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Pepsi Bottling Group 10-K 2007 Documents found in this filing:
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the Fiscal Year Ended December 30, 2006
or
For
the transition period from
to
Commission file number 1-14893
The Pepsi Bottling Group, Inc.
(Exact name of Registrant as Specified in its Charter)
Registrant’s telephone number, including area code: (914) 767-6000
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities
Act.
Yes þ No o Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act.
Yes o No þ Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. þ
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The number of shares of Capital Stock of The Pepsi Bottling Group, Inc. outstanding as of
February 15, 2007 was 226,665,468. The aggregate market value of The Pepsi Bottling Group,
Inc. Capital Stock held by non-affiliates of The Pepsi Bottling Group, Inc. as of June 17, 2006 was
$4,430,692,479.
TABLE OF CONTENTS
Table of Contents
PART I
Item 1. Business
Introduction
The Pepsi Bottling Group, Inc. (“PBG”) was incorporated in Delaware in January, 1999, as a
wholly owned subsidiary of PepsiCo, Inc. (“PepsiCo”) to effect the separation of most of PepsiCo’s
company-owned bottling businesses. PBG became a publicly traded company on March 31, 1999. As of
January 26, 2007, PepsiCo’s ownership represented 38.3% of the outstanding common stock and 100% of
the outstanding Class B common stock, together representing 44.4% of the voting power of all
classes of PBG’s voting stock. PepsiCo also owned approximately 6.7% of the equity interest of
Bottling Group, LLC, PBG’s principal operating subsidiary, as of January 26, 2007. When used in
this Report, “PBG,” “we,” “us” and “our” each refers to The Pepsi Bottling Group, Inc. and, where
appropriate, to Bottling Group, LLC, which we also refer to as “Bottling LLC.”
PBG operates in one industry, carbonated soft drinks and other ready-to-drink beverages, and
all of our segments derive revenue from these products. We conduct business in all or a portion of
the United States, Mexico, Canada, Spain, Russia, Greece and Turkey. Beginning with the fiscal
quarter ended March 25, 2006, we changed our financial reporting methodology to three reportable
segments: United States & Canada, Europe (which includes Spain, Russia, Greece and Turkey) and
Mexico. The operations of the United States & Canada are aggregated into a single reportable
segment due to their economic similarity as well as similarity across products, manufacturing and
distribution methods, types of customers and regulatory environments.
In 2006, approximately 78% of our net revenues were generated in the United States & Canada,
12% of our net revenues were generated in Europe, and the remaining 10% of our net revenues were
generated in Mexico. See “Management’s Discussion and Analysis of Financial Condition and Results
of Operations” and Note 16 to our Consolidated Financial Statements for additional information
regarding the business and operating results of our reportable segments.
Principal Products
PBG is the world’s largest manufacturer, seller and distributor of Pepsi-Cola beverages. In
addition, in some of our territories we have the right to manufacture, sell and distribute soft
drink products of companies other than PepsiCo, including Dr Pepper and Squirt. We also have the
right in some of our territories to manufacture, sell and distribute beverages under trademarks
that we own, including Electropura, e-puramr and Garci Crespo. The majority of our
volume is derived from brands licensed from PepsiCo or PepsiCo joint ventures.
We have the exclusive right to manufacture, sell and distribute Pepsi-Cola beverages in all or
a portion of 41 states and the District of Columbia in the United States, nine Canadian provinces,
Spain, Greece, Russia, Turkey and all or a portion of 23 states in Mexico.
In 2006, approximately 75% of our sales volume in the United States & Canada was derived from
carbonated soft drinks and the remaining 25% was derived from non-carbonated beverages, 70% of our
sales volume in Europe was derived from carbonated soft drinks and the remaining 30% was derived
from non-carbonated beverages, and 51% of our Mexico sales volume was derived from carbonated
soft drinks and the remaining 49% was derived from
non-carbonated beverages.
Our principal beverage brands include the following:
United States & Canada
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Europe
Mexico
No customer accounted for 10% or more of our net revenues in 2006. We have an extensive
direct store distribution system in the United States & Canada and in Mexico. In Europe, we use a
combination of direct store distribution and distribution through wholesalers, depending on local
marketplace considerations.
Raw Materials and Other Supplies
We purchase the concentrates to manufacture Pepsi-Cola beverages and other beverage products
from PepsiCo and other beverage companies.
In addition to concentrates, we purchase sweeteners, glass and plastic bottles, cans,
closures, syrup containers, other packaging materials, carbon dioxide and some finished goods. We
generally purchase our raw materials, other than concentrates, from multiple suppliers. PepsiCo
acts as our agent for the purchase of such raw materials in the United States and Canada and, with
respect to some of our raw materials, in certain of our international markets. The Pepsi beverage
agreements, as described below, provide that, with respect to the beverage products of PepsiCo, all
authorized containers, closures, cases, cartons and other packages and labels may be purchased only
from manufacturers approved by PepsiCo. There are no materials or supplies used by PBG that are
currently in short supply. The supply or cost of specific materials could be adversely affected by
various factors, including price changes, strikes, weather conditions and governmental controls.
Franchise Agreements
We conduct our business primarily under agreements with PepsiCo. These agreements give us the
exclusive right to market, distribute, and produce beverage products of PepsiCo in authorized
containers and to use the related trade names and trademarks in specified territories.
Set forth below is a description of the Pepsi beverage agreements and other bottling
agreements to which we are a party.
Terms of the Master Bottling Agreement. The Master Bottling Agreement under which we
manufacture, package, sell and distribute the cola beverages bearing the Pepsi-Cola and Pepsi
trademarks in the United States was entered into in March of 1999. The Master Bottling Agreement
gives us the exclusive and perpetual right to distribute cola beverages for sale in specified
territories in authorized containers of the nature currently used by us. The Master Bottling
Agreement provides that we will purchase our entire requirements of concentrates for the cola
beverages from PepsiCo at prices, and on terms and conditions, determined from time to time by
PepsiCo. PepsiCo may determine from time to time what types of containers to authorize for use by
us. PepsiCo has no rights under the Master Bottling Agreement with respect to the prices at which
we sell our products.
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Under the Master Bottling Agreement we are obligated to:
The Master Bottling Agreement requires us to meet annually with PepsiCo to discuss plans for
the ensuing year and the following two years. At such meetings, we are obligated to present plans
that set out in reasonable detail our marketing plan, our management plan and advertising plan with
respect to the cola beverages for the year. We must also present a financial plan showing that we
have the financial capacity to perform our duties and obligations under the Master Bottling
Agreement for that year, as well as sales, marketing, advertising and capital expenditure plans for
the two years following such year. PepsiCo has the right to approve such plans, which approval
shall not be unreasonably withheld. In 2006, PepsiCo approved our plans.
If we carry out our annual plan in all material respects, we will be deemed to have satisfied
our obligations to push vigorously the sale of the cola beverages, increase and fully meet the
demand for the cola beverages in our territories and maintain the financial capacity required under
the Master Bottling Agreement. Failure to present a plan or carry out approved plans in all
material respects would constitute an event of default that, if not cured within 120 days of notice
of the failure, would give PepsiCo the right to terminate the Master Bottling Agreement.
If we present a plan that PepsiCo does not approve, such failure shall constitute a primary
consideration for determining whether we have satisfied our obligations to maintain our financial
capacity, push vigorously the sale of the cola beverages and increase and fully meet the demand for
the cola beverages in our territories.
If we fail to carry out our annual plan in all material respects in any segment of our
territory, whether defined geographically or by type of market or outlet, and if such failure is
not cured within six months of notice of the failure, PepsiCo may reduce the territory covered by
the Master Bottling Agreement by eliminating the territory, market or outlet with respect to which
such failure has occurred.
PepsiCo has no obligation to participate with us in advertising and marketing spending, but it
may contribute to such expenditures and undertake independent advertising and marketing activities,
as well as cooperative advertising and sales promotion programs that would require our cooperation
and support. Although PepsiCo has advised us that it intends to continue to provide cooperative
advertising funds, it is not obligated to do so under the Master Bottling Agreement.
The Master Bottling Agreement provides that PepsiCo may in its sole discretion reformulate any
of the cola beverages or discontinue them, with some limitations, so long as all cola beverages are
not discontinued. PepsiCo may also introduce new beverages under the Pepsi-Cola trademarks or any
modification thereof. When that occurs, we are obligated to manufacture, package, distribute and
sell such new beverages with the same obligations as then exist with respect to other cola
beverages. We are prohibited from producing or handling cola products, other than those of
PepsiCo, or products or packages that imitate, infringe or cause confusion with the products,
containers or trademarks of PepsiCo. The Master Bottling Agreement also imposes requirements with
respect to the use of PepsiCo’s trademarks, authorized containers, packaging and labeling.
If we acquire control, directly or indirectly, of any bottler of cola beverages, we must cause
the acquired bottler to amend its bottling appointments for the cola beverages to conform to the
terms of the Master Bottling Agreement.
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Under the Master Bottling Agreement, PepsiCo has agreed not to withhold approval for any
acquisition of rights to manufacture and sell Pepsi trademarked cola beverages within a specific
area – currently representing approximately 11.5% of PepsiCo’s U.S. bottling system in terms of
volume – if we have successfully negotiated the acquisition and, in PepsiCo’s reasonable judgment,
satisfactorily performed our obligations under the Master Bottling Agreement. We have agreed not
to acquire or attempt to acquire any rights to manufacture and sell Pepsi trademarked cola
beverages outside of that specific area without PepsiCo’s prior written approval.
The Master Bottling Agreement is perpetual, but may be terminated by PepsiCo in the event of
our default. Events of default include:
An event of default will also occur if any person or affiliated group acquires any contract,
option, conversion privilege, or other right to acquire, directly or indirectly, beneficial
ownership of more than 15% of any class or series of our voting securities without the consent of
PepsiCo. As of February 15, 2007, to our knowledge, no shareholder of PBG, other than PepsiCo,
held more than 14.3% of our common stock.
We are prohibited from assigning, transferring or pledging the Master Bottling Agreement, or
any interest therein, whether voluntarily, or by operation of law, including by merger or
liquidation, without the prior consent of PepsiCo.
The Master Bottling Agreement was entered into by us in the context of our separation from
PepsiCo and, therefore, its provisions were not the result of arm’s-length negotiations.
Consequently, the agreement contains provisions that are less favorable to us than the exclusive
bottling appointments for cola beverages currently in effect for independent bottlers in the United
States.
Terms of the Non-Cola Bottling Agreements. The beverage products covered by the non-cola
bottling agreements are beverages licensed to us by PepsiCo, consisting of Mountain Dew, Aquafina,
Sierra Mist, Diet Mountain Dew, Mug Root Beer and Mountain Dew Code Red. The non-cola bottling
agreements contain provisions that are similar to those contained in the Master Bottling Agreement
with respect to pricing, territorial restrictions, authorized containers, planning, quality
control, transfer restrictions, term and related matters. Our non-cola bottling agreements will
terminate if PepsiCo terminates our Master Bottling Agreement. The exclusivity provisions
contained in the non-cola bottling agreements would prevent us from manufacturing, selling or
distributing beverage products that imitate, infringe upon, or cause confusion with, the beverage
products covered by the non-cola bottling agreements. PepsiCo may also elect to discontinue the
manufacture, sale or distribution of a non-cola beverage and terminate the applicable non-cola
bottling agreement upon six months notice to us.
Terms of Certain Distribution Agreements. We also have agreements with PepsiCo granting us
exclusive rights to distribute AMP and Dole in all of our territories and SoBe in certain
specified territories. The distribution agreements contain provisions generally similar to those
in the Master Bottling Agreement as to use of trademarks, trade names, approved containers and
labels and causes for termination. We also have the right to sell Tropicana juice drinks in the
United States and Canada, Tropicana juices in Russia and Spain, and Gatorade in Spain,
Greece and Russia and in certain limited channels of distribution in the United States and Canada.
Some of these beverage agreements have limited terms and, in most instances, prohibit us from
dealing in similar beverage products.
Terms of the Master Syrup Agreement. The Master Syrup Agreement grants us the exclusive right
to manufacture, sell and distribute fountain syrup to local customers in our territories. We have
agreed to act as a manufacturing and delivery agent for national accounts within our territories
that specifically request direct delivery without using a middleman. In addition, PepsiCo may
appoint us to manufacture and deliver fountain syrup to national accounts that elect delivery
through independent distributors. Under the Master Syrup Agreement, we have the exclusive right to
service fountain equipment for all of the national account customers within our territories. The
Master Syrup Agreement provides that the determination of whether an account is local or national
is at the sole discretion of PepsiCo.
The Master Syrup Agreement contains provisions that are similar to those contained in the
Master Bottling Agreement
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with respect to concentrate pricing, territorial restrictions with respect to local customers
and national customers electing direct-to-store delivery only, planning, quality control, transfer
restrictions and related matters. The Master Syrup Agreement had an initial term of five years
which expired in 2004 and was renewed for an additional five-year period. The Master Syrup
Agreement will automatically renew for additional five-year periods, unless PepsiCo terminates it
for cause. PepsiCo has the right to terminate the Master Syrup Agreement without cause at any time
upon twenty-four months notice. In the event PepsiCo terminates the Master Syrup Agreement without
cause, PepsiCo is required to pay us the fair market value of our rights thereunder.
Our Master Syrup Agreement will terminate if PepsiCo terminates our Master Bottling Agreement.
Terms of Other U.S. Bottling Agreements. The bottling agreements between us and other
licensors of beverage products, including Cadbury Schweppes plc for Dr Pepper, Schweppes, Canada
Dry, Hawaiian Punch and Squirt, the Pepsi/Lipton Tea Partnership for Lipton Brisk and Lipton Iced
Tea, and the North American Coffee Partnership for Starbucks Frappuccino®, contain provisions
generally similar to those in the Master Bottling Agreement as to use of trademarks, trade names,
approved containers and labels, sales of imitations and causes for termination. Some of these
beverage agreements have limited terms and, in most instances, prohibit us from dealing in similar
beverage products.
Terms of the Country-Specific Bottling Agreements. The country-specific bottling agreements
contain provisions generally similar to those contained in the Master Bottling Agreement and the
non-cola bottling agreements and, in Canada, the Master Syrup Agreement with respect to authorized
containers, planning, quality control, transfer restrictions, term, causes for termination and
related matters. These bottling agreements differ from the Master Bottling Agreement because,
except for Canada, they include both fountain syrup and non-fountain beverages. Certain of these
bottling agreements contain provisions that have been modified to reflect the laws and regulations
of the applicable country. For example, the bottling agreements in Spain do not contain a
restriction on the sale and shipment of Pepsi-Cola beverages into our territory by others in
response to unsolicited orders. In addition, in Mexico and Turkey we are restricted in our ability
to manufacture, sell and distribute beverages sold under non-PepsiCo trademarks.
Seasonality
Sales of our products are seasonal, particularly in our Europe segment, where sales volumes
tend to be more sensitive to weather conditions. Our peak season across all of our segments is the
warm summer months beginning in May and ending in September. More than 65% of our operating income
is typically earned during the second and third quarters. More than 75% of cash flow from
operations is typically generated in the third and fourth quarters.
Competition
The carbonated soft drink market and the non-carbonated beverage market are highly
competitive. Our competitors in these markets include bottlers and distributors of nationally
advertised and marketed products, bottlers and distributors of regionally advertised and marketed
products, as well as bottlers of private label soft drinks sold in chain stores. Among our major
competitors are bottlers that distribute products from The Coca-Cola Company including Coca-Cola
Enterprises Inc., Coca-Cola Hellenic Bottling Company S.A., Coca-Cola FEMSA S.A. de C.V. and
Coca-Cola Bottling Co. Consolidated. Our market share for carbonated soft drinks sold under
trademarks owned by PepsiCo in our U.S. territories ranges from approximately 20% to approximately
38%. Our market share for carbonated soft drinks sold under trademarks owned by PepsiCo for each
country outside the United States in which we do business is as follows: Canada 43%; Russia 23%;
Turkey 18%; Spain 12% and Greece 9% (including market share for our IVI brand). In addition,
market share for our territories and the territories of other Pepsi bottlers in Mexico is 14% for
carbonated soft drinks sold under trademarks owned by PepsiCo. All market share figures are based
on generally available data published by third parties. Actions by our major competitors and
others in the beverage industry, as well as the general economic environment, could have an impact
on our future market share.
