Pepsi 2006 Annual Report Download - page 76

limit our exposure to individual counter-
parties to manage credit risk.
Commodity Prices
We are subject to commodity price risk
because our ability to recover increased
costs through higher pricing may be lim-
ited in the competitive environment in
which we operate. This risk is managed
through the use of fixed-price purchase
orders, pricing agreements, geographic
diversity and derivatives. We use deriva-
tives, with terms of no more than two
years, to economically hedge price fluctu-
ations related to a portion of our
anticipated commodity purchases, pri-
marily for natural gas and diesel fuel. For
those derivatives that qualify for hedge
accounting, any ineffectiveness is
recorded immediately. However, such
commodity cash flow hedges have not
had any significant ineffectiveness for all
periods presented. We classify both the
earnings and cash flow impact from
these derivatives consistent with the
underlying hedged item. During the next
12 months, we expect to reclassify net
gains of $1 million related to cash flow
hedges from accumulated other compre-
hensive loss into net income. Derivatives
used to hedge commodity price risks that
do not qualify for hedge accounting are
marked to market each period and
reflected in our income statement.
Foreign Exchange
Our operations outside of the U.S. gener-
ate approximately 40% of our net
revenue, with Mexico, the United
Kingdom and Canada comprising
approximately 20% of our net revenue.
As a result, we are exposed to foreign
currency risks from unforeseen economic
changes and political unrest. On
occasion, we enter into hedges, primarily
forward contracts with terms of no more
than two years, to reduce the effect of
foreign exchange rates. Ineffectiveness of
these hedges has not been material.
Interest Rates
We centrally manage our debt and
investment portfolios considering invest-
ment opportunities and risks, tax
consequences and overall financing
strategies. We may use interest rate and
cross currency interest rate swaps to man-
age 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. These swaps are
entered into only with strong creditwor-
thy counterparties, are settled on a net
basis and are of relatively short duration.
Stock Prices
The portion of our deferred compensa-
tion liability that is based on certain
market indices and on our stock price is
subject to market risk. We hold mutual
fund investments and prepaid forward
contracts to manage this risk. Changes in
the fair value of these investments and
contracts are recognized immediately in
earnings and are offset by changes in
the related compensation liability.
Fair Value
All derivative instruments are
recognized on our balance sheet at fair
value. The fair value of our derivative
instruments is generally based on
quoted market prices. Book and fair
values of our derivative and financial
instruments are as follows:
74
2006 2005
Book Value Fair Value Book Value Fair Value
Assets
Cash and cash equivalents(a) $1,651 $1,651 $1,716 $1,716
Short-term investments(b) $1,171 $1,171 $3,166 $3,166
Forward exchange contracts(c) $8 $8 $19 $19
Commodity contracts(d) $2 $2 $41 $41
Prepaid forward contracts(e) $73 $73 $107 $107
Cross currency interest rate swaps(f) $1 $1 $6 $6
Liabilities
Forward exchange contracts(c) $24 $24 $15 $15
Commodity contracts(d) $29 $29 $3 $3
Debt obligations $2,824 $2,955 $5,202 $5,378
Interest rate swaps(g) $4 $4 $9 $9
The above items are included on our balance sheet under the captions noted or as indicated below. In addition, derivatives qualify for hedge accounting unless
otherwise noted below.
(a) Book value approximates fair value due to the short maturity.
(b) Principally short-term time deposits and includes $145 million at December 30, 2006 and $124 million at December 31, 2005 of mutual fund investments used
to 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 that
do not qualify for hedge accounting. Assets are reported within current assets and other assets and liabilities are reported within current liabilities and other liabilities.
(d) The 2006 liability includes $28 million related to derivatives that do not qualify for hedge accounting. The 2005 asset includes $2 million related to derivatives
that do not qualify for hedge accounting and the liability relates entirely to derivatives that do not qualify for hedge accounting. Assets are reported within
current assets and other assets and liabilities are reported within current liabilities and other liabilities.
(e) Included in current assets and other assets.
(f) Asset included within other assets.
(g) Reported in other liabilities.
This table excludes guarantees, including our guarantee of $2.3 billion of Bottling Group, LLC’s long-term debt. The guarantee had
a fair value of $35 million at December 30, 2006 and $47 million at December 31, 2005 based on a third-party estimate of the cost
to us of transferring the liability to an independent financial institution. See Note 9 for additional information on our guarantees.
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