b)2006 – – – $(602)AJCA tax charge (c)2005 – – $468 $(8)Net income2006 $1,019 $1,358 $1,481 $1,7842005 $912 $1,194 $864 $1,108Net income per common share — basic2006 $0.61 $0.82 $0.90 $1.092005 $0.54 $0.71 $0.52 $0.66Net income per common share — diluted2006 $0.60 $0.80 $0.88 $1.062005 $0.53 $0.70 $0.51 $0.65Cash dividends declared per common share2006 $0.26 $0.30 $0.30 $0.302005 $0.23 $0.26 $0.26 $0.262006 stock price per share (d)High $60.55 $61.19 $65.99 $65.99Low $56.00 $56.51 $58.65 $61.15Close $59.34 $59.70 $64.73 $62.552005 stock price per share (d)High $55.71 $57.20 $56.73 $60.34Low $51.34 $51.78 $52.07 $53.55Close $52.62 $55.52 $54.65 $59.08The first, second, and third quarters consist of 12 weeks and the fourthquarter consists of 16 weeks in 2006 and 17 weeks in 2005.(a) The 2006 restructuring and impairment charges were $67 million($43 million or $0.03 per share after-tax). The 2005 restructuring chargeswere $83 million ($55 million or $0.03 per share after-tax). See Note 3.(b) Represents non-cash tax benefits in connection with the 2006 TaxAdjustments. See Note 5.(c) Represents income tax expense associated with our repatriation of earningsin connection with the AJCA. See Note 5.(d) Represents the composite high and low sales price and quarterly closingprices for one share of PepsiCo common stock.Five-Year Summary 2006 2005 2004Net revenue $35,137 $32,562 $29,261Income from continuingoperations $5,642 $4,078 $4,174Net income $5,642 $4,078 $4,212Income per common share —basic, continuing operations $3.42 $2.43 $2.45Income per common share —diluted, continuing operations $3.34 $2.39 $2.41Cash dividends declaredper common share $1.16 $1.01 $0.85Total assets $29,930 $31,727 $27,987Long-term debt $2,550 $2,313 $2,397Return on invested capital (a) 30.4% 22.7% 27.4%Five-Year Summary (Cont.) 2003 2002Net revenue $26,971 $25,112Net income $3,568 $3,000Income per common share — basic $2.07 $1.69Income per common share — diluted $2.05 $1.68Cash dividends declared percommon share $0.63 $0.595Total assets $25,327 $23,474Long-term debt $1,702 $2,187Return on invested capital (a) 27.5% 25.7%(a) Return on invested capital is defined as adjusted net income divided bythe sum of average shareholders’ equity and average total debt. Adjustednet income is defined as net income plus net interest expense after-tax.Net interest expense after-tax was $72 million in 2006, $62 million in 2005,$60 million in 2004, $72 million in 2003 and $93 million in 2002.• Includes restructuring and impairment charges of:2006 2005 2004 2003Pre-tax $67 $83 $150 $147After-tax $43 $55 $96 $100Per share $0.03 $0.03 $0.06 $0.06• Includes Quaker merger-related costs of:2003 2002Pre-tax $59 $224After-tax $42 $190Per share $0.02 $0.11• In 2006, we recognized non-cash tax benefits of $602 million ($0.36 pershare) in connection with the 2006 Tax Adjustments. In 2005, we recordedincome tax expense of $460 million ($0.27 per share) related to our repatriationof earnings in connection with the AJCA. In 2004, we reached agreementwith the IRS for an open issue related to our discontinued restaurantoperations which resulted in a tax benefit of $38 million ($0.02 per share).• On December 30, 2006, we adopted SFAS 158 which reduced total assetsby $2,016 million, total common shareholders’ equity by $1,643 millionand total liabilities by $373 million.• The 2005 fiscal year consisted of fifty-three weeks compared to fifty-twoweeks in our normal fiscal year. The 53rd week increased 2005 netrevenue by an estimated $418 million and net income by an estimated$57 million ($0.03 per share).81

267419_L01_P82.v5.qxd 3/6/07 4:11 PM Page 1Reconciliation of GAAP and Non–GAAP InformationThe financial measures listed below are not measures definedby generally accepted accounting principles. However, webelieve investors should consider these measures as they aremore indicative of our ongoing performance. Specifically,investors should consider the following:• Our 2006 and 2005 division operating profit and our 2006division operating profit growth;• Our 2006 net income without the impact of the 2006 TaxAdjustments, our share of PBG’s tax settlement and restructuringand impairment charges; our 2005 net income without theimpact of the AJCA tax charge, restructuring charges and theextra week in 2005; and our 2006 net income growth withoutthe impact of the aforementioned items;• Our 2006 diluted EPS without the impact of the 2006 TaxAdjustments, our share of PBG’s tax settlement and