We compete primarily on the basis of advertising and marketing programs to create brand
awareness, price and promotions, retail space management, customer service, consumer points of
access, new products, packaging innovations and distribution methods. We believe that brand
recognition, market place pricing, consumer value, customer service, availability and consumer and
customer goodwill are primary factors affecting our competitive position.
Governmental Regulation Applicable to PBG
Our operations and properties are subject to regulation by various federal, state and local
governmental entities and agencies in the United States as well as foreign governmental entities
and agencies in Canada, Spain, Greece, Russia, Turkey and Mexico. As a producer of food products,
we are subject to production, packaging, quality, labeling and distribution standards in each of
the countries where we have operations, including, in the United States, those of the Federal Food,
Drug and Cosmetic Act and the Public Health Security and Bioterrorism Preparedness and Response
Act. The operations of our production and distribution facilities are subject to laws and
regulations relating to the protection of our employees’ health and
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safety and the environment in the countries in which we do business. In the United States, we
are subject to the laws and regulations of various governmental entities, including the Department
of Labor, the Environmental Protection Agency and the Department of Transportation, and various
federal, state and local occupational, labor and employment and environmental laws. These laws and
regulations include the Occupational Safety and Health Act, the Clean Air Act, the Clean Water Act,
the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation
and Liability Act, the Superfund Amendments and Reauthorization Act, the Federal Motor Carrier
Safety Act and the Fair Labor Standards Act.
We believe that our current legal, operational and environmental compliance programs are
adequate and that we are in substantial compliance with applicable laws and regulations of the
countries in which we do business. We do not anticipate making any material expenditures in
connection with environmental remediation and compliance. However, compliance with, or any
violation of, future laws or regulations could require material expenditures by us or otherwise
have a material adverse effect on our business, financial condition or results of operations.
Bottle and Can Legislation
Legislation has been enacted in certain U.S. states and Canadian provinces where we operate
that generally prohibits the sale of certain beverages in non-refillable containers unless a
deposit or levy is charged for the container. These include California, Connecticut, Delaware,
Hawaii, Iowa, Maine, Massachusetts, Michigan, New York, Oregon, West Virginia, British Columbia,
Alberta, Saskatchewan, Manitoba, New Brunswick, Nova Scotia, Ontario, Prince Edward Island and
Quebec.
Massachusetts and Michigan have statutes that require us to pay all or a portion of unclaimed
container deposits to the state and Hawaii and California impose a levy on beverage containers to
fund a waste recovery system.
In addition to the Canadian deposit legislation described above, Ontario, Canada currently has
a regulation requiring that at least 30% of all soft drinks sold in Ontario be bottled in
refillable containers.
The European Commission issued a packaging and packing waste directive that was incorporated
into the national legislation of most member states. This has resulted in targets being set for
the recovery and recycling of household, commercial and industrial packaging waste and imposes
substantial responsibilities upon bottlers and retailers for implementation. Similar legislation
has been enacted in Turkey.
Mexico adopted legislation regulating the disposal of solid waste products. In response to
this legislation, PBG Mexico maintains agreements with local and federal Mexican governmental
authorities as well as with civil associations, which require PBG Mexico, and other participating
bottlers, to provide for collection and recycling of certain minimum amounts of plastic bottles.
We are not aware of similar material legislation being enacted in any other areas served by
us. We are unable to predict, however, whether such legislation will be enacted or what impact its
enactment would have on our business, financial condition or results of operations.
Soft Drink Excise Tax Legislation
Specific soft drink excise taxes have been in place in certain states for several years. The
states in which we operate that currently impose such a tax are West Virginia and Arkansas and,
with respect to fountain syrup only, Washington. In Mexico, there are excise taxes on any
sweetened beverage products produced without sugar, including our diet soft drinks and imported
beverages that are not sweetened with sugar.
Value-added taxes on soft drinks vary in our territories located in Canada, Spain, Greece,
Russia, Turkey and Mexico, but are consistent with the value-added tax rate for other consumer
products. In addition, there is a special consumption tax applicable to cola products in Turkey.
In Mexico, bottled water in containers over 10.1 liters are exempt from value-added tax, and we
obtained a tax exemption for containers holding less than 10.1 liters of water.
We are not aware of any material soft drink taxes that have been enacted in any other market
served by us. We are unable to predict, however, whether such legislation will be enacted or what
impact its enactment would have on our business, financial condition or results of operations.
Trade Regulation
As a manufacturer, seller and distributor of bottled and canned soft drink products of PepsiCo
and other soft drink manufacturers in exclusive territories in the United States and
internationally, we are subject to antitrust and competition laws. Under the Soft Drink Interbrand
Competition Act, soft drink bottlers operating in the United States, such as us, may have an
exclusive right to manufacture, distribute and sell a soft drink product in a geographic territory
if the soft drink product is in
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substantial and effective competition with other products of the same class in the same market
or markets. We believe that there is such substantial and effective competition in each of the
exclusive geographic territories in which we operate.
School Sales Legislation; Industry Guidelines
In 2004, Congress passed the Child Nutrition Act, which requires school districts to implement
a school wellness policy by July 2006. In May 2006, members of the American Beverage Association,
the Alliance for a Healthier Generation, the American Heart Association and The William J. Clinton
Foundation entered into a memorandum of understanding that sets forth standards for what beverages
can be sold in elementary, middle and high schools in the United States (the “ABA Policy”). Also,
the beverage associations in the European Union and various provinces in Canada have recently
issued guidelines relating to the sale of beverages in schools. We intend to comply fully with the
ABA Policy and these guidelines.
California Carcinogen and Reproductive Toxin Legislation
A California law requires that any person who exposes another to a carcinogen or a
reproductive toxin must provide a warning to that effect. Because the law does not define
quantitative thresholds below which a warning is not required, virtually all manufacturers of food
products are confronted with the possibility of having to provide warnings due to the presence of
trace amounts of defined substances. Regulations implementing the law exempt manufacturers from
providing the required warning if it can be demonstrated that the defined substances occur
naturally in the product or are present in municipal water used to manufacture the product. We
have assessed the impact of the law and its implementing regulations on our beverage products and
have concluded that none of our products currently requires a warning under the law. We cannot
predict whether or to what extent food industry efforts to minimize the law’s impact on food
products will succeed. We also cannot predict what impact, either in terms of direct costs or
diminished sales, imposition of the law may have.
Mexican Water Regulation
In Mexico, we pump water from our own wells and we purchase water directly from municipal
water companies pursuant to concessions obtained from the Mexican government on a plant-by-plant
basis. The concessions are generally for ten-year terms and can generally be renewed by us prior
to expiration with minimal cost and effort. Our concessions may be terminated if, among other
things, (a) we use materially more water than permitted by the concession, (b) we use materially
less water than required by the concession, (c) we fail to pay for the rights for water usage or
(d) we carry out, without governmental authorization, any material construction on or improvement
to, our wells. Our concessions generally satisfy our current water requirements and we believe
that we are generally in compliance in all material respects with the terms of our existing
concessions.
Employees
As of December 30, 2006, we employed approximately 70,400 workers, of whom approximately
33,500 were employed in the United States. Approximately 9,100 of our workers in the United States
are union members and approximately 18,500 of our workers outside the United States are union
members. We consider relations with our employees to be good and have not experienced significant
interruptions of operations due to labor disagreements.
Available Information
We maintain a website at www.pbg.com. We make available, free of charge, through the Investor
Relations – Financial Information – SEC Filings section of our website, our annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, as amended, as soon as reasonably practicable after such reports are electronically filed
with, or furnished to, the Securities and Exchange Commission (the “SEC”).
Additionally, we have made available, free of charge, the following governance materials on
our website at www.pbg.com under Investor Relations – Company Information – Corporate Governance:
Certificate of Incorporation, Bylaws, Corporate Governance Principles and Practices, Worldwide Code
of Conduct (including any amendment thereto), Director Independence Policy, the Audit and
Affiliated Transactions Committee Charter, the Compensation and Management Development Committee
Charter, the Nominating and Corporate Governance Committee Charter and the Disclosure Committee
Charter. These governance materials are available in print, free of charge, to any PBG shareholder
upon request.
Financial Information on Industry Segments and Geographic Areas
Beginning with the fiscal quarter ended March 25, 2006, we changed our financial reporting
methodology to three reportable segments. Prior year financial information has been restated to
reflect our current segment reporting structure. The change to segment reporting has no effect on
our reported earnings. For additional information, see Note 16 to PBG’s
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Consolidated Financial Statements included in Item 7 below.
Item 1A.
Risk Factors
Our business and operations entail a variety of risks and uncertainties, including those described below.
We may not be able to respond successfully to consumer trends related to carbonated and non-carbonated beverages.
Consumers are seeking increased variety in their beverages, and there is a growing interest
among the public regarding health and wellness issues. This interest has resulted in a decline in
consumer demand for full-calorie carbonated soft drinks and an increase in consumer demand for
products associated with health and wellness, such as water, reduced calorie carbonated soft drinks
and certain non-carbonated beverages. Because we rely mainly on PepsiCo to provide us with the
products that we sell, if PepsiCo fails to develop innovative products that respond to these and
other consumer trends, we could be put at a competitive disadvantage in the marketplace and our
business and financial results could be adversely affected.
We may not be able to respond successfully to the demands of our largest customers.
Our retail customers are consolidating, leaving fewer customers with greater overall
purchasing power. Because we do not operate in all markets in which these customers operate, we
must rely on PepsiCo and other PepsiCo bottlers to service such customers outside of our markets.
Our inability, or the inability of PepsiCo and PepsiCo bottlers as a whole, to meet the product,
packaging and service demands of our largest customers could lead to a loss or decrease in business
from such customers and have a material adverse effect on our business and financial results.
We may not be able to compete successfully within the highly competitive carbonated and non-carbonated beverage markets.
The carbonated and non-carbonated beverage markets are both highly competitive. Competitive
pressures in our markets could cause us to reduce prices or forego price increases required to
off-set increased costs of raw materials and fuel, increase capital and other expenditures, or lose
market share, any of which could have a material adverse effect on our business and financial
results.
Because we depend upon PepsiCo to provide us with concentrate, certain funding and various
services, changes in our relationship with PepsiCo could adversely affect our business and
financial results.
We conduct our business primarily under beverage agreements with PepsiCo. If our beverage
agreements with PepsiCo are terminated for any reason, it would have a material adverse effect on
our business and financial results. These agreements provide that we must purchase all of the
concentrate for such beverages at prices and on other terms which are set by PepsiCo in its sole
discretion. Any significant concentrate price increases could materially affect our business and
financial results.
PepsiCo has also traditionally provided bottler incentives and funding to its bottling
operations. PepsiCo does not have to maintain or continue these incentives or funding.
Termination or decreases in bottler incentives or funding levels could materially affect our
business and financial results.
Under our shared services agreement, we obtain various services from PepsiCo, including
procurement of raw materials and certain administrative services. If any of the services under the
shared services agreement was terminated, we would have to obtain such services on our own. This
could result in a disruption of such services, and we might not be able to obtain these services on
terms, including cost, that are as favorable as those we receive through PepsiCo.
Our business requires a significant supply of raw materials and energy, the limited availability or
increased costs of which could adversely affect our business and financial results.
The production and distribution of our beverage products is highly dependent on certain raw
materials and energy. In particular, we require significant amounts of aluminum and plastic bottle
components, such as resin. We also require access to significant amounts of water. In addition, we
use a significant amount of electricity, natural gas and other energy sources to operate our fleet
of trucks and our bottling plants. Any sustained interruption in the supply of raw materials or
energy or any significant increase in their prices could have a material adverse effect on our
business and financial results.
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PepsiCo’s equity ownership of PBG could affect matters concerning us.
As of January 26, 2007, PepsiCo owned approximately 44.4% of the combined voting power of our
voting stock (with the balance owned by the public). PepsiCo will be able to significantly affect
the outcome of PBG’s shareholder votes, thereby affecting matters concerning us.
We may have potential conflicts of interest with PepsiCo, which could result in PepsiCo’s
objectives being favored over our objectives.
Our past and ongoing relationship with PepsiCo could give rise to conflicts of interests. In
addition, two members of our Board of Directors and one of the three Managing Directors of Bottling
LLC, our primary operating subsidiary, are Senior Vice Presidents of PepsiCo, a situation which may
create conflicts of interest.
These potential conflicts include balancing the objectives of increasing sales volume of
PepsiCo beverages and maintaining or increasing our profitability. Other possible conflicts could
relate to the nature, quality and pricing of services or products provided to us by PepsiCo or by
us to PepsiCo.
Conflicts could also arise in the context of our potential acquisition of bottling territories
and/or assets from PepsiCo or other independent PepsiCo bottlers. Under our Master Bottling
Agreement, we must obtain PepsiCo’s approval to acquire any independent PepsiCo bottler. PepsiCo
has agreed not to withhold approval for any acquisition within agreed-upon U.S. territories if we
have successfully negotiated the acquisition and, in PepsiCo’s reasonable judgment, satisfactorily
performed our obligations under the master bottling agreement. We have agreed not to attempt to
acquire any independent PepsiCo bottler outside of those agreed-upon territories without PepsiCo’s
prior written approval.
Our acquisition strategy may be limited by our ability to successfully integrate acquired
businesses into ours or our failure to realize our expected return on acquired businesses.
We intend to continue to pursue acquisitions of bottling assets and territories from PepsiCo’s
independent bottlers. The success of our acquisition strategy may be limited because of unforeseen
costs and complexities. We may not be able to acquire, integrate successfully or manage profitably
additional businesses without substantial costs, delays or other difficulties. Unforeseen costs
and complexities may also prevent us from realizing our expected rate of return on an acquired
business. Any of the foregoing could have a material adverse effect on our business and financial
results.
Our success depends on key members of our management, the loss of whom could disrupt our business
operations.
Our success depends largely on the efforts and abilities of key management employees. Key
management employees are not parties to employment agreements with us. The loss of the services of
key personnel could have a material adverse effect on our business and financial results.
If we are unable to fund our substantial capital requirements, it could cause us to reduce our
planned capital expenditures and could result in a material adverse effect on our business and
financial results.
We require substantial capital expenditures to implement our business plans. If we do not
have sufficient funds or if we are unable to obtain financing in the amounts desired or on
acceptable terms, we may have to reduce our planned capital expenditures, which could have a
material adverse effect on our business and financial results.
Our substantial indebtedness could adversely affect our financial health.
We have a substantial amount of indebtedness, which requires us to dedicate a substantial
portion of our cash flow from operations to payments on our debt. This could limit our flexibility
in planning for, or reacting to, changes in our business and place us at a competitive disadvantage
compared to competitors that have less debt. Our indebtedness also exposes us to interest rate
fluctuations, because the interest on some of our indebtedness is at variable rates, and makes us
vulnerable to general adverse economic and industry conditions. All of the above could make it
more difficult for us, or make us unable to satisfy our obligations with respect to all or a
portion of such indebtedness and could limit our ability to obtain additional financing for future
working capital expenditures, strategic acquisitions and other general corporate requirements.
Our foreign operations are subject to social, political and economic risks and may be adversely
affected by foreign currency fluctuations.
In the fiscal year ended December 30, 2006, approximately 30% of our net revenues were
generated in territories outside the United States. Social, economic and political conditions in
our international markets may adversely affect our
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business and financial results. The overall risks to our international businesses include
changes in foreign governmental policies and other political or economic developments. These
developments may lead to new product pricing, tax or other policies and monetary fluctuations that
may adversely impact our business and financial results. In addition, our results of operations
and the value of our foreign assets are affected by fluctuations in foreign currency exchange
rates.
If we are unable to maintain brand image and product quality, or if we encounter other product
issues such as product recalls, our business may suffer.
Maintaining a good reputation globally is critical to our success. If we fail to maintain
high standards for product quality, or if we fail to maintain high ethical, social and
environmental standards for all of our operations and activities, our reputation could be
jeopardized. In addition, we may be liable if the consumption of any of our products causes injury
or illness, and we may be required to recall products if they become contaminated or are damaged or
mislabeled. A significant product liability or other product-related legal judgment against us or
a widespread recall of our products could have a material adverse effect on our business and
financial results.
Newly adopted governmental regulations could increase our costs or liabilities or impact the sale
of our products.
