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44 PepsiCo, Inc. 2009 Annual Report
Management’s Discussion and Analysis
Market Risks
We are exposed to market risks arising from adverse changes in:
• commodity prices, affecting the cost of our raw materials
and energy,
• foreign exchange rates, and
• interest rates.
In the normal course of business, we manage these risks
through a variety of strategies, including productivity initiatives,
global purchasing programs and hedging strategies. Ongoing
productivity initiatives involve the identification and effective
implementation of meaningful cost saving opportunities or
efficiencies. Our global purchasing programs include fixed-price
purchase orders and pricing agreements. See Note 9 for further
information on our non-cancelable purchasing commitments.
Our hedging strategies include the use of derivatives. Certain
derivatives are designated as either cash flow or fair value hedges
and qualify for hedge accounting treatment, while others do not
qualify and are marked to market through earnings. Cash flows
from derivatives used to manage commodity, foreign exchange
or interest risks are classified as operating activities. We do not
use derivative instruments for trading or speculative purposes.
We perform assessments of our counterparty credit risk regularly,
including a review of credit ratings, credit default swap rates and
potential nonperformance of the counterparty. Based on our most
recent assessment of our counterparty credit risk, we consider this
risk to be low. In addition, we enter into derivative contracts with a
variety of financial institutions that we believe are creditworthy in
order to reduce our concentration of credit risk and generally settle
with these financial institutions on a net basis.
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 market fluctuations.
Inflationary, deflationary and recessionary conditions
impacting these market risks also impact the demand for and
pricing of our products.
Commodity Prices
We expect to be able to reduce the impact of volatility in our
raw material and energy costs through our hedging strategies
and ongoing sourcing initiatives.
Our open commodity derivative contracts that qualify for hedge
accounting had a face value of $151 million as of December 26, 2009
and $303 million as of December 27, 2008. These contracts resulted
in net unrealized losses of $29 million as of December 26, 2009 and
$117 million as of December 27, 2008. At the end of 2009, the
potential change in fair value of commodity derivative instruments,
assuming a 10% decrease in the underlying commodity price, would
have increased our net unrealized losses in 2009 by $13 million.
Our open commodity derivative contracts that do not qualify
for hedge accounting had a face value of $231 million as of
December 26, 2009 and $626 million as of December 27, 2008.
These contracts resulted in net losses of $57 million in 2009 and
$343 million in 2008. At the end of 2009, the potential change in
fair value of commodity derivative instruments, assuming a 10%
decrease in the underlying commodity price, would have
increased our net losses in 2009 by $17 million.
Foreign Exchange
Financial statements of foreign subsidiaries are translated into
U.S. dollars using period-end exchange rates for assets and liabilities
and weighted-average exchange rates for revenues and expenses.
Adjustments resulting from translating net assets are reported as a
separate component of accumulated other comprehensive loss
within shareholders’ equity under the caption currency translation
adjustment.
Our operations outside of the U.S. generate 48% of our net
revenue, with Mexico, Canada and the United Kingdom compris-
ing 16% of our net revenue. As a result, we are exposed to foreign
currency risks. During 2009, net unfavorable foreign currency,
primarily due to depreciation of the Mexican peso, British pound,
euro and Russian ruble, reduced net revenue growth by 5 percent-
age points. Currency declines against the U.S. dollar which are
not offset could adversely impact our future results.
In addition, we continue to use the official exchange rate
to translate the financial statements of our snack and beverage
businesses in Venezuela. We use the official rate as we currently
intend to remit dividends solely through the government-
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