restructuringand impairment charges; our 2005 diluted EPS without theimpact of the AJCA tax charge, restructuring charges and theextra week in 2005; our 2006 diluted EPS growth without theimpact of the aforementioned items; and our 2004 dilutedEPS without the impact of restructuring and impairmentcharges and certain tax benefits; and• Our 2006 return on invested capital (ROIC) without the impactof the 2006 Tax Adjustments, our adoption of SFAS 158, theAJCA tax charge, restructuring and impairment charges andthe extra week in 2005.Net Income Reconciliation 2006 2005 GrowthReported Net Income $5,642 $4,078 38%2006 Tax Adjustments (602) –PepsiCo Share of PBG Tax Settlement (18) –AJCA Tax Charge – 460Extra Week – (57)Restructuring and Impairment Charges 43 55Net Income Excluding above Items $5,065 $4,536 12%2006Diluted EPS Reconciliation 2006 2005 Growth 2004Reported Diluted EPS $3.34 $2.39 40% $2.442006 Tax Adjustments (0.36) – –PepsiCo Share of PBG TaxSettlement (0.01) – –AJCA Tax Charge – 0.27 –Extra Week – (0.03) –Restructuring and ImpairmentCharges 0.03 0.03 0.062004 Tax Benefits – – (0.18)Diluted EPS Excluding above Items $3.00 $2.66 13% $2.32Operating Profit Reconciliation 2006 2005 GrowthTotal PepsiCo ReportedOperating Profit $6,439 $5,922 9%Corporate Unallocated 733 788PepsiCo Total DivisionOperating Profit $7,172 $6,710 7%ROIC Reconciliation 2006Reported ROIC 30%2006 Tax Adjustments (3)SFAS 158 Adoption (1)AJCA Tax Charge (1)ROIC Excluding above Items 26%** Does not sum due to rounding. Additionally, the impact on ROIC of the 2006and 2005 restructuring and impairment charges and the extra week in 2005rounds to zero.Glossary82Anchor bottlers: The Pepsi Bottling Group(PBG), PepsiAmericas (PAS) and Pepsi BottlingVentures (PBV).Bottler: customers to whom we have grantedexclusive contracts to sell and manufacture certainbeverage products bearing our trademarkswithin a specific geographical area.Bottler Case Sales (BCS): measure of physicalbeverage volume sold from our bottlers toindependent distributors and retailers.Bottler funding: financial incentives we give toour bottlers to assist in the distribution andpromotion of our beverage products.Business Process Transformation (BPT): our comprehensivemulti-year effort to drive efficiencies.It includes efforts to consolidate, or integrate, keybusiness functions to take advantage of our scale.It also includes moving to a common set ofprocesses that underlie our key activities, andsupporting them with a common technologyapplication. And finally, it includes our SAPinstallation, the computer system that will link allof our systems and processes.Concentrate Shipments and Equivalents (CSE):measure of our physical beverage volume sold toour customers. This measure is reported on ourfiscal year basis.Consumers: people who eat and drinkour products.Customers: authorized bottlers and independentdistributors and retailers.CSD: carbonated soft drinks.Derivatives: financial instruments that we use tomanage our risk arising from changes in commodityprices, interest rates, foreign exchangerates and stock prices.Direct-Store-Delivery (DSD): delivery system usedby us and our bottlers to deliver snacks and beveragesdirectly to retail stores where our productsare merchandised.Effective net pricing: reflects the year-over-yearimpact of discrete pricing actions, sales incentiveactivities and mix resulting from selling varyingproducts in different package sizes and indifferent countries.Management operating cash flow: net cashprovided by operating activities less capitalspending plus sales of property, plant andequipment. It is our primary measure used tomonitor cash flow performance.Marketplace spending: sales incentives offeredthrough various programs to our customers andconsumers (trade spending), as well as advertisingand other marketing activities.Servings: common metric reflecting our consolidatedphysical unit volume. Our divisions’ physicalunit measures are converted into servings basedon U.S. Food and Drug Administration guidelinesfor single-serving sizes of our products.Smart Spot: our initiative that helps consumersfind our products that can contribute tohealthier lifestyles.Transaction gains and losses: the impact on ourconsolidated financial statements of exchangerate changes arising from specific transactions.Translation adjustments: the impact of theconversion of our foreign affiliates’ financialstatements to U.S. dollars for the purpose ofconsolidating our financial statements.