Our operations and properties are subject to regulation by various federal, state and local
governmental entities and agencies as well as foreign governmental entities. Such regulations
relate to, among other things, food and drug laws, environmental laws, competition laws, taxes, and
accounting standards. We cannot assure you that we have been or will at all times be in compliance
with all regulatory requirements or that we will not incur material costs or liabilities in
connection with existing or new regulatory requirements.
Adverse weather conditions could reduce the demand for our products.
Demand for our products is influenced to some extent by the weather conditions in the markets
in which we operate. Unseasonably cool temperatures in these markets could have a material adverse
effect on our sales volume and financial results.
Catastrophic events in the markets in which we operate could have a material adverse effect on our
financial condition.
Natural disasters, terrorism, pandemic, strikes or other catastrophic events could impair our
ability to manufacture or sell our products. Failure to take adequate steps to mitigate the
likelihood or potential impact of such events, or to manage such events effectively if they occur,
could adversely affect our sales volume, cost of raw materials, earnings and financial results.
Item 1B.
Unresolved Staff Comments
None.
Item 2. Properties
Our corporate headquarters is located in leased property in Somers, New York. In addition, we
have a total of 649 manufacturing and distribution facilities, as follows:
We also own or lease and operate approximately 44,000 vehicles, including delivery trucks,
delivery and transport tractors and trailers and other trucks and vans used in the sale and
distribution of our beverage products. We also own more than two million coolers, soft drink
dispensing fountains and vending machines.
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With a few exceptions, leases of plants in the United States & Canada are on a long-term
basis, expiring at various times, with options to renew for additional periods. Our leased plants
in Europe and Mexico are generally leased for varying and usually shorter periods, with or without
renewal options. We believe that our properties are in good operating condition and are adequate
to serve our current operational needs.
Item 3. Legal Proceedings
From time to time we are a party to various litigation proceedings arising in the ordinary
course of our business, none of which, in the opinion of management, is likely to have a material
adverse effect on our financial condition or results of operations, including the following:
At the end of the fourth quarter of 2004 and during the first three quarters of 2005, we
received Notices of Violation (“NOVs”) and Orders For Compliance from the Environmental Protection
Agency, Region 9 (“EPA”), relating to operations at four bottling plants in California and one in
Hawaii. The NOVs allege that we violated our permits and the Clean Water Act as a result of
certain events relating to waste water discharge and storm water run-off.
We have been cooperating with the authorities in their investigation of these matters,
including responding to various document requests pertaining to our plants in California and each
of our plants in Arizona and Hawaii. In August 2005, we met with representatives of the EPA to
discuss the circumstances giving rise to the NOVs and our responses. We believe monetary sanctions
may be sought in connection with one or more of the NOVs. We further believe that neither the
sanctions nor the remediation costs associated with these NOVs will be material to our results of
operations or financial condition.
In addition, on May 10, 2006, we met with representatives of the Michigan Department of
Environmental Quality (the “DEQ”) regarding certain previous waste water permit violations at our
bottling plant in Howell, Michigan. At that meeting, we learned that the DEQ would seek monetary
sanctions that we believe will exceed $100,000. We believe that in no event will such sanctions or
other associated costs be material to our results of operations or financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Executive Officers of the Registrant
Executive officers are elected by our Board of Directors, and their terms of office continue
until the next annual meeting of the Board or until their successors are elected and have been
qualified. There are no family relationships among our executive officers.
Set forth below is information pertaining to our executive officers who held office as of
February 15, 2007:
John T. Cahill, 49, was appointed Executive Chairman of the Board in July 2006. Mr. Cahill
served as our Chairman of the Board since January 2003 and Chief Executive Officer since September
2001. Previously, Mr. Cahill served as our President and Chief Operating Officer from August 2000
to September 2001. Mr. Cahill has been a member of our Board of Directors since January 1999 and
served as our Executive Vice President and Chief Financial Officer prior to becoming President and
Chief Operating Officer in August 2000. He was Executive Vice President and Chief Financial
Officer of the Pepsi-Cola Company from April 1998 until November 1998. Prior to that, Mr. Cahill
was Senior Vice President and Treasurer of PepsiCo, having been appointed to that position in April
1997. In 1996, he became Senior Vice President and Chief Financial Officer of Pepsi-Cola North
America. Mr. Cahill joined PepsiCo in 1989 where he held several other senior financial positions
through 1996. Mr. Cahill is also a director of the Colgate-Palmolive Company.
Eric J. Foss, 48, was appointed President and Chief Executive Officer and elected to our Board
in July 2006. Previously, Mr. Foss served as our Chief Operating Officer from September 2005 to
July 2006 and President of PBG North America from September 2001 to September 2005. Prior to that,
Mr. Foss was the Executive Vice President and General Manager of PBG North America from August 2000
to September 2001. From October 1999 until August 2000, he served as our Senior Vice President,
U.S. Sales and Field Operations, and prior to that, he was our Senior Vice President, Sales and
Field Marketing, since March 1999. Mr. Foss joined the Pepsi-Cola Company in 1982 where he held a
variety of field and headquarters-based sales, marketing and general management positions. From
1994 to 1996, Mr. Foss was General Manager of Pepsi-Cola North America’s Great West Business Unit.
In 1996, Mr. Foss was named General Manager for the Central Europe Region for Pepsi-Cola
International, a position he held until joining PBG in March 1999. Mr. Foss is also a director of
United Dominion Realty Trust, Inc. and on the Industry Affairs Council of the Grocery Manufacturers
of America.
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Alfred
H. Drewes, 51, was appointed Senior Vice President and Chief
Financial Officer in June 2001. Mr. Drewes previously served as Senior Vice President and Chief
Financial Officer of Pepsi-Cola International (“PCI”). Mr. Drewes joined PepsiCo in 1982 as a
financial analyst in New Jersey. During the next nine years, he rose through increasingly
responsible finance positions within Pepsi-Cola North America in field operations and headquarters.
In 1991, Mr. Drewes joined PCI as Vice President of Manufacturing Operations, with responsibility
for the global concentrate supply organization. In 1994, he was appointed Vice President of
Business Planning and New Business Development and, in 1996, relocated to London as the Vice
President and Chief Financial Officer of the Europe and Sub-Saharan Africa Business Unit of PCI.
Robert C. King, 48, was appointed President of PBG’s North American business in December 2006.
Previously, Mr. King served as President of PBG’s North American Field Operations from October
2005 to December 2006. Prior to that, Mr. King served as Senior Vice President and General Manager
of PBG’s Mid-Atlantic Business Unit from October 2002 to October 2005. From 2001 to October 2002,
he served as Senior Vice President, National Sales and Field Marketing. In 1999, he was appointed
Vice President, National Sales and Field Marketing. Mr. King joined Pepsi-Cola North America in
1989 as a Business Development Manager and has held a variety of other field and headquarters-based
sales and general management positions.
Pablo Lagos, 51, was appointed President and General Manager of PBG Mexico in June 2006.
Previously, Mr. Lagos served as Chief Operating Officer of PBG Mexico from October 2003 to June
2006. Prior to joining PBG Mexico, he served as Vice President of Sales and Operations for
Sabritas, the Mexican salty snack food unit of Frito-Lay International (“FLI”) from 2002 to 2003.
From 1996 to 2002, Mr. Lagos served as President of FLI in Chile and area Vice President Chile,
Peru, Ecuador. In 1991 he joined the leadership team of FLI’s Gamesa business in Mexico, where he
then served as Gamesa’s Vice President of Operations, and later served as National Sales Vice
President. Mr. Lagos joined Pepsi-Cola International, a division of PepsiCo, Inc., in Latin
America in 1983.
Yiannis Petrides, 48, is the President of PBG Europe. He was appointed to this position in
June 2000, with responsibilities for our operations in Spain, Greece, Turkey and Russia. Prior to
that, Mr. Petrides served as Business Unit General Manager for PBG in Spain and Greece. Mr.
Petrides joined PepsiCo in 1987 in the international beverage division. In 1993, he was named
General Manager of Frito-Lay’s Greek operation with additional responsibility for the Balkan
countries. In 1995, Mr. Petrides was appointed Business Unit General Manager for Pepsi Beverages
International’s bottling operation in Spain.
Steven
M. Rapp, 53, was appointed Senior Vice President, General
Counsel and Secretary in January 2005. Mr. Rapp previously served as Vice President, Deputy General Counsel
and Assistant Secretary from 1999 through 2004. Mr. Rapp joined PepsiCo as a corporate attorney in
1986 and was appointed Division Counsel of Pepsi-Cola Company in 1994.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is listed on the New York Stock Exchange under the symbol “PBG.” Our Class B
common stock is not publicly traded. On February 15, 2007, the last sales price for our common
stock on the New York Stock Exchange was $32.19 per share. The following table sets forth the high
and low sales prices per share of our common stock during each of our
fiscal quarters in 2006 and 2005.
Shareholders
As
of February 15, 2007, there were approximately 57,652 registered and beneficial holders
of our common stock. PepsiCo is the holder of all of our outstanding shares of Class B common
stock.
Dividend Policy
Quarterly
cash dividends are usually declared in late January or early
February, March, July and October and paid at
the end of March, June, and September and at the beginning of January. The dividend record dates
for 2007 are expected to be March 9, June 8, September 7 and December 7.
We declared the following dividends on our common stock during fiscal years 2006 and
2005:
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Performance Graph
The following performance graph compares the cumulative total return of our common stock to
the Standard & Poor’s 500 Stock Index and to an index of peer companies selected by us (the
“Bottling Group Index”). The Bottling Group Index consists of Coca-Cola Amatil Limited, Coca-Cola
Bottling Co. Consolidated, Coca-Cola Enterprises Inc., Coca-Cola FEMSA ADRs and PepsiAmericas, Inc.
The graph assumes the return on $100 invested on December 28, 2001 until December 29, 2006. The
returns of each member of the Bottling Group Index are weighted according to each member’s stock
market capitalization as of the beginning of the period measured and includes the subsequent
reinvestment of dividends on a quarterly basis.
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PBG Purchases of Equity Securities
We repurchased approximately 8 million shares of PBG common stock in the fourth quarter of
2006 and approximately 18 million shares of PBG common stock during fiscal year 2006. Since the
inception of our share repurchase program in October 1999 and through the end of fiscal year 2006,
approximately 119 million shares of PBG common stock have been repurchased. Our share repurchases
for the fourth quarter of 2006 are as follows:
Unless terminated by resolution of our Board, each share repurchase program expires when we
have repurchased all shares authorized for repurchase thereunder.
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Item 6. Selected Financial Data
SELECTED FINANCIAL AND OPERATING DATA
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
MANAGEMENT’S FINANCIAL REVIEW
Tabular dollars in millions, except per share data OVERVIEW
The Pepsi Bottling Group, Inc. (“PBG” or the “Company”) is the world’s largest manufacturer,
seller and distributor of Pepsi-Cola beverages. When used in these Consolidated Financial
Statements, “PBG,” “we,” “our” and “us” each refers to The Pepsi Bottling Group, Inc. and, where
appropriate, to Bottling Group, LLC (“Bottling LLC”), our principal operating subsidiary.
We have the exclusive right to manufacture, sell and distribute Pepsi-Cola beverages in all or
a portion of the U.S., Mexico, Canada and Europe, which consists of our operations in Spain,
Greece, Russia and Turkey. In 2006, PBG changed its financial reporting methodology to three
reportable segments — U.S. & Canada, Europe and Mexico. Operationally, the Company is organized
along geographic lines with specific regional management teams having responsibility for the
financial results in each reportable segment. The Company has restated segment information
contained in the Results of Operations — 2005 section of this report to conform to the current
segment reporting structure. See Note 16 in the Notes to Consolidated Financial Statements for
further discussion on our segments. As shown in the graph below, the U.S. & Canada segment is the
dominant driver of our results, generating 68% of our volume, 78% of our net revenues and 86% of
our operating income.
At the core of PBG’s business are the products we sell. Our products are some of the world’s
best-known brands, which span virtually every non-alcoholic liquid beverage category. The majority
of our volume is derived from brands licensed from PepsiCo, Inc. (“PepsiCo”) or joint ventures in
which PepsiCo participates. In some of our territories we have the right to manufacture, sell and
distribute soft drink products of companies other than PepsiCo, including Dr Pepper and Squirt. We
also have the right in some of our territories to manufacture, sell and distribute beverages under
trademarks that we own, including Electropura, e-puramr and Garci Crespo. See Part I,
Item 1 of the non-financial section of this report for a listing of our principal products by
segment.
We sell our products through either a cold-drink or take-home channel. Our cold-drink channel
consists of chilled products sold in the retail and foodservice channels. We earn the highest
profit margins on a per-case basis in the cold-drink channel. Our take-home channel consists of
unchilled products that are sold in the retail, mass and club channels for at-home future
consumption.
Our products are brought to market primarily through direct store delivery (“DSD”) or
third-party distribution, including foodservice and vending distribution networks. The hallmarks
of PBG’s DSD system are speed to market, flexibility and reach, all critical factors in bringing
new products to market, adding accounts to our existing base and meeting increasing volume demands.
Our customers span from large format accounts, including large chain foodstores, supercenters,
mass merchandisers, chain drug stores, club stores and military bases to small independently owned
shops and foodservice businesses.
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Among the services we provide to our customers are proven methods to grow not only PepsiCo
brand sales, but the overall beverage category. Ultimately, our goal is to help our customers grow
their beverage business by making our product line-up readily available.
We measure our sales in terms of physical cases as sold to our customers. Each package,
regardless of configuration or number of units within a package sold to a customer, represents one
physical case. Our net price and gross margin on a per-case basis are impacted by how much we
charge for the product, the mix of brands and packages we sell, and the channels in which the
product is sold. For example, we realize a higher net revenue and gross margin per case on a
20-ounce chilled bottle sold in a convenience store than on a 2-liter unchilled bottle sold in a
grocery store.
Our financial success is dependent on a number of factors, including: our strong partnership
with PepsiCo, the customer relationships we cultivate, the pricing we achieve in the marketplace,
our market execution, our ability to meet changing consumer preferences and the efficiency we
achieve in manufacturing and distributing our products. Key indicators of our financial success
are: the number of physical cases we sell, the net price and gross margin we achieve on a per-case
basis, and our overall cost productivity, which reflects how well we manage our raw material,
manufacturing, distribution and other overhead costs.
Management’s Financial Review is provided below and organized in the following sections:
The discussion and analysis throughout Management’s Financial Review should be read in
conjunction with the Consolidated Financial Statements and the related accompanying notes. The
preparation of our Consolidated Financial Statements in conformity with accounting principles
generally accepted in the United States of America (“U.S. GAAP”) requires us to make estimates and
assumptions that affect the reported amounts in our Consolidated Financial Statements and the
related accompanying notes, including various claims and contingencies related to lawsuits, taxes,
environmental and other matters arising out of the normal course of business. We use our best
judgment, the advice of external experts, our knowledge of existing facts and circumstances and
actions that we may undertake in the future, in determining the estimates that affect our
Consolidated Financial Statements.
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CRITICAL ACCOUNTING POLICIES
The preparation of our consolidated financial statements in conformity with U.S. GAAP often
requires us to make judgments, estimates, and assumptions regarding uncertainties that affect the
results of operations, financial position and cash flows of the Company, as well as the related
footnote disclosures. Management bases its estimates on knowledge of our operations, markets in
which we operate, historical trends, future expectations and other assumptions. Actual results
could differ from these estimates under different assumptions or conditions. Significant
accounting policies are discussed in Note 2 in the Notes to Consolidated Financial Statements. Our
critical accounting policies are those policies which management believes are most important to the
portrayal of PBG’s financial condition and results of operations and require the use of estimates,
assumptions and the application of judgment. Management has reviewed these critical accounting
policies and related disclosures with the Audit and Affiliated Transactions Committee of our Board
of Directors.
Allowance for Doubtful Accounts — Our allowance for doubtful accounts is determined through
evaluation of the aging of accounts receivable, sales return trend analysis, detailed analysis of
high-risk customer accounts, overall market environment and financial conditions of our customers.
Estimating an allowance for doubtful accounts requires significant management judgment and
assumptions regarding the potential for losses on receivable balances. Accordingly, we estimate
the amounts necessary to provide for losses on receivables by using quantitative and qualitative
measures, including historical write-off experience, evaluating specific customer accounts for risk
of loss, and adjusting for changes in economic conditions in which we and our customers operate.
