Pepsi 2005 Annual Report Download - page 33

In the normal course of business, we
manage these risks through a variety of
strategies, including productivity initiatives,
global purchasing programs and hedging
strategies. Ongoing productivity initiatives
involve the identification and effective
implementation of meaningful cost saving
opportunities or efficiencies. Our global
purchasing programs include fixed-price
purchase orders and pricing agreements.
Our hedging strategies involve the use of
derivatives. Certain derivatives are desig-
nated as either cash flow or fair value
hedges and qualify for hedge accounting
treatment, while others do not qualify and
are marked to market through earnings. We
do not use derivative instruments for trading
or speculative purposes and we limit our
exposure to individual counterparties to
manage credit risk. The fair value of our
derivatives fluctuates based on market
rates and prices. The sensitivity of our
derivatives to these market fluctuations is
discussed below. See Note 10 for further
discussion of these derivatives and our
hedging policies. See “Our Critical
Accounting Policies” for a discussion of
the exposure of our pension plan assets
and pension and retiree medical liabilities
to risks related to stock prices and
discount rates.
Inflationary, deflationary and recessionary
conditions impacting these market risks
also impact the demand for and pricing of
our products.
Commodity Prices
Our open commodity derivative contracts
had a face value of $89 million at
December 31, 2005 and $155 million at
December 25, 2004. The open derivative
contracts designated as accounting hedges
resulted in net unrecognized gains of
$39 million at December 31, 2005 and an
unrecognized loss of $1 million at
December 25, 2004. We estimate that a
10% decline in commodity prices would
have reduced our unrecognized gains on
open contracts to $35 million in 2005 and
increased our unrecognized losses to
$9 million in 2004. The open derivatives
contracts that were not designated as
accounting hedges resulted in net recog-
nized losses of $3 million in 2005 and
$2 million in 2004.
We do not use derivative
instruments for trading or
speculative purposes.
Market Risks
We are exposed to the market risks arising from adverse changes in:
• commodity prices, affecting the cost of our raw materials and energy,
• foreign exchange rates,
• interest rates,
• stock prices, and
• discount rates affecting the measurement of our pension and retiree
medical liabilities.
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operating results could be adversely
affected by increased costs due to
increased competition for employees,
higher employee turnover or increased
employee benefit costs. Any unplanned
turnover could deplete our institutional
knowledge base and erode our
competitive advantage.
Our operating results may be adversely
affected by increased costs or shortages of
raw materials.
We are exposed to the market risks arising
from adverse changes in commodity prices,
affecting the cost of our raw materials and
energy. The raw materials and energy
which we use for the production of our
products are largely commodities that are
subject to price volatility and fluctuations
in availability caused by changes in global
supply and demand, weather conditions,
agricultural uncertainty or governmental
controls. We purchase these materials and
energy mainly in the open market. If com-
modity price changes result in unexpected
increases in raw materials and energy
costs, we may not be able to increase our
prices to offset these increased costs with-
out suffering reduced volume, revenue and
operating income.
Our business could suffer if we are unable
to compete effectively.
Our businesses operate in highly competi-
tive markets. We compete against global,
regional and private label manufacturers
on the basis of price, quality, product vari-
ety and effective distribution. Increased
competition and anticipated actions by our
competitors could lead to downward pres-
sure on prices and/or a decline in our mar-
ket share, either of which could adversely
affect our results. See “Our Competition”
for more information about our competitors.