Common Stock InformationStock Trading Symbol — PEPStock Exchange ListingsThe New York Stock Exchange is the principal market forPepsiCo common stock, which is also listed on theAmsterdam, Chicago and Swiss Stock Exchanges.ShareholdersAt year-end 2006, there were approximately 190,000shareholders of record.Dividend PolicyWe target an annual dividend payout of approximately45% of prior year’s net income from continuing operations.Dividends are usually declared in January, May, Julyand November and paid at the end of March, June andSeptember and the beginning of January. The dividendrecord dates for these payments are March 9, and, subjectto approval of the Board of Directors, expected to beJune 8, September 7 and December 7, 2007. We havepaid quarterly cash dividends since 1965.Cash Dividends DeclaredPer Share (In $).59502.63003.850Stock Performance1.0104 05 06PepsiCo was formed through the 1965 merger of Pepsi-ColaCompany and Frito-Lay, Inc. A $1,000 investment in ourstock made on December 31, 2001 was worth about$1,393 on December 31, 2006, assuming the reinvestmentof dividends into PepsiCo stock. This performancerepresents a compounded annual growth rate of 7%.The closing price for a share of PepsiCo common stockon the New York Stock Exchange was the price as reportedby Bloomberg for the years ending 2002-2006. Pastperformance is not necessarily indicative of future returnson investments in PepsiCo common stock.Year-end Market Price of StockBased on calendar year-end (In $)60402001.1602 03 04 05 06Shareholder InformationAnnual MeetingThe Annual Meeting of Shareholders will be held atFrito-Lay Corporate Headquarters, 7701 Legacy Drive,Plano, Texas, on Wednesday, May 2, 2007, at 9 a.m. localtime. Proxies for the meeting will be solicited by anindependent proxy solicitor. This Annual Report is notpart of the proxy solicitation.Inquiries Regarding Your Stock HoldingsRegistered Shareholders (shares held by you inyour name) should address communications concerningtransfers, statements, dividend payments, address changes,lost certificates and other administrative matters to:The Bank of New YorkShareholder Services DepartmentP.O. Box 11258Church Street StationNew York, NY 10286-1258Telephone: 800-226-0083212-815-3700 (Outside the U.S.)E-mail: shareowners@bankofny.comWebsite: www.stockbny.comorManager Shareholder RelationsPepsiCo, Inc.700 Anderson Hill RoadPurchase, NY 10577Telephone: 914-253-3055In all correspondence or telephone inquiries, pleasemention PepsiCo, your name as printed on your stockcertificate, your Social Security number, your address andtelephone number.SharePower Participants (employees withSharePower options) should address all questions regardingyour account, outstanding options or shares receivedthrough option exercises to:Merrill Lynch/SharePowerStock Option Unit1600 Merrill Lynch DriveMail Stop 06-02-SOPPennington, NJ 08534Telephone: 800-637-6713 (U.S., Puerto Ricoand 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), youraddress, your telephone number and mention PepsiCoSharePower. For telephone inquiries, please have a copy ofyour most recent statement available.Employee Benefit Plan ParticipantsPepsiCo 401(k) Plan & PepsiCo Stock Purchase ProgramThe PepsiCo Savings & Retirement Center at FidelityP.O. Box 770003Cincinnati, OH 45277-0065Telephone: 800-632-2014(Overseas: Dial your country’s AT&T Access