Actual collections of accounts receivable could differ from management’s estimates due to changes
in future economic or industry conditions or specific customers’ financial condition.
Recoverability of Goodwill and Intangible Assets with Indefinite Lives — Our intangible
assets principally arise from the allocation of the purchase price of businesses acquired, and
consist primarily of franchise rights, distribution rights, brands and residual goodwill.
Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible
Assets” classifies intangible assets into three categories: (1) intangible assets with finite lives
subject to amortization; (2) intangible assets with indefinite lives not subject to amortization;
and (3) goodwill, which is not amortized.
Intangible assets with finite lives are amortized over their estimated useful lives. Tests
for impairment are performed only if a triggering event indicates the carrying value may not be
recoverable. For goodwill and intangible assets with indefinite lives, tests for impairment are
performed at least annually or more frequently if a triggering event indicates the assets may be
impaired.
We evaluate goodwill for impairment at a reporting unit level. A reporting unit can be an
operating segment or a business within an operating segment (component). Based on an evaluation of
our reporting units, we determined that the countries in which we operate are our reporting units.
We evaluate goodwill for impairment by comparing the fair value of the reporting unit with its
carrying value. We measure the fair value of a reporting unit as the discounted estimated future
cash flows, including a terminal value, which assumes the business continues in perpetuity. Our
long-term terminal growth assumptions reflect our current long-term view of the marketplace. Our
discount rate is based upon our weighted-average cost of capital for each reporting unit. If the
carrying value of a reporting unit exceeds its fair value, we compare the implied fair value of the
reporting unit’s goodwill to its carrying amount to measure the amount of impairment loss.
In determining whether our intangible assets have an indefinite useful life, we consider the
following as applicable: the nature and terms of underlying agreements; our intent and ability to
use the specific asset; the age and market position of the products within the territories we are
entitled to sell; the historical and projected growth of those products; and costs, if any, to
renew the agreement. We evaluate intangible assets with indefinite useful lives, including
franchise rights, distribution rights and brands we own for impairment by comparing the estimated
fair values with the carrying values. The fair value of our franchise rights and distribution
rights is measured using a multi-period excess earnings method that is based upon estimated
discounted future cash flows. The fair value of our brands is measured using a multi-period royalty
savings method, which reflects the savings realized by owning the brand and, therefore, not having
to pay a royalty fee to a third party. In the fair value calculation of these intangibles we use a
discount rate that is based upon the reporting unit’s weighted-average cost of capital plus an
additional risk premium to reflect the risk and uncertainty inherent in separately acquiring the
identified intangible asset between a willing buyer and a willing seller. The additional risk
premium associated with our discount rate
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effectively eliminates the benefit that we believe
results from synergies, scale and our assembled workforce, all of which are components of goodwill.
Considerable management judgment is necessary to estimate discounted future cash flows in
conducting an impairment test for goodwill and other identified intangible assets, which may be
impacted by future actions taken by us and our competitors and the volatility in the markets in
which we conduct business. An inability to achieve strategic business plan targets in a reporting
unit, a change in our discount rate, or other assumptions within our cash flow models could have a
significant impact on the fair value of our reporting units and other intangible assets, which
could then result in a material impairment charge to our results of operations. In Mexico, we have
approximately $1 billion of intangible assets on our balance sheet. Prior to 2006, Mexico did not
meet our profit expectations. While Mexico has met our profit expectations in 2006, an impairment
charge could be required in the future if we do not achieve our long-term expected results there.
We will continue to closely monitor our performance in Mexico and evaluate the realizability of
each intangible asset. For further information about our goodwill and intangible assets see Note 9
in the Notes to Consolidated Financial Statements.
Pension and Postretirement Medical Benefit Plans — We sponsor pension and other
postretirement medical benefit plans in various forms in the United States and similar plans
outside the United States, covering employees who meet specified eligibility requirements.
We account for our defined benefit pension plans and our postretirement medical benefit plans
using actuarial models required by SFAS No. 87, “Employers’ Accounting for Pensions,” and SFAS No.
106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.”
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS 158”).
Effective for our fiscal year ending 2006, we adopted the balance sheet provisions of this standard
and recognized the funded status of each of the pension and postretirement medical plans we sponsor
in the United States and other similar plans we sponsor outside the United States. Accordingly, we
recorded a decrease of approximately $159 million, net of taxes and minority interest, to our
shareholders’ equity due to the adoption of SFAS 158.
The assets, liabilities and expense associated with our international plans were not
significant to our results of operations, and accordingly, assumptions and sensitivity analyses
regarding these plans are not included in the discussion below.
Assumptions
Our U.S. employees participate in non-contributory defined benefit pension plans, which cover
substantially all full-time salaried employees, as well as most hourly employees. Assumptions and
estimates are required to calculate the expenses and obligations for these plans including discount
rate, expected return on plan assets, retirement age, mortality, turnover, health care cost trend
rates and compensation-rate increases.
We evaluate these assumptions with our actuarial advisors on an annual basis and we believe
that they are appropriate. Our assumptions are based upon historical experience of the plan and
expectations for the future. These assumptions may differ materially from actual results due to
changing market and economic conditions. An increase or decrease in the assumptions or economic
events outside our control could have a material impact on reported net income and the related
funding requirements.
The discount rate is a significant assumption and is derived from the present value of our
expected pension and postretirement medical benefit payment streams. The present value is
calculated by utilizing a yield curve that matches the timing of our expected benefit payments.
The yield curve is developed by our actuarial advisers using a portfolio of several hundred
high-quality non-callable corporate bonds. The bonds are rated Aa or better by Moody’s and have at
least $250 million in principal amount. The bonds are denominated in U.S. dollars and have maturity
dates ranging from six months to thirty years. Once the present value of all the expected payment
streams has been calculated, a single discount rate is determined. The fiscal year 2007
weighted-average discount rate for our pension and postretirement medical plans is 6.00 percent and
5.80 percent, respectively.
The expected return on plan assets is important, since a portion of our defined benefit
pension plans is funded. In evaluating the expected rate of return on assets for a given fiscal
year, we consider the actual 10 to 15-year
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historic returns on asset classes in our pension
investment portfolio, reflecting the weighted-average return of our asset allocation and use them
as a guide for future returns. Our target asset allocation for our U.S. pension assets is 75
percent equity investments, of which approximately 80 percent is invested in domestic equities and
20 percent is invested in foreign equities. The remaining 25 percent of our plan assets is invested
primarily in fixed income securities, which is equally divided between U.S. government and
corporate bonds. Our current portfolio’s target asset allocation for the 10 and 15-year periods
had weighted average returns of 8.46 percent and 9.77 percent, respectively. Over time, the
expected rate of return on pension plan assets should approximate the actual long-term returns.
Based on the historic and estimated future returns of our portfolio, we estimate the long-term rate
of return on assets for our domestic pension plans to be 8.50 percent in 2007.
The cost or benefit of plan changes, such as increasing or decreasing benefits for prior
employee service, is deferred and included in expense on a straight-line basis over the average
remaining service period of the employees expected to receive benefits.
Gains and losses have resulted from changes in actuarial assumptions and from differences
between assumed and actual experience, including among other items, changes in discount rates,
actual returns on plan assets as compared to assumed returns, and changes in compensation
increases. Differences between assumed and actual returns on plan assets are amortized on a
straight-line basis over five years and are recognized in the net periodic pension calculation over
five years. To the extent the amount of all unrecognized gains and losses exceeds 10 percent of
the larger of the benefit obligation or plan assets, such amount is amortized over the average
remaining service period of active participants. Net unrecognized losses, within our pension and
postretirement plans in the United States, totaled $558 million and $611 million at December 30,
2006 and December 31, 2005, respectively.
The following table provides our current and expected weighted-average assumptions for our
pension and postretirement medical plans’ expense in the United States:
During 2006, our Company-sponsored defined benefit pension and postretirement medical plan
expenses in the United States totaled $119 million. In 2007, our ongoing expenses will decrease by
approximately $2 million to $117 million as a result of the combination of the following factors:
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Sensitivity Analysis
It is unlikely that in any given year the actual rate of return will be the same as the
assumed long-term rate of return of 8.50 percent. The following table provides a summary of the
last three years of actual returns versus the expected long-term returns for our U.S. pension
plans:
Sensitivity of changes in key assumptions for our U.S. pension and postretirement plans’
expense in 2007 are as follows:
For further information about our pension and postretirement plans and the adoption of SFAS
158 see Notes 2 and 14 in the Notes to Consolidated Financial Statements.
Casualty Insurance Costs — Due to the nature of our business, we require insurance coverage
for certain casualty risks. In the United States, we use a combination of insurance and
self-insurance mechanisms, including a wholly owned captive insurance entity, which participates in
a reinsurance pool to provide for workers’ compensation and automobile risks for occurrences up to
$10 million, and product and general liability risks for occurrences up to $5 million. For losses
exceeding these self-insurance thresholds, we purchase casualty insurance from a third-party
provider.
Our liability for casualty costs is estimated using individual case-based valuations and
statistical analyses and is based upon historical experience, actuarial assumptions and
professional judgment. We do not discount our loss expense reserves. These estimates are subject to
the effects of trends in loss severity and frequency and are subject to a significant degree of
inherent variability. We evaluate these estimates with our actuarial advisors periodically during
the year and we believe that they are appropriate, although an increase or decrease in the
estimates or events outside our control could have a material impact on reported net income.
Accordingly, the ultimate settlement of these costs may vary significantly from the estimates
included in our financial statements. For further information about our casualty insurance costs
see Note 2 in the Notes to Consolidated Financial Statements.
Share-Based Compensation — Effective January 1, 2006, the Company adopted SFAS No. 123
(revised), “Share-Based Payment” (“SFAS 123R”). Among its provisions, SFAS 123R requires the
Company to recognize compensation expense for equity awards over the vesting period based on the
award’s grant-date fair value.
Historically, we offered stock option awards as our primary form of long-term incentive
compensation. These stock option awards generally vest over three years and have a 10 year term.
The Company uses the Black-Scholes-Merton option valuation model to value stock option awards.
Beginning in 2006, we granted a combination of stock option awards and restricted stock units to
our middle and senior management and our board of directors. The fair value of restricted stock
unit awards is based on the fair value of PBG stock on the date of grant. Each restricted stock
unit award generally vests over three years and is settled in shares of PBG stock after the vesting
period.
The Black-Scholes-Merton valuation model for our stock option awards estimates the potential
value the employee will receive based on current interest rates, expected time at which the
employee will exercise the award and the expected volatility of the Company’s stock price. These
assumptions are based on historical experience and future expectations of employee behavior and
stock price.
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Another significant assumption utilized in calculating our share-based compensation is the
amount of awards that we expect to forfeit. Compensation expense is recognized only for share-based
payments expected to vest and we estimate forfeitures, both at the date of grant as well as
throughout the vesting period, based on the Company’s historical experience and future
expectations.
Changes in our assumptions utilized to value our stock options and forfeiture rates could
materially affect the amount of share-based compensation expense recognized in the Consolidated
Statement of Operations.
For the year ended December 30, 2006, the adoption of SFAS 123R reduced our diluted earnings
per share by approximately $0.17. We expect a similar impact to our diluted earnings per share for
2007.
For further information about our share-based compensation see Note 4 in the Notes to
Consolidated Financial Statements.
Income Taxes — Our effective tax rate is based on pre-tax income, statutory tax rates, tax
regulations and tax planning strategies available to us in the various jurisdictions in which we
operate. The tax bases of our assets and liabilities reflect our best estimate of the tax benefits
and costs we expect to realize. We establish valuation allowances to reduce our deferred tax
assets to an amount that will more likely than not be realized. A significant portion of deferred
tax assets consists of net operating loss carryforwards (“NOLs”). We have NOLs totaling $1,118
million at December 30, 2006, which are available to reduce future taxes in the U.S., Spain,
Greece, Russia, Turkey and Mexico. The majority of our NOLs are generated overseas, the largest of
which is coming from our Mexican and Spanish operations. Of these NOLs, $26 million expire in 2007
and $1,092 million expire at various times between 2008 and 2026.
Significant management judgment is required in determining our effective tax rate and in
evaluating our tax position. We establish tax reserves when, based on the applicable tax law and
facts and circumstances relating to a particular transaction or tax position, it becomes probable
that the position will not be sustained when challenged by a taxing authority. A change in our tax
reserves could have a significant impact on our results of operations.
Under our tax separation agreement with PepsiCo, PepsiCo maintains full control and absolute
discretion for any combined or consolidated tax filings for tax periods ended on or before our
initial public offering that occurred in March 1999. However, PepsiCo may not settle any issue
without our written consent, which consent cannot be unreasonably withheld. PepsiCo has
contractually agreed to act in good faith with respect to all tax examination matters affecting us.
In accordance with the tax separation agreement, we will bear our allocable share of any risk or
benefit resulting from the settlement of tax matters affecting us for these tax periods.
A number of years may elapse before a particular matter for which we have established a tax
contingency reserve is audited and finally resolved. The number of years for which we have audits
that are open varies depending on the tax jurisdiction. The U.S. Internal Revenue Service (“IRS”)
is currently examining PBG’s and PepsiCo’s joint tax returns for 1998 through March 1999. The
statute of limitations for the IRS audit of PBG’s 1999-2000 tax returns closed on December 30,
2006, and we released approximately $55 million in tax contingency reserves relating to such audit.
The IRS is currently examining PBG’s tax returns for the 2001 and 2002 tax years. While it is
often difficult to predict the final outcome or the timing of the resolution, we believe that our
tax reserves reflect the probable outcome of known tax contingencies. Favorable resolutions would
be recognized as a reduction of our tax expense in the year of resolution.
For further information about our income taxes see Note 15 in the Notes to Consolidated Financial
Statements.
RELATIONSHIP WITH PEPSICO
PepsiCo is considered a related party due to the nature of our franchise relationship and its
ownership interest in our company. More than 80 percent of our volume is derived from the sale of
brands from PepsiCo. At December 30, 2006, PepsiCo owned approximately 38.4 percent of our
outstanding common stock and 100 percent of our outstanding class B common stock, together
representing approximately 44.5 percent of the voting power of all classes of our voting stock. In
addition, at December 30, 2006, PepsiCo owned 6.7 percent of the equity of Bottling LLC. We fully
consolidate the results of Bottling LLC and present PepsiCo’s share as minority interest in our
Consolidated Financial Statements.
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Our business is conducted primarily under beverage agreements with PepsiCo, including a master
bottling agreement, a non-cola bottling agreement and a master syrup agreement. These agreements
provide PepsiCo with the ability, at its sole discretion, to establish prices, and other terms and
conditions for our purchase of concentrates and finished product from PepsiCo. Additionally, under
a shared services agreement, we obtain various services from PepsiCo, which include services for
information technology maintenance and the procurement of raw materials. We also provide services
to PepsiCo, including facility and credit and collection support.
Because we depend on PepsiCo to provide us with concentrate, bottler incentives and various
services, changes in our relationship with PepsiCo could have a material adverse effect on our
business and financial results.
For further information about our relationship with PepsiCo and its affiliates see Note 17 in
the Notes to Consolidated Financial Statements.
ITEMS THAT AFFECT HISTORICAL OR FUTURE COMPARABILITY
The year-over-year comparisons of our financial results are affected by the following items:
2006 Items
SFAS 123R
Effective January 1, 2006, the Company adopted SFAS 123R. Among its provisions, SFAS 123R
requires the Company to recognize compensation expense for equity awards over the vesting period
based on the award’s grant-date fair value. Prior to 2006, in accordance with accounting
guidelines, the Company was not required to recognize this expense. For further information see
our Critical Accounting Policies and Note 4 in the Notes to Consolidated Financial Statements.
Tax Law Changes
During 2006, tax law changes were enacted in Canada, Turkey, and in various U.S. jurisdictions
which decreased our income tax expense, resulting in an increase to net income, after the impact of
minority interest, of $10 million or $0.05 of diluted EPS. Please see our Income Tax Expense
discussion in the Financial Performance section below for further details.
Tax Audit Settlement
Included in our fourth quarter and the full year diluted earnings per share was an
approximate $0.22 tax gain which was primarily driven by the reversal of approximately $55 million
of tax contingency reserves in the fourth quarter of 2006. These reserves, which related to the
IRS audit of PBG’s 1999-2000 income tax returns, resulted from the expiration of the statute of
limitations for this IRS audit on December 30, 2006.
