Pepsi 2005 Annual Report Download - page 34

32
We estimate that a 10% decline in
commodity prices would have increased
our recognized losses on open contracts
to $4 million in 2005 and to $5 million
in 2004.
In 2006, we expect continued pricing
pressures on our raw materials and energy
costs. We expect to be able to mitigate
the impact of these increased costs through
our hedging strategies and ongoing
productivity initiatives.
Foreign Exchange
Financial statements of foreign sub-
sidiaries are translated into U.S. dollars
using period-end exchange rates for assets
and liabilities and weighted-average
exchange rates for revenues and expenses.
Adjustments resulting from translating net
assets are reported as a separate compo-
nent of accumulated other comprehensive
loss within shareholders’ equity under the
caption currency translation adjustment.
Our operations outside of the U.S.
generate over a third of our net revenue of
which Mexico, the United Kingdom and
Canada comprise nearly 20%. As a result,
we are exposed to foreign currency risks,
including unforeseen economic changes
and political unrest. During 2005, net
favorable foreign currency, primarily
increases in the Mexican peso, Brazilian
real, and Canadian dollar, contributed over
1 percentage point to net revenue growth.
Currency declines which are not offset
could adversely impact our future results.
Exchange rate gains or losses related to
foreign currency transactions are recognized
as transaction gains or losses in the
income statement as incurred. We may
enter into derivatives to manage our
exposure to foreign currency transaction
risk. Our foreign currency derivatives had a
total face value of $1.1 billion at
December 31, 2005 and $908 million at
December 25, 2004. The contracts desig-
nated as accounting hedges resulted in net
unrecognized losses of $9 million at
December 31, 2005 and $27 million at
December 25, 2004. We estimate that an
unfavorable 10% change in the exchange
rates would have resulted in unrecognized
losses of $81 million in 2005 and $110
million in 2004. The contracts not desig-
nated as accounting hedges resulted in net
recognized gains of $14 million and less
than $1 million at December 31, 2005
and December 25, 2004, respectively.
These gains were almost entirely offset by
changes in the underlying hedged items,
resulting in no net impact on earnings.
Interest Rates
We centrally manage our debt and invest-
ment portfolios considering investment
opportunities and risks, tax consequences
and overall financing strategies. We may
use interest rate and cross currency
interest rate swaps to manage our overall
interest expense and foreign exchange risk.
These instruments effectively change the
interest rate and currency of specific debt
issuances. These swaps are entered into
concurrently with the issuance of the
debt that they are intended to modify.
The notional amount, interest payment
and maturity date of the swaps match the
principal, interest payment and maturity
date of the related debt. Our counterparty
credit risk is considered low because these
swaps are entered into only with strong
creditworthy counterparties, are generally
settled on a net basis and are of relatively
short duration.
Assuming year-end 2005 and 2004
variable rate debt and investment levels,
a one point increase in interest rates
would have decreased net interest expense
by $8 million in 2005 and $11 million
in 2004.
Stock Prices
A portion of our deferred compensation lia-
bility is tied to certain market indices and
our stock price. We manage these market
risks with mutual fund investments and
prepaid forward contracts for the purchase
of our stock. The combined gains or losses
on these investments are substantially
offset by changes in our deferred
compensation liability.