Number+800-632-2014. In the U.S., access numbers are availableby calling 800-331-1140. From anywhere in theworld, access numbers are available online atwww.att.com/traveler.)Website: www.netbenefits.fidelity.comPepsiCo Stock Purchase Program – for Canadian employees:Fidelity Stock Plan ServicesP.O. Box 5000Cincinnati, OH 45273-8398Telephone: 800-544-0275Website: www.iStockPlan.com/ESPPPlease have a copy of your most recent statementavailable when calling with inquiries.If using overnight or certified mail send to:Fidelity Investments100 Crosby ParkwayMail Zone KC1F-LCovington, KY 41015Shareholder ServicesBuyDIRECT PlanInterested investors can make their initial purchase directlythrough The Bank of New York, transfer agent for PepsiCo,and Administrator for the Plan. A brochure detailing thePlan is available on our website www.pepsico.com or fromour transfer agent:The Bank of New YorkPepsiCo PlanChurch Street StationP.O. Box 1958Newark, NJ 07101-9774Telephone: 800-226-0083212-815-3700 (Outside the U.S.)Website: www.stockbny.comE-mail: shareowners@bankofny.comOther services include dividend reinvestment, optionalcash investments by electronic funds transfer or checkdrawn on a U.S. bank, sale of shares, online accountaccess, and electronic delivery of shareholder materials.Financial and Other InformationPepsiCo’s 2007 quarterly earnings releases are expectedto be issued the weeks of April 23, July 23, October 8,2007, and February 4, 2008.Copies of PepsiCo’s SEC reports, earnings and otherfinancial releases, corporate news and additional companyinformation are available on our website www.pepsico.com.Our CEO and CFO Certifications required underSarbanes-Oxley Section 302 were filed as an exhibit to ourForm 10-K filed on February 20, 2007. Our 2006 DomesticCompany Section 303A CEO Certification was filed withthe New York Stock Exchange (NYSE).If you have questions regarding PepsiCo’s financialperformance contact:Jamie CaulfieldVice President, Investor RelationsPepsiCo, Inc.Purchase, NY 10577Telephone: 914-253-3035Independent AuditorsKPMG LLP345 Park AvenueNew York, NY 10154-0102Telephone: 212-758-9700Corporate HeadquartersPepsiCo, Inc.700 Anderson Hill RoadPurchase, NY 10577Telephone: 914-253-2000PepsiCo Website: www.pepsico.com© 2007 PepsiCo, Inc.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 productsand services of outstanding quality. America On the Move is an initiative of the nonprofit organization, The Partnership to Promote Healthy Eating and Active Living (The Partnership:www.americaonthemove.org). Komen Race for the Cure is an initiative of the National Volunteer Recognition Program.Design: Eisenman Associates. Cover concept: Sondra Greenspan, Arcanna, Inc. Cover illustrations: 3DI Studio. Printing: L.P. Thebault. Photography: Stephen Wilkes, Ben Rosenthal, Grover Sterling,Steve Bonini, Kayte Deioma, PhotoBureau. Special thanks to Starbucks.This report is entirely recyclable. The cover and editorial pages are printed on Sterling Ultra Recycled Cover and Sterling Ultra Recycled Dull Text. That paper was manufactured by NewPage withwood procurement certified by the Sustainable Forestry Initiative ® . The financial pages are printed on Plainfield Smooth Opaque Text. That paper was manufactured by Domtar Inc., using sustainableenergy sources and wood procurement practices certified by the Forest Stewardship Council © .