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2005 Items
High Fructose Corn Syrup (“HFCS”) Litigation Settlement
Included in our selling, delivery and administrative expenses for 2005 was a pre-tax gain of
$29 million in the U.S. from the settlement of the HFCS class action lawsuit. The lawsuit related
to purchases of high fructose corn syrup by several companies, including bottling entities owned
and operated by PepsiCo, during the period from July 1, 1991 to June 30, 1995 (the “Claims
Period”). Certain of the bottling entities owned by PepsiCo during the Claims Period were
transferred to PBG when PepsiCo formed PBG in 1999. With respect to these entities, which we
currently operate, we received $23 million in HFCS settlement proceeds. We received an additional
$6 million in HFCS settlement proceeds related to bottling operations not previously owned by
PepsiCo, such as manufacturing co-operatives of which we are a member.
53rd Week
Our fiscal year ends on the last Saturday in December and, as a result, a 53rd week
is added every five or six years. Fiscal years 2006 and 2004 consisted of 52 weeks. In 2005, our
fiscal year consisted of 53 weeks. Our 2005 results included pre-tax income of approximately $19
million due to the 53rd week, which increased our operating income by $24 million offset
by additional interest expense of $5 million.
Strategic Spending Initiatives
We reinvested both the pre-tax gain of $29 million from the HFCS settlement and the pre-tax
income of $19 million from the 53rd week in long-term strategic spending initiatives in
the U.S., Canada and Europe. The strategic spending initiatives included programs designed
primarily to enhance our customer service agenda, drive productivity and improve our management
information systems. These strategic spending initiatives were recorded in selling, delivery and
administrative expenses.
FINANCIAL PERFORMANCE SUMMARY
During 2006, we delivered strong results, reflecting outstanding top-line growth which was
partially offset by higher raw material costs and selling, delivery and administrative expenses,
including the impact of adopting SFAS 123R. Diluted earnings per share increased 16 percent, which
included the $0.22 tax gain primarily due to the reversal of tax contingency reserves in the fourth
quarter and a $0.05 tax gain due to income tax law changes enacted in the third quarter. These tax
gains were partially offset by the $0.17 earnings per share charge from the impact of adopting SFAS
123R.
Overall, we increased our worldwide revenue by seven percent and our gross profit improved by
five percent. Worldwide operating income was down less than one percent as a result of the
six-percentage-point negative impact from the adoption of SFAS 123R. Strong results in our core
operations were fueled by double-digit operating income growth in our Mexico and Europe segments
and a solid performance in our U.S. & Canada segment. Reported operating income in our U.S. &
Canada segment was down five percent driven by the six-percentage-point
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negative impact from the adoption of SFAS 123R and the net two-percentage-point positive impact in the prior year from the
53rd week, HFCS settlement and strategic initiatives.
On a worldwide basis, we achieved three percent volume growth, reflecting increases across all
segments. In the U.S. & Canada, volume increased two percent. Volume growth, excluding the impact
from acquisitions and the impact of the 53rd week in 2005, was driven by strong brand
performance in non-carbonated beverages. Strong volume growth in Europe of seven percent was driven by
double-digit growth in Russia and Turkey.
In Mexico, volume increased four percent, of which three percent was due to acquisitions.
Our strong worldwide revenue growth was a result of strong brand performance across
non-carbonated beverages, product and package innovation, pricing improvements and strong execution
in the marketplace. Growth was driven primarily by a four-percent increase in net revenue per case,
including a one-percentage-point impact from the effect of foreign currency translation, and a
three-percent increase in volume. Each of our segments delivered strong increases in net revenue
per case as a result of the Company’s successful pricing and margin strategy.
Our worldwide cost of sales increased by nine percent driven by our strong volume growth and
increases in some of our raw material costs, which have continued to pressure our bottom-line
results. On a per-case basis, cost of sales increased six percent, reflecting increases in raw
material costs and the impact of package mix.
Worldwide selling, delivery and administrative (“SD&A”) expenses increased six percent.
Increases in selling, delivery and administrative costs were driven by higher volume growth, wage
and benefit costs, increased pension expense and planned spending as a result of investment in high
growth European markets. The impact from the adoption of SFAS 123R in 2006 offset the net impact
of the 53rd week, the HFCS settlement and the strategic spending initiatives in 2005.
Interest expense, net increased by $16 million largely due to higher effective interest rates
from interest rate swaps which convert our fixed-rate debt to variable-rate debt. Other
non-operating expenses, net increased by $10 million primarily due to foreign exchange losses
associated with the devaluation of the Turkish lira.
Our cash flow from operations continued to be strong in 2006. We generated more than $1.2
billion of cash from operations, after contributing $68 million into our pension plans. With our
strong cash flows, we utilized $725 million of cash for capital investments to grow our business
and returned $643 million to our shareholders through share repurchases and dividends during the
year. During 2006, we increased our annual dividend by 38 percent, raising it from $0.32 to $0.44
per share. In addition, our Board of Directors authorized an expansion of our share repurchase
program for an additional 25 million shares of common stock on the open market and through
negotiated transactions. This brings the total number of shares authorized for repurchase to 150
million since we initiated our share repurchase program in October 1999.
2007 Outlook
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In 2007, we expect to increase our net revenue per case, using rate increases where
marketplace conditions allow, while also managing the mix of products we plan to sell in order to
offset the cost of raw materials which is expected to continue to pressure our cost of sales.
In July 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in
Income Taxes,” which provides specific guidance on the financial statement recognition,
measurement, reporting and disclosure of uncertain tax positions taken or expected to be taken in a
tax return. FIN 48 becomes effective beginning with our first quarter 2007 fiscal period and is
likely to cause greater volatility in our quarterly statements of operations and impact the
calendarization of our effective tax rate on a quarterly basis as interest on tax reserves is
recognized discretely within income tax expense. Please see Note 15 in the Notes to Consolidated
Financial Statements for further discussion on FIN 48.
The impact from this accounting change will result in an approximate one-percentage point
increase in PBG’s effective tax rate. Accordingly, we expect our full year effective tax rate,
including the impact of FIN 48, to be in the range of 34.5 to 35.0 percent. The impact of FIN 48
will increase our income tax expense by approximately $6 million and reduce EPS by approximately
$0.02. Consequently, PBG’s full-year reported diluted earnings per share are expected to be in the
range of $1.90 to $1.98.
RESULTS OF OPERATIONS — 2006
Volume
Our full-year reported worldwide physical case volume increased three percent in 2006 versus
2005. Worldwide volume growth reflects increases across all segments.
In the U.S. & Canada, volume growth, excluding the impact from acquisitions and the impact of
the 53rd week in 2005, was fueled by strong brand performance across non-carbonated
beverages, innovation and our ability to capture the growth in emerging channels such as Club and
Dollar stores.
In the U.S., volume increased three percent due mainly to a three-percent increase in base
business volume and a one percent increase from acquisitions that was offset by the impact of the
53rd week in 2005. Base business volume growth was driven by a double-digit increase in
both water and other non-carbonated beverages, fueled by outstanding growth in Lipton Iced Tea and
energy drinks. Our total carbonated soft drink (“CSD”) portfolio decreased about one percent,
mostly driven by declines in Trademark Pepsi. Our flavored CSD portfolio increased about
two percent due to growth in Trademark Mountain Dew. From a channel perspective, growth in the
U.S. was driven by a four-percent increase in our take-home channel as a result of double-digit
increases in Club and Dollar stores as well as mass retailers and drug stores, and a two-percent
increase in our cold-drink channel. Cold-drink growth was driven by strong results in the
foodservice channel and in the convenience and gas channel.
In Canada, volume increased about one percent in 2006 versus 2005, primarily driven by a
two-percent increase in base business and partially offset by the impact of the 53rd
week in 2005. Base business growth was primarily driven by double-digit growth in both water and
other non-carbonated beverages.
In Europe, volume grew seven percent in 2006 versus 2005, driven by double-digit increases in
Russia and Turkey. Solid growth in our non-carbonated portfolio, including bottled water and
Lipton Iced Tea, Trademark Pepsi and local brands helped drive overall growth in these countries.
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In Mexico, excluding the impact of acquisitions, volume increased one percent in 2006 versus
2005, mainly as a result of growth in bottled water and other non-carbonated beverages and
partially offset by declines in jug water and CSD volume.
Net Revenues
Worldwide net revenues were $12.7 billion in 2006, a seven-percent increase over the prior
year. The increase in net revenues for the year was driven primarily by strong volume growth and
solid increases in net price per case across all segments, coupled with the impact of acquisitions
in the U.S. and Mexico and the favorable impact from foreign currency translation in Canada. This
growth was partially offset by the impact of the 53rd week in 2005 in our U.S. & Canada
segment. Increases in net price per case were primarily driven by rate improvements across all
segments.
In the U.S. & Canada, six-percent growth in net revenues was consistent with worldwide trends.
In the U.S., we achieved revenue growth of five percent with three-percent volume growth due
primarily to base business volume increases in water and non-carbonated beverages. Net price per
case in the U.S. increased by three percent mainly due to rate increases. In Canada, revenue growth
of 12 percent was driven primarily by the favorable impact of foreign currency translation, coupled
with a three-percent increase in net price per case and volume improvements of one percent.
Net revenues in Europe increased 12 percent in 2006 versus 2005, driven primarily by
double-digit volume growth in Russia and Turkey and strong increases in net price per case
primarily as a result of rate increases.
In Mexico, net revenues increased nine percent mostly due to strong increases in net price per
case as a result of rate increases and the impact of acquisitions, coupled with positive volume
growth.
Cost of Sales
Worldwide cost of sales was $6.8 billion in 2006, a nine-percent increase over 2005. The
growth in cost of sales across all of our segments was driven by cost per case increases and volume
growth. Worldwide cost-per-case increases were driven primarily by increases in raw material
costs and the impact of package mix. Changes in our package mix were driven by faster volume
growth in higher cost non-carbonated products. The impact of acquisitions in the U.S. and Mexico
and the negative impact of foreign currency translation in Canada each
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contributed about one
percentage point of growth to our worldwide increase, which was partially offset by the impact of
the 53rd
week in the prior year in our U.S. & Canada segment.
Selling, Delivery and Administrative Expenses
Worldwide SD&A expenses were $4.9 billion, a six-percent increase over 2005. This increase was
driven by volume growth and higher wage and benefit costs across all of our segments, increased
pension expense in the U.S and planned spending as a result of investment in high-growth European
markets. The impact from the adoption of SFAS 123R in 2006 contributed approximately one
percentage point of growth to our worldwide increase in SD&A expenses. Additionally, the prior
year combined impact from the strategic spending initiatives and the additional expenses from the
53rd week
in our U.S. & Canada segment, partially offset by the pre-tax gain in the
U.S. from the HFCS settlement decreased our worldwide SD&A growth in 2006 by approximately one
percentage point.
Interest Expense, net
Interest expense, net increased by $16 million largely due to higher effective interest rates
from interest rate swaps which convert our fixed-rate debt to variable-rate debt.
Other Non-Operating Expenses, net
Other non-operating expenses, net increased by $10 million primarily due to foreign exchange
losses associated with the devaluation of the Turkish lira. This devaluation caused transactional
losses due to the revaluation of our U.S. dollar denominated liabilities in Turkey, which were
repaid in June of 2006.
Minority Interest
Minority interest primarily represents PepsiCo’s approximate 6.7 percent ownership in Bottling
LLC for both years ended 2006 and 2005.
Income Tax Expense
Our effective tax rates for 2006 and 2005 were 23.4 percent and 34.7 percent, respectively.
The decrease in our effective tax rate versus the prior year is due primarily to the reversal of
tax contingency reserves of approximately $55 million relating to the completion of the IRS audit
of PBG’s 1999-2000 income tax returns. In addition, during 2006 changes to the income tax laws in
Canada, Turkey and certain jurisdictions within the U.S. were enacted. These tax law changes
enabled us to re-measure our net deferred tax liabilities using lower tax rates which decreased our
income tax expense by approximately $11 million during the year ended December 30, 2006, resulting
in an increase in net income of $10 million after the impact of minority interest.
Diluted Weighted-Average Shares Outstanding
Diluted earnings per share reflect the potential dilution that could occur if equity awards
from our stock compensation plans were exercised and converted into common stock that would then
participate in net income.
Our diluted weighted-average shares outstanding for 2006, 2005 and 2004 were 242 million, 250
million and 263 million, respectively.
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The decrease in shares outstanding reflects the effect of our share repurchase program, which
began in October 1999, partially offset by share issuances from the exercise of stock options. The
amount of shares authorized by the Board of Directors to be repurchased totals 150 million shares,
of which we have repurchased approximately 18
million shares in 2006 and 119 million shares since the inception of our share repurchase
program. For further discussion on our earnings per share calculation see Note 3 in the Notes to
Consolidated Financial Statements.
RESULTS OF OPERATIONS — 2005
Volume
Our full-year reported worldwide physical case volume increased five percent in 2005 versus
2004, reflecting strong volume growth across all segments.
In the U.S. & Canada, volume grew five percent in 2005 versus 2004, primarily driven by strong
non-carbonated beverage sales and the impact of the 53rd week, coupled with the impact
of acquisitions.
In the U.S., volume grew five percent in 2005 versus 2004. Increases in volume, excluding
acquisitions and the impact of the 53rd week, were driven by a three-percent increase in
our take-home channel and a two-percent increase in our cold-drink channel. These volume
increases were attributable to solid results in large format businesses and foodservice venues. In
the U.S., our growth reflects consumer trends. Our non-carbonated beverage volume increased 18
percent, led by 31-percent growth in Trademark Aquafina and the successful introduction of Aquafina
FlavorSplash, coupled with solid performance in Trademark Starbucks and in our
energy drinks. Our total CSD portfolio was down about one percent, mostly driven by
declines in brand Pepsi, partially offset by the successful introduction of Pepsi Lime,
double-digit growth in brand Wild Cherry Pepsi, and a three-percent increase in our
diet portfolio. The 53rd week contributed two percentage points of growth.
In Canada, volume increased three percent in 2005 versus 2004, primarily driven by increases
in both the cold-drink and take-home channels. This growth was fueled by strong execution and
strategic marketing programs that were designed to gain consumer interest. The 53rd
week contributed approximately one percentage point of growth.
In Europe, volume grew eight percent in 2005 versus 2004, driven by double-digit increases in
Russia and Turkey. In Russia, we had solid growth in Trademark Pepsi and Aqua Minerale, coupled
with strong growth in Tropicana juice drinks, Lipton Iced Tea and local brands. In
Turkey, we continued to improve our customer service through the consolidation of third-party
distributors and the migration of selling activities to our own employees. These improvements and
an effective advertising campaign resulted in volume increases in brand Pepsi and in local brands,
such as Yedigun.
Total volume in Mexico was up five percent for the year, driven largely by growth in our water
business, including an 11-percent increase in our jug water business and a 13-percent increase in
our bottled water business. The investments that we began making in 2004 in the marketplace and in
our infrastructure in Mexico have enabled us to improve both our bottled water and jug water
businesses, including expansion of our home delivery system for jug water. Our CSD portfolio in
Mexico was down about one percent primarily due to competitive pressure in the Mexico City area.
This decline was partially offset by solid performance in our CSD business outside the Mexico City
area which accounts for 75 percent of our volume.
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Net Revenues
Worldwide net revenues were $11.9 billion in 2005, a nine-percent increase over 2004. The
increase in net revenues for the year was driven primarily by strong volume growth and increases in
net price per case, coupled with the favorable impact from foreign currency translation in Canada
and Mexico, acquisitions and the impact of the 53rd week.
In the U.S. & Canada, nine-percent growth in net revenues was consistent with worldwide
trends. Net price per case in the U.S. increased three percent, mostly due to rate increases.
In Europe, net revenues increased 12 percent in 2005 versus 2004, reflecting strong volume
growth, coupled with net price per case increases.
In Mexico, net revenues grew 10 percent versus 2004, driven primarily by strong volume and the
favorable impact from foreign currency translation.
Cost of Sales
Worldwide cost of sales was $6.3 billion in 2005, an 11-percent increase over 2004. The
growth in cost of sales was driven primarily by strong volume growth in all of our segments and
cost-per-case increases, coupled with the negative impact of foreign currency translation in Canada
and Mexico, acquisitions in the U.S. and the impact of the 53rd week in the U.S. and
Canada. During 2005, we continued to see increases in resin prices, exacerbated by a severe
hurricane season in the U.S. These increases added approximately $100 million of costs or
approximately two percentage points of growth to our worldwide cost of sales per case.
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Selling, Delivery and Administrative Expenses
Worldwide SD&A expenses were $4.6 billion, an eight-percent increase over 2004. Increases in
selling, delivery and administrative costs across all of our segments were driven by strong volume
growth, wage and benefit increases and rising fuel prices. The impact of the 53rd week
in the U.S. & Canada and the strategic spending initiatives, partially offset by the pre-tax gain
of $29 million in the U.S. from the HFCS settlement contributed approximately one percentage point
of a net increase in SD&A expenses. PBG invested both the HFCS gain and the additional income
from the 53rd week in long-term strategic spending initiatives, which totaled $48
million. The strategic spending initiatives included programs to enhance our customer service
agenda, drive productivity, including restructuring in Europe, and improve our management
information systems.
In addition, SD&A expenses in Mexico were higher than expected as certain of the cost savings
initiatives did not yield expected results. This increase was partially offset by the impact of a
$9 million non-cash impairment charge taken in the prior year for the franchise licensing agreement
associated with the Squirt trademark in Mexico.
Interest Expense, net
Interest expense, net increased by $20 million, when compared with 2004, largely due to higher
effective interest rates from interest rate swaps, which convert our fixed-rate debt to variable
debt, coupled with the impact of the 53rd week of approximately $5 million. As of
December 31, 2005 approximately 26 percent of our total debt was variable.
Minority Interest
Minority interest primarily represents PepsiCo’s approximate 6.7 percent and 6.8 percent
ownership in our principal operating subsidiary, Bottling LLC for the years ended 2005 and 2004,
respectively.
Income Tax Expense
Our effective tax rates for 2005 and 2004 were 34.7 percent and 33.7 percent, respectively.
The increase in our 2005 effective tax rate versus the prior year is mainly due to higher earnings
in the U.S. and increased tax contingencies related to certain historic tax positions and resulting
from changes in our international legal entity and debt structure. These increases in our tax
provision were partially offset by the reversal of valuation allowances and the tax deduction for
qualified domestic production activities enacted pursuant to the American Jobs Creation Act of
2004. The reversal of the valuation allowances was due in part to improved profitability trends in
Russia and a change to the Russia tax law that enables us to use a greater amount of our Russian
net operating losses. Additionally, the implementation of U.S. legal entity restructuring
contributed to the remainder of the valuation allowance reversal.
LIQUIDITY AND FINANCIAL CONDITION
Liquidity and Capital Resources
Our principal sources of cash come from our operating activities, and the issuance of debt and
bank borrowings. We believe that these cash inflows will be sufficient to fund capital
expenditures, benefit plan contributions, acquisitions, share repurchases, dividends and working
capital requirements for the foreseeable future.
2006 Long-Term Debt Activities
On March 30, 2006, Bottling LLC issued $800 million of 5.50% senior notes due 2016 (the
“Notes”). The net proceeds received, after deducting the underwriting discount and offering
expenses, were approximately $793 million. The net proceeds were used to repay outstanding
commercial paper and the 2.45% senior notes due October of 2006. The Notes are general unsecured
obligations and rank on an equal basis with all of Bottling LLC’s
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other existing and future
unsecured indebtedness and are senior to all of Bottling LLC’s future subordinated indebtedness.
2006 Short-Term Debt Activities
In March 2006, we entered into a new $450 million committed revolving credit facility (“2006
Agreement”) which expires in March 2011 and increased our existing facility, which expires in April
2009, from $500 million to $550 million. Our combined committed credit facilities of $1 billion,
which are guaranteed by Bottling LLC,
support our $1 billion commercial paper program. Subject to certain conditions stated in the
2006 Agreement, the Company may borrow, prepay and reborrow amounts, including issuing standby
letters of credit up to $250 million, at any time during the term of the 2006 Agreement. Funds
borrowed may be used for general corporate purposes, including supporting our commercial paper
program.
At December 30, 2006, we had $115 million in outstanding commercial paper with a
weighted-average interest rate of 5.4 percent. At December 31, 2005, we had $355 million in
outstanding commercial paper with a weighted-average interest rate of 4.3 percent.
We had available bank credit lines of approximately $741 million at December 30, 2006. These
lines were used to support the general operating needs of our businesses. As of year-end 2006, we
had $242 million outstanding under these lines of credit at a weighted-average interest rate of 5.0
percent. As of year-end 2005, we had available short-term bank credit lines of approximately $835
million and $156 million was outstanding under these lines of credit at a weighted-average interest
rate of 4.3 percent.
Our peak borrowing timeframe varies with our working capital requirements and the seasonality
of our business. Additionally, throughout the year, we may have further short-term borrowing
requirements driven by other operational needs of our business. During 2006, borrowings from our
commercial paper program in the U.S. peaked at $408 million. Borrowings from our line of credit
facilities peaked at $262 million, reflecting payments for working capital requirements.
Financial Covenants
Certain of our other senior notes have redemption features and non-financial covenants that
will, among other things, limit our ability to create or assume liens, enter into sale and
lease-back transactions, engage in mergers or consolidations and transfer or lease all or
substantially all of our assets. Additionally, certain of our credit facilities and senior notes
have financial covenants. For a discussion of our covenants, see Note 11 in the Notes to
Consolidated Financial Statements. We are in compliance with all debt covenants.
On December 30, 2006, we adopted the balance sheet provisions of SFAS 158, and accordingly we
recorded a decrease to our shareholders’ equity of approximately $159 million, net of taxes and
minority interest. This did not have an impact on our liquidity or our debt covenants.
Cash Flows
Fiscal 2006 Compared with Fiscal 2005
Net cash provided by operations increased by $9 million to $1,228 million in 2006. Increases
in net cash provided by operations were driven by higher cash profits, lower tax disbursements and
lower pension contributions, partially offset by the impact of strong collections in the prior
year. In 2005, net cash provided by operations included the excess tax benefit from the exercise
of stock options. Beginning with the adoption of SFAS 123R in 2006, the excess tax benefit from
the exercise of stock options is now required to be included in cash flows from financing
activities.
Net cash used for investments decreased by $111 million to $731 million, principally
reflecting lower acquisition costs, partially offset by higher capital spending.
Net cash used for financing increased by $188 million to $371 million, driven primarily by the
repayment of our $500 million note and other long-term debt, reduction in our short-term borrowings
and higher dividend payments, partially offset by the proceeds from the $800 million bond issuance
in March of 2006.
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Fiscal 2005 Compared with Fiscal 2004
Net cash provided by operations decreased by $3 million to $1,219 million in 2005. Decreases
in net cash provided by operations were driven by higher tax disbursements as a result of the
expiration of the tax stimulus package in 2004 and higher incentive compensation payments in 2005,
partially offset by lower pension contributions and working capital improvements, particularly in
the area of our receivables.
Net cash used for investments increased by $80 million to $842 million, principally reflecting
higher acquisition and capital spending, partially offset by higher proceeds from sales of
property, plant and equipment.
Net cash used for financing decreased by $1,212 million to $183 million driven primarily by
the repayment of our $1.0 billion note in February 2004 and lower purchases of treasury stock,
partially offset by higher dividend payouts.
Contractual Obligations
The following table summarizes our contractual obligations as of December 30, 2006:
Off-Balance Sheet Arrangements
There are no off-balance sheet arrangements that have or are reasonably likely to have a
current or future material effect on our financial condition, results of operations, liquidity,
capital expenditures or capital resources.
Capital Expenditures
Our business requires substantial infrastructure investments to maintain our existing level of
operations and to fund investments targeted at growing our business. Capital expenditures included
in our cash flows from investing activities totaled $725 million, $715 million and $688 million
during 2006, 2005 and 2004, respectively.
MARKET RISKS AND CAUTIONARY STATEMENTS
Quantitative and Qualitative Disclosures about Market Risk
In the normal course of business, our financial position is routinely subject to a variety of
risks. These risks include the risk associated with the price of commodities purchased and used in
our business, interest rates on outstanding debt and currency movements impacting our non-U.S.
dollar denominated assets and liabilities. We are also subject to the risks associated with the
business environment in which we operate, including the collectibility of
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accounts receivable. We regularly assess all of these risks and have policies and procedures
in place to protect against the adverse effects of these exposures.
Our objective in managing our exposure to fluctuations in commodity prices, interest rates and
foreign currency exchange rates is to minimize the volatility of earnings and cash flows associated
with changes in the applicable rates and prices. To achieve this objective, we have derivative
instruments to hedge against the risk of adverse movements in commodity prices, interest rates and
foreign currency. Our corporate policy prohibits the use of derivative instruments for trading or
speculative purposes, and we have procedures in place to monitor and control their use. See Note
13 in the Notes to Consolidated Financial Statements for additional information relating to our
derivative instruments.
A sensitivity analysis has been prepared to determine the effects that market risk exposures
may have on our financial instruments. We performed the sensitivity analyses for hypothetical
changes in commodity prices, interest rates and foreign currency exchange rates and changes in our
stock price on our unfunded deferred compensation liability. Information provided by these
sensitivity analyses does not necessarily represent the actual changes in fair value that we would
incur under normal market conditions because, due to practical limitations, all variables other
than the specific market risk factor were held constant. As a result, the reported changes in the
values of some financial instruments that are affected by the sensitivity analyses are not matched
with the offsetting changes in the values of the items that those instruments are designed to
finance or hedge.
Commodity Price Risk
We are subject to market risks with respect to commodities because our ability to recover
increased costs through higher pricing may be limited by the competitive environment in which we
operate. We use future and option contracts to hedge the risk of adverse movements in commodity
prices related primarily to anticipated purchases of raw materials and energy used in our
operations. With respect to commodity price risk, we currently have various contracts outstanding
for commodity purchases in 2007, which establish our purchase prices within defined ranges. We
estimate that a 10-percent decrease in commodity prices with all other variables held constant
would have resulted in a decrease in the fair value of our financial instruments of $7 million and
$1 million at December 30, 2006 and December 31, 2005, respectively.
Interest Rate Risk
Interest rate risk is present with both fixed and floating-rate debt. We use interest rate
swaps to manage our interest expense risk. These instruments effectively change the interest rate
of specific debt issuances. As a result, changes in interest rates on our variable debt would
change our interest expense. We estimate that a 50-basis point increase in interest rates on our
variable rate debt and cash equivalents with all other variables held constant would have resulted
in an increase to net interest expense of $2 million and $4 million in 2006 and 2005, respectively.
We also enter into treasury rate lock agreements to hedge against adverse interest rate
changes on certain debt financing arrangements.
Foreign Currency Exchange Rate Risk
In 2006, approximately 30 percent of our net revenues came from outside the United States.
Social, economic and political conditions in these international markets may adversely affect our
results of operations, cash flows and financial condition. The overall risks to our international
businesses include changes in foreign governmental policies and other political or economic
developments. These developments may lead to new product pricing, tax or other policies and
monetary fluctuations that may adversely impact our business. In addition, our results of
operations and the value of the foreign assets and liabilities are affected by fluctuations in
foreign currency exchange rates.
As currency exchange rates change, translation of the statements of operations of our
businesses outside the U.S. into U.S. dollars affects year-over-year comparability. We generally
have not hedged against these types of currency risks because cash flows from our international
operations are usually reinvested locally.
We have foreign currency transactional risks in certain of our international territories for
transactions that are denominated in currencies that are different from their functional currency.
We have entered into forward exchange
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contracts to hedge portions of our forecasted U.S. dollar cash flows in our Canadian business.
A 10-percent weaker U.S. dollar against the Canadian dollar, with all other variables held
constant, would result in a decrease in the fair value of these contracts of $11 million and $9
million at December 30, 2006 and December 31, 2005, respectively.
Foreign currency gains and losses reflect both transaction gains and losses in our foreign
operations, as well as translation gains and losses arising from the re-measurement into U.S.
dollars of the net monetary assets of businesses in highly inflationary countries. Beginning in
2006, Turkey was no longer considered highly inflationary, and changed its functional currency from
the U.S. Dollar to the Turkish Lira.
Unfunded Deferred Compensation Liability
Our unfunded deferred compensation liability is subject to changes in our stock price, as well
as price changes in certain other equity and fixed-income investments. Employee investment
elections include PBG stock and a variety of other equity and fixed-income investment options.
Since the plan is unfunded, employees’ deferred compensation amounts are not directly invested in
these investment vehicles. Instead, we track the performance of each employee’s investment
selections and adjust his or her deferred compensation account accordingly. The adjustments to the
employees’ accounts increases or decreases the deferred compensation liability reflected on our
Consolidated Balance Sheets with an offsetting increase or decrease to our selling, delivery and
administrative expenses in our Consolidated Statements of Operations. We use prepaid forward
contracts to hedge the portion of our deferred compensation liability that is based on our stock
price. Therefore, changes in compensation expense as a result of changes in our stock price are
substantially offset by the changes in the fair value of these contracts. We estimate that a
10-percent unfavorable change in the year-end stock price would have reduced the fair value from
these forward contract commitments by $2 million in 2006 and 2005.
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Cautionary Statements
Except for the historical information and discussions contained herein, statements contained
in this annual report on Form 10-K and in the annual report to the shareholders may constitute
forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.
These forward-looking statements are based on currently available competitive, financial and
economic data and our operating plans. These statements involve a number of risks, uncertainties
and other factors that could cause actual results to be materially different. Among the events and
uncertainties that could adversely affect future periods are:
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The Pepsi Bottling Group, Inc.
Consolidated Statements of Operations Fiscal years ended December 30, 2006, December 31, 2005 and December 25, 2004
in millions, except per share data
See accompanying notes to Consolidated Financial Statements.
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The Pepsi Bottling Group, Inc.
Consolidated Statements of Cash Flows Fiscal years ended December 30, 2006, December 31, 2005 and December 25, 2004
in millions
See accompanying notes to Consolidated Financial Statements.
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The Pepsi Bottling Group, Inc.
Consolidated Balance Sheets December 30, 2006 and December 31, 2005
in millions, except per share data
See accompanying notes to Consolidated Financial Statements.
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The Pepsi Bottling Group, Inc.
Consolidated Statements of Changes in Shareholders’ Equity Fiscal years ended December 30, 2006, December 31, 2005 and December 25, 2004
See accompanying notes to Consolidated Financial Statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Tabular dollars in millions, except per share data
Note 1—Basis of Presentation
The Pepsi Bottling Group, Inc. (“PBG” or the “Company”) is the world’s largest manufacturer,
seller and distributor of Pepsi-Cola beverages. We have the exclusive right to manufacture, sell
and distribute Pepsi-Cola beverages in all or a portion of the United States, Mexico, Canada and
Europe, which consists of our operations in Spain, Greece, Russia and Turkey. When used in these
Consolidated Financial Statements, “PBG,” “we,” “our” and “us” each refers to The Pepsi Bottling
Group, Inc. and, where appropriate, to Bottling Group, LLC (“Bottling LLC”), our principal
operating subsidiary.
At December 30, 2006, PepsiCo, Inc. (“PepsiCo”) owned 88,511,358 shares of our common stock,
consisting of 88,411,358 shares of common stock and 100,000 shares of Class B common stock. All
shares of Class B common stock that have been authorized have been issued to PepsiCo. At December
30, 2006, PepsiCo owned approximately 38.4 percent of our outstanding common stock and 100 percent
of our outstanding Class B common stock, together representing 44.5 percent of the voting power of
all classes of our voting stock. In addition, PepsiCo owns approximately 6.7 percent of the equity
of Bottling LLC. We fully consolidate the results of Bottling LLC and present PepsiCo’s share as
minority interest in our Consolidated Financial Statements.
The common stock and Class B common stock both have a par value of $0.01 per share and are
substantially identical, except for voting rights. Holders of our common stock are entitled to one
vote per share and holders of our Class B common stock are entitled to 250 votes per share. Each
share of Class B common stock is convertible into one share of common stock. Holders of our common
stock and holders of our Class B common stock share equally on a per-share basis in any dividend
distributions.
Our Board of Directors has the authority to provide for the issuance of up to 20,000,000
shares of preferred stock, and to determine the price and terms, including, but not limited to,
preferences and voting rights of those shares without stockholder approval. At December 30, 2006,
there was no preferred stock outstanding.
Certain reclassifications have been made to the prior years’ Consolidated Financial Statements
to conform to the current year presentation. These reclassifications had no effect on previously
reported results of operations or retained earnings.
Note 2—Summary of Significant Accounting Policies
Basis of Consolidation — We consolidate in our financial statements, entities in which we
have a controlling financial interest, as well as variable interest entities where we are the
primary beneficiary. We have eliminated all intercompany accounts and transactions in
consolidation.
Fiscal Year — Our U.S. and Canadian operations report using a fiscal year that
consists of fifty-two weeks, ending on the last Saturday in December. Every five or six years a
fifty-third week is added. Fiscal years 2006 and 2004 consisted of fifty-two weeks. In 2005, our
fiscal year consisted of fifty-three weeks (the additional week was added to the fourth quarter).
Our remaining countries report using a calendar-year basis. Accordingly, we recognize our
quarterly business results as outlined below:
Revenue Recognition — Revenue, net of sales returns, is recognized when our products are
delivered to customers in accordance with the written sales terms. We offer certain sales
incentives on a local and national level
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through various customer trade agreements designed to
enhance the growth of our revenue. Customer trade agreements are accounted for as a reduction to
our revenues.
Customer trade agreements with our customers include payments for in-store displays, volume
rebates, featured advertising and other growth incentives. A number of our customer trade
agreements are based on quarterly and annual targets that generally do not exceed one year. Amounts
recognized in our financial statements are based on amounts estimated to be paid to our customers
depending upon current performance, historical experience, forecasted volume and other performance
criteria.
Advertising and Marketing Costs — We are involved in a variety of programs to promote our
products. We include advertising and marketing costs in selling, delivery and administrative
expenses. Advertising and marketing
costs were $403 million, $421 million and $426 million in 2006, 2005 and 2004, respectively,
before bottler incentives received from PepsiCo and other brand owners.
Bottler Incentives — PepsiCo and other brand owners, at their discretion, provide us with
various forms of bottler incentives. These incentives cover a variety of initiatives, including
direct marketplace support and advertising support. We classify bottler incentives as follows:
Total bottler incentives recognized as adjustments to net revenues, cost of sales and selling,
delivery and administrative expenses in our Consolidated Statements of Operations were as follows:
Share-Based Compensation — Effective January 1, 2006, the Company adopted the fair value
based method of accounting prescribed in Statement of Financial Accounting Standards (“SFAS”) No.
123 (revised), “Share-Based Payment” (“SFAS 123R”) for its employee stock option plans. See Note 4
in the Notes to Consolidated Financial Statements for further discussion on our share-based
compensation.
Shipping and Handling Costs — Our shipping and handling costs reported in the Consolidated
Statements of Operations are recorded primarily within selling, delivery and administrative
expenses. Such costs recorded within selling, delivery and administrative expenses totaled $1.7
billion, $1.5 billion and $1.6 billion in 2006, 2005 and 2004, respectively.
Foreign Currency Gains and Losses — We translate the balance sheets of our foreign
subsidiaries at the exchange rates in effect at the balance sheet date, while we translate the
statements of operations at the average rates of exchange during the year. The resulting
translation adjustments of our foreign subsidiaries are recorded directly to accumulated other
comprehensive loss. Foreign currency gains and losses reflect both transaction gains and losses in
our foreign operations, as well as translation gains and losses arising from the re-measurement
into U.S. dollars of the net monetary assets of businesses in highly inflationary countries.
Beginning January 1, 2006, Turkey was no longer considered to be a highly inflationary economy for
accounting purposes.
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Pension and Postretirement Medical Benefit Plans — We sponsor pension and other
postretirement medical benefit plans in various forms both in the U.S. and similar plans outside
the U.S., covering employees who meet specified eligibility requirements.
We account for our defined benefit pension plans and our postretirement medical benefit plans
using actuarial models required by SFAS No. 87, “Employers’ Accounting for Pensions,” and SFAS No.
106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.”
In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS 158”).
Effective for our fiscal year ending 2006, we recognized on our balance sheet the funded status of
each of the pension and other postretirement medical plans we sponsor in the United States and
other similar plans we sponsor outside the United States.
The assets, liabilities and expense associated with our international plans were not
significant to our results of operations, and accordingly assumptions regarding these plans are not
included in the discussion below.
The assets, liabilities and assumptions used to measure pension and postretirement medical
expense for any fiscal year are determined as of September 30 of the preceding year (“measurement
date”). The discount rate assumption used in our pension and postretirement medical benefit plans’
accounting is based on current interest rates for high-quality,
long-term corporate debt as
determined on each measurement date. In evaluating the expected rate of return on assets for a
given fiscal year, we consider the actual 10 to 15-year historic returns on asset classes in our
pension investment portfolio, reflecting the weighted-average return of our asset allocation and
use them as a guide for future returns. Differences between actual and expected returns are
generally recognized in the net periodic pension calculation over five years. To the extent the
amount of all unrecognized gains and losses exceeds 10 percent of the larger of the pension benefit
obligation or plan assets, such amount is amortized over the average remaining service period of
active participants. We amortize prior service costs on a straight-line basis over the average
remaining service period of employees expected to receive benefits.
Income Taxes — Our effective tax rate is based on pre-tax income, statutory tax rates, tax
regulations and tax planning strategies available to us in the various jurisdictions in which we
operate. The tax bases of our assets and liabilities reflect our best estimate of the tax benefit
and costs we expect to realize. We establish valuation allowances to reduce our deferred tax
assets to an amount that will more likely than not be realized.
Significant management judgment is required in determining our effective tax rate and in
evaluating our tax position. We establish tax reserves when, based on the applicable tax law and
facts and circumstances relating to a particular transaction or tax position, it becomes probable
that the position will not be sustained when challenged by a taxing authority. A change in our tax
reserves could have a significant impact on our results of operations.
Earnings Per Share — We compute basic earnings per share by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted earnings per share
reflect the potential dilution that could occur if securities or other contracts to issue common
stock were exercised and converted into common stock that would then participate in net income.
Cash Equivalents — Cash equivalents represent funds we have temporarily invested with
original maturities not exceeding three months.
Allowance for Doubtful Accounts — A portion of our accounts receivable will not be collected
due to non-payment, bankruptcies and sales returns. Our accounting policy for the provision for
doubtful accounts requires reserving an amount based on the evaluation of the aging of accounts
receivable, sales return trend analysis, detailed analysis of high-risk customers’ accounts, and
the overall market and economic conditions of our customers.
Inventories — We value our inventories at the lower of cost or net realizable value. The
cost of our inventory is generally computed on the first-in, first-out method.
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Property, Plant and Equipment — We state property, plant and equipment (“PP&E”) at cost,
except for PP&E that has been impaired, for which we write down the carrying amount to estimated
fair market value, which then becomes the new cost basis.
Goodwill and Other Intangible Assets, net — Goodwill consists of the excess cost of acquired
enterprises over the sum of the amounts assigned to assets acquired less liabilities assumed.
Goodwill and intangible assets with indefinite useful lives are not amortized, but are evaluated
for impairment annually, or more frequently if impairment indicators arise. The Company completed
the annual impairment test for 2006 in the fiscal fourth quarter and no impairment was determined.
Other intangible assets that are subject to amortization are amortized on a straight-line
basis over the period in which we expect to receive economic benefit and are reviewed for
impairment when facts and circumstances indicate that the carrying value of the asset may not be
recoverable. The determination of the expected life will be dependent upon the use and underlying
characteristics of the intangible asset. In our evaluation of these intangible assets, we consider
the nature and terms of the underlying agreements, competitive environment, and brand history, as
applicable. If the carrying value is not recoverable, impairment is measured as the amount by which
the carrying value exceeds its estimated fair value. Fair value is generally estimated based on
either appraised value or other valuation techniques.
Casualty Insurance Costs — In the United States, we use a combination of insurance and
self-insurance mechanisms, including a wholly owned captive insurance entity, which participates in
a reinsurance pool, to provide for the potential liabilities for workers’ compensation, product and
general risk liability and automobile risks. We are self-insured or have large deductible programs
for workers’ compensation and automobile risks for occurrences up to $10 million, and product and
general liability risks for occurrences up to $5 million. For losses exceeding these
self-insurance thresholds, we purchase casualty insurance from a third-party provider. Our
liability for casualty costs was $214 million as of December 30, 2006 of which $62 million was
reported in accounts payable and other current liabilities and $152 million was recorded in other
liabilities in our Consolidated Balance Sheet. At December 31, 2005, our liability for casualty
costs was $188 million of which $61 million was reported in accounts payable and other current
liabilities and $127 million was recorded in other liabilities in our Consolidated Balance Sheet.
Our liability for casualty costs is estimated using individual case-based valuations and
statistical analyses and is based upon historical experience, actuarial assumptions and
professional judgment. We do not discount our loss expense reserves.
Minority Interest — PBG and PepsiCo contributed bottling businesses and assets used in the
bottling businesses to Bottling LLC in connection with the formation of Bottling LLC in February
1999. At December 30, 2006, PBG owned 93.3 percent of Bottling LLC and PepsiCo owned the remaining
6.7 percent. Accordingly, minority interest in the Consolidated Financial Statements primarily
reflects PepsiCo’s share of the consolidated net income of Bottling LLC as minority interest in our
Consolidated Statements of Operations, and PepsiCo’s share of consolidated net assets of Bottling
LLC as minority interest in our Consolidated Balance Sheets.
Treasury Stock — We record the repurchase of shares of our common stock at cost and classify
these shares as treasury stock within shareholders’ equity. Repurchased shares are included in our
authorized and issued shares but not included in our shares outstanding. We record shares
reissued using an average cost. At December 30, 2006 we had 150 million shares authorized under
our share repurchase program. Since the inception of our share repurchase program in October 1999,
we have repurchased approximately 119 million shares and have reissued approximately 39 million for
stock option exercises.
Financial Instruments and Risk Management — We use derivative instruments to hedge against
the risk of adverse movements associated with commodity prices, interest rates and foreign
currency. Our corporate policy prohibits the use of derivative instruments for trading or
speculative purposes, and we have procedures in place to monitor and control their use.
All derivative instruments are recorded at fair value as either assets or liabilities in our
Consolidated Balance Sheets. Derivative instruments are generally designated and accounted for as
either a hedge of a recognized asset or
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liability (“fair value hedge”) or a hedge of a forecasted
transaction (“cash flow hedge”). The derivative’s gain or loss recognized in earnings is recorded
consistent with the expense classification of the underlying hedged item.
If a fair value or cash flow hedge were to cease to qualify for hedge accounting or were
terminated, it would continue to be carried on the balance sheet at fair value until settled, but
hedge accounting would be discontinued prospectively. If the
underlying hedged transaction ceases to exist, any associated amounts
reported in accumulated other comprehensive loss are reclassified to
earnings at that time.
We also may enter into a derivative instrument for which hedge accounting is not required
because it is entered into to offset changes in the fair value of an underlying transaction
recognized in earnings (“natural hedge”). These instruments are reflected in the Consolidated
Balance Sheets at fair value with changes in fair value recognized in earnings.
Commitments and Contingencies — We are subject to various claims and
contingencies related to lawsuits, taxes, environmental and other matters arising out of the normal
course of business. Liabilities related to commitments and contingencies are recognized when a loss
is probable and reasonably estimable.
New Accounting Standards
SFAS No. 158
In September 2006, the FASB issued SFAS 158. Effective December 30, 2006 the Company adopted
the balance sheet recognition provisions of this standard and accordingly recognized the funded
status of each of the pension, postretirement plans, and other similar plans we sponsor. Effective
for fiscal year ending 2008, we will be required to measure a plan’s assets and liabilities as of
the end of the fiscal year instead of our current measurement date of September 30. We are
currently evaluating the impact of the change in measurement date on our Consolidated Financial
Statements. See Note 14 in the Notes to Consolidated Financial Statements for further discussion
on SFAS 158.
SAB No. 108
In September 2006, the U.S. Securities and Exchange Commission staff issued Staff Accounting
Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements” (“SAB 108”). The intent of SAB 108 is to reduce
diversity in practice for the method companies use to quantify financial statement misstatements,
including the effect of prior year uncorrected errors. SAB 108 establishes an approach that
requires quantification of financial statement errors using both an income statement and a
cumulative balance sheet approach. SAB 108 is effective for the
fiscal year ending after November
15, 2006. The adoption of SAB 108 did not have an impact on our Consolidated Financial Statements.
FASB Interpretation No. 48
In July 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in
Income Taxes,” which clarifies the accounting for uncertainty in income taxes recognized in the
financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 is a
new and comprehensive structured approach to accounting for uncertainty in income taxes that
provides specific guidance on the financial statement recognition, measurement, reporting and
disclosure of uncertain tax positions taken or expected to be taken in a tax return. FIN 48
becomes effective beginning with our first quarter 2007 fiscal period. We have determined the
impact of adopting FIN 48 and the cumulative effect is an approximate $5 million increase to our
beginning retained earnings balance as of December 31, 2006. See Note 15 in the Notes to
Consolidated Financial Statements for further discussion on FIN 48.
SFAS No. 157
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which
establishes a framework for reporting fair value and expands disclosures about fair value
measurements. SFAS 157
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becomes effective beginning with our first quarter 2008 fiscal period. We
are currently evaluating the impact of this standard on our Consolidated Financial Statements.
Note 3—Earnings per Share
The following table reconciles the shares outstanding and net earnings used in the
computations of both basic and diluted earnings per share:
Diluted earnings per share reflects the potential dilution that could occur if stock options
or other equity awards from our stock compensation plans were exercised and converted into common
stock that would then participate in net income. For the years ended December 30, 2006, December
31, 2005 and December 25, 2004, options to purchase 1.7 million shares, 9.9 million shares, and
6.8 million shares, respectively are not included in the computation of diluted earnings per share
because the option exercise prices were greater than the average market price of the Company’s
common shares during the related periods and the effect of including the options in the computation
would be antidilutive.
Note 4—Share-Based Compensation
Accounting for Share-Based Compensation — Effective January 1, 2006, the Company adopted SFAS
123R. Among its provisions, SFAS 123R requires the Company to recognize compensation expense for
equity awards over the vesting period based on their grant-date fair value. Prior to the adoption
of SFAS 123R, the Company utilized the intrinsic-value based method of accounting under Accounting
Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related
interpretations, and adopted the disclosure requirements of SFAS No. 123, “Accounting for
Stock-Based Compensation” (“SFAS 123”). Under the intrinsic-value based method of accounting,
compensation expense for stock options granted to the Company’s employees was measured as the
excess of the quoted market price of common stock at the grant date over the amount the employee
must pay for the stock. The Company’s policy is to grant stock options at fair value on the date of
grant and as a result, no compensation expense was historically recognized for stock options.
The Company adopted SFAS 123R in the first quarter of 2006 using the modified prospective
approach. Under this transition method, the measurement and our method of amortization of costs for
share-based payments granted prior to, but not vested as of January 1, 2006, would be based on the
same estimate of the grant-date fair value and the same amortization method that was previously
used in our SFAS 123 pro forma disclosure. Results for prior periods have not been restated as
provided for under the modified prospective approach. For equity awards granted after the date of
adoption, we amortize share-based compensation expense on a straight-line basis over the vesting
term.
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Compensation expense is recognized only for share-based payments expected to vest. We
estimate forfeitures, both at the date of grant as well as throughout the vesting period, based on
the Company’s historical experience and future expectations. Prior to the adoption of SFAS 123R,
the effect of forfeitures on the pro forma expense amounts was recognized based on estimated
forfeitures.
The adoption of SFAS 123R reduced our basic earnings per share by $0.18 and diluted earnings
per share by $0.17 for the year ended 2006. Total share-based compensation expense recognized in
selling, delivery and administrative expenses in the Consolidated Statement of Operations for the
year ended 2006 was $65 million, which is before an income tax benefit of $18 million and minority
interest of $4 million, resulting in a decrease to net income of $43 million.
The following table shows the effect on net income and earnings per share for the years ended
December 31, 2005 and December 25, 2004 had compensation expense been recognized based upon the
estimated fair value on the grant date of awards, in accordance with SFAS 123, as amended by SFAS
No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure”:
Share-Based Long-Term Incentive Compensation Plans — Prior to 2006, we granted non-qualified
stock options to certain employees, including middle and senior management under our share-based
long-term incentive compensation plans (“incentive plans”). Additionally, we granted restricted
stock units to certain senior executives. Non-employee members of our Board of Directors
(“Directors”) participate in a separate incentive plan and receive non-qualified stock options or
restricted stock units.
Beginning in 2006, we granted a mix of stock options and restricted stock units to middle and
senior management employees and Directors under our incentive plans.
Shares available for future issuance to employees and Directors under existing plans were 11.5
million at December 30, 2006.
The fair value of PBG stock options was estimated at the date of grant using the
Black-Scholes-Merton option-valuation model. The table below outlines the weighted average
assumptions for options granted during years ended December 30, 2006, December 31, 2005 and
December 25, 2004:
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The risk-free interest rate is based on the implied yield available on U.S. Treasury
zero-coupon issues with an equivalent remaining expected term. The expected term of the options
represents the estimated period of time employees will retain their vested stocks until exercise
and is based on historical experience of similar awards, giving consideration to the contractual
terms, vesting schedules and expectations of future employee behavior. Expected stock price
volatility is based on a combination of historical volatility of the Company’s stock and the
implied volatility of its traded options. The expected dividend yield is management’s long-term
estimate of annual dividends to be paid as a percentage of share price.
The fair value of restricted stock units is based on the fair value of PBG stock on the date
of grant.
We receive a tax deduction for certain stock option exercises when the options are exercised,
generally for the excess of the stock price when the options are exercised over the exercise price
of the options. Additionally, we receive a tax deduction for restricted stock units equal to the
fair market value of PBG’s stock at the date of conversion to PBG stock. Prior to the adoption of
SFAS 123R, the Company presented all tax benefits resulting from equity awards as operating cash
inflows in the Consolidated Statements of Cash Flows. SFAS 123R requires the benefits of tax
deductions in excess of the grant-date fair value for these equity awards to be classified as
financing cash inflows rather than operating cash inflows, on a prospective basis. For the year
ended December 30, 2006, we recognized $37 million in tax benefits from the exercise of equity
awards, of which $19 million was recorded as excess tax benefits in the Consolidated Statements of
Cash Flows, resulting in a decrease of cash from operations and an increase in cash from financing
of $19 million.
As of December 30, 2006, there was approximately $77 million of total unrecognized
compensation cost related to nonvested share-based compensation arrangements granted under the
incentive plans. That cost is expected to be recognized over a weighted-average period of 1.9
years.
Stock Options — Stock options expire after 10 years and prior to the 2006 grant year, stock
options granted to employees were generally exercisable 25 percent after each of the first two
years, and the remainder after three years. Beginning in 2006, new stock options granted to
employees generally will vest ratably over three years. Stock options granted to Directors are
typically fully vested on the grant date.
The following table summarizes option activity during the year ended December 30, 2006:
The aggregate intrinsic value in the table above is before income taxes, based on the
Company’s closing stock price of $30.91 as of the last business day of the period ended December
30, 2006.
During the years ended December 30, 2006 and December 31, 2005, the total intrinsic value of
stock options exercised was $115 million and $89 million, respectively. The weighted-average
grant-date fair value of stock options granted during 2006 and 2005 was $8.75 and $8.68,
respectively.
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Restricted Stock Units — Restricted stock units granted to employees generally vest over
three years. In addition, restricted stock unit awards to certain senior executives contain vesting
provisions that are contingent upon the achievement of pre-established performance targets. The
initial restricted stock award to Directors remains restricted while the individual serves on the
Board. The annual grants to Directors vest immediately, but may be deferred. All restricted stock
unit awards are settled in shares of PBG common stock.
The following table summarizes restricted stock unit activity during the year ended December
30, 2006:
The weighted average fair value of restricted stock units granted for the years ended December
30, 2006 and December 31, 2005, was $29.55 and $28.12, respectively. The total intrinsic value of
restricted stock units converted during the year ended December 30, 2006, was approximately $248
thousand. No restricted stock units were converted in the fiscal years of 2005 and 2004.
Note 5—Inventories
Note 6—Prepaid Expenses and Other Current Assets
Note 7—Accounts Receivable
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Note 8—Property, Plant and Equipment, net
We calculate depreciation on a straight-line basis over the estimated lives of the assets as
follows:
Note 9—Other Intangible Assets, net and Goodwill
The components of other intangible assets are as follows:
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Intangible asset amortization expense was $12 million, $15 million and $13 million in
2006, 2005 and 2004, respectively. The estimated amortization expense expected to be recognized
over the next five years is as follows:
In the fourth quarter of 2004, we recorded a $9 million non-cash impairment charge ($6 million
net of tax and minority interest) in selling, delivery and administrative expenses relating to our
re-evaluation of the fair value of our franchise licensing agreement for the Squirt trademark in
Mexico, as a result of a change in its estimated accounting life. Due to the reduction in the
useful life of these franchise rights, we wrote the carrying value of the Squirt franchise rights
down to its current estimated fair value in 2004. The remaining carrying value is amortized over
the estimated useful life of 10 years.
The changes in the carrying value of goodwill by reportable segment for the years ended
December 31, 2005 and December 30, 2006 are as follows:
During the third quarter of 2006, the Company completed the acquisition of Bebidas
Purificadas, S.A. de C.V. (Bepusa), a bottler in the northwestern region of Mexico. The
acquisition did not have a material impact on our Consolidated Financial Statements.
In September 2005, we acquired the operations and exclusive right to manufacture, sell and
distribute Pepsi-Cola beverages from the Pepsi-Cola Bottling Company of Charlotte, North Carolina.
As a result of the acquisition, we assigned $60 million to goodwill, $127 million to franchise
rights, $12 million to non-compete arrangements and $2 million to customer relationships. The
goodwill and franchise rights are not subject to amortization. The non-compete agreements are
being amortized over ten years and the customer relationships are being amortized over 20
years. The acquisition did not have a material impact on our Consolidated Financial Statements.
The purchase price allocations also include adjustments to goodwill as a result of changes in
taxes associated with prior year acquisitions.
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Note 10—Accounts Payable and Other Current Liabilities
Note 11—Short-term Borrowings and Long-term Debt
Aggregate Maturities — Long-term Debt — Aggregate maturities of long-term debt as of
December 30, 2006 are as follows: 2007: $11 million, 2008: $2 million, 2009: $1,300 million and
2012 and thereafter: $3,450 million. We do not have any maturities in 2010 and 2011. The
maturities of long-term debt do not include the capital lease obligations, the non-cash impact of
the SFAS 133 adjustment and the interest effect of the unamortized discount.
2006 Short-Term Debt Activities — In March 2006, we entered into a new $450 million committed
revolving credit facility (“2006 Agreement”) which expires in March 2011 and increased our existing
facility, which expires in
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April 2009, from $500 million to $550 million. Our combined committed
credit facilities of $1 billion, which are guaranteed by Bottling LLC, support our $1 billion
commercial paper program. Subject to certain conditions stated in the 2006 Agreement, the Company
may borrow, prepay and reborrow amounts, including issuing standby letters of credit up to $250
million, at any time during the term of the 2006 Agreement. Funds borrowed may be used for general
corporate purposes, including supporting our commercial paper program.
At December 30, 2006, we had $115 million in outstanding commercial paper with a
weighted-average interest rate of 5.4 percent. At December 31, 2005, we had $355 million in
outstanding commercial paper with a weighted-average interest rate of 4.3 percent.
We had available bank credit lines of approximately $741 million at December 30, 2006. These
lines were used to support the general operating needs of our businesses. As of year-end 2006, we
had $242 million outstanding under these lines of credit at a weighted-average interest rate of 5.0
percent. As of year-end 2005, we had available short-term bank credit lines of approximately $835
million and $156 million was outstanding under these lines of credit at a weighted-average interest
rate of 4.3 percent.
Financial Covenants — Certain of our senior notes have redemption features and non-financial
covenants that will, among other things, limit our ability to create or assume liens, enter into
sale and lease-back transactions, engage in mergers or consolidations and transfer or lease all or
substantially all of our assets. Additionally, certain of our credit facilities and senior notes
have financial covenants consisting of the following:
We are in compliance with all debt covenants.
Interest Payments and Expense — Amounts paid to third parties for interest, net
of settlements from our interest rate swaps, was $289 million, $246 million and $232 million in
2006, 2005 and 2004, respectively. Total interest expense incurred during 2006, 2005 and 2004 was
$298 million, $258 million and $236 million, respectively.
Letters of Credit, Bank Guarantees and Surety Bonds — At December 30, 2006, we
have outstanding letters of credit, bank guarantees and surety bonds valued at $282 million from
financial institutions primarily to provide collateral for estimated self-insurance claims and
other insurance requirements.
Note 12—Leases
We have non-cancellable commitments under both capital and long-term operating leases,
principally for buildings, office equipment and vending equipment. Certain of our operating leases
for our buildings contain escalation clauses, holiday rent allowances and other rent incentives.
We recognize rent expense on our operating leases, including these allowances and incentives, on a
straight-line basis over the lease term. Capital and operating lease commitments expire at various
dates through 2072. Most leases require payment of related executory costs, which include property
taxes, maintenance and insurance.
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The cost of buildings, office equipment and vending equipment under capital leases is included
in the Consolidated Balance Sheet as property, plant and equipment. Amortization of assets under
capital leases is included in depreciation expense. In 2006, we entered into a $25 million capital
lease agreement with PepsiCo to lease vending equipment. See Note 17 for further discussion about
our related party transactions. Capital lease additions totaled $33 million, $2 million and $0
million for 2006, 2005 and 2004, respectively.
The future minimum lease payments by year and in the aggregate, under capital leases and under
non-cancellable operating leases consisted of the following at December 30, 2006:
We plan to receive a total of $10 million of sublease income during the period from 2007 through
2013.
Components of net rental expense under operating leases:
Note 13—Financial Instruments and Risk Management
Cash Flow Hedges — We are subject to market risk with respect to the cost of
commodities because our ability to recover increased costs through higher pricing may be limited by
the competitive environment in which we operate. We use future and option contracts to hedge the
risk of adverse movements in commodity prices related primarily to anticipated purchases of raw
materials and energy used in our operations. These contracts generally range from one to 12 months
in duration and qualify for cash flow hedge accounting treatment.
We are subject to foreign currency transactional risks in certain of our international
territories for transactions that are denominated in currencies that are different from their
functional currency. Beginning in 2004, we entered into forward exchange contracts to hedge
portions of our forecasted U.S. dollar purchases in our Canadian business. These
contracts generally range from one to 12 months in duration and qualify for cash flow hedge
accounting treatment.
In anticipation of the $800 million debt issuance in March 2006, Bottling LLC entered into
treasury rate lock agreements to hedge against adverse interest rate changes. We recognized $15
million as a deferred gain (before taxes and minority interest) reported in accumulated other
comprehensive loss (“AOCL”) resulting from these treasury rate contracts. The deferred gain is
released to match the underlying interest expense on the debt. In previous years, we have entered
into additional treasury rate lock agreements to hedge against adverse interest rate
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changes on certain debt financing arrangements. These agreements qualify for cash flow hedge accounting
treatment.
For a cash flow hedge, the effective portion of the change in the fair value of a derivative
instrument is deferred in AOCL until the underlying hedged item is recognized in earnings. The
ineffective portion of a fair value change on a qualifying cash flow hedge is recognized in
earnings immediately and is recorded consistent with the expense classification of the underlying
hedged item.
The following summarizes activity in AOCL related to derivatives designated as cash flow
hedges held by the Company during the applicable periods:
Assuming no change in the commodity prices and foreign currency rates as measured on December
30, 2006, $3 million of deferred gain will be recognized in earnings over the next 12 months. The
ineffective portion of the change in fair value of these contracts was not material to our results
of operations in 2006, 2005 or 2004.
Fair Value Hedges — We finance a portion of our operations through fixed-rate debt
instruments. We effectively converted $550 million of our senior notes to floating-rate debt
through the use of interest rate swaps with the objective of reducing our overall borrowing costs.
These interest rate swaps meet the criteria for fair value hedge accounting and are 100 percent
effective in eliminating the market rate risk inherent in our long-term debt. Accordingly, any
gain or loss associated with these swaps is fully offset by the opposite market impact on the
related debt. During 2006, the fair value of the interest rate swap liability decreased from $19
million at December 31, 2005 to $13 million at December 30, 2006. In 2006, the fair value change
of our swaps and debt was recorded in other liabilities and long-term debt in our Consolidated
Balance Sheets. In 2005, the current portion of the fair value change of our swaps and debt was
recorded in accounts payable and other current liabilities and current maturities of long-term debt
in our Consolidated Balance Sheets. The long-term portion of the fair value change in 2005 was
recorded in other liabilities and long-term debt.
Unfunded Deferred Compensation Liability — Our unfunded deferred compensation liability is
subject to changes in our stock price as well as price changes in other equity and fixed-income
investments. Participating employees in our deferred compensation program can elect to defer all
or a portion of their compensation to be paid out on a future date or dates. As part of the
deferral process, employees select from phantom investment options that determine the earnings on
the deferred compensation liability and the amount that they will ultimately receive. Employee
investment elections include PBG stock and a variety of other equity and fixed-income investment
options.
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Since the plan is unfunded, employees’ deferred compensation amounts are not directly invested
in these investment vehicles. Instead, we track the performance of each employee’s investment
selections and adjust his or her deferred compensation account accordingly. The adjustments to the
employees’ accounts increases or decreases the deferred compensation liability reflected on our
Consolidated Balance Sheets with an offsetting increase or decrease to our selling, delivery and
administrative expenses.
We use prepaid forward contracts to hedge the portion of our deferred compensation liability
that is based on our stock price. At December 30, 2006, we had a prepaid forward contract for
660,000 shares at a price of $32.00, which was accounted for as a natural hedge. This contract
requires cash settlement and has a fair value at December 30, 2006, of $20 million recorded in
prepaid expenses and other current assets in our Consolidated Balance Sheets. The fair value of
this contract changes based on the change in our stock price compared with the contract exercise
price. We recognized $2 million in income in 2006 and $1 million in income in 2005, resulting from
the change in fair value of these prepaid forward contracts. The earnings impact from these
instruments is classified as selling, delivery and administrative expenses.
Other Financial Assets and Liabilities — Financial assets with carrying values approximating
fair value include cash and cash equivalents and accounts receivable. Financial liabilities with
carrying values approximating fair value include accounts payable and other accrued liabilities and
short-term debt. The carrying value of these financial assets and liabilities approximates fair
value due to their short maturities and since interest rates approximate current market rates for
short-term debt.
Long-term debt at December 30, 2006, had a carrying value and fair value of $4.8 billion and
$4.9 billion, respectively, and at December 31, 2005, had a carrying value and fair value of $4.6
billion and $4.8 billion, respectively. The fair value is based on interest rates that are
currently available to us for issuance of debt with similar terms and remaining maturities.
Note 14—Pension and Postretirement Medical Benefit Plans
Employee Benefit Plans — We sponsor pension and other postretirement medical
benefit plans in various forms in the United States and other similar plans outside the United
States, covering employees who meet specified eligibility requirements.
In September 2006, the FASB issued SFAS 158 which requires, among other things, the
recognition of the funded status of each defined benefit pension plan and other postretirement plan
on the balance sheet. Effective for our fiscal year ending 2006, we recognized the funded status of
each of the pension and other postretirement medical plans we sponsor in the U.S. and other similar
plans we sponsor outside the U.S. Accordingly, we recorded a net decrease of approximately $159
million, net of taxes and minority interest, to our shareholders’ equity through the AOCL account.
The assets, liabilities and expense associated with our international plans were not
significant to our results of operations and are not included in the tables and discussion
presented below, except for the table describing the incremental effect of adopting SFAS 158 on our
worldwide balance sheet.
Defined Benefit Pension Plans — Our U.S. employees participate in non-contributory
defined benefit pension plans, which cover substantially all full-time salaried employees, as well
as most hourly employees. Benefits generally are based on years of service and compensation, or
stated amounts for each year of service. Effective January 1, 2007, newly hired salaried and
non-union hourly employees will not be eligible to participate in our U.S. defined benefit pension
plans. Corresponding with this change, newly hired employees who are not eligible for the defined
benefit pension plan will instead receive an additional Company contribution equal to two percent
of their compensation into their 401(k) account. All of our qualified plans are funded and
contributions are made in amounts not less than the minimum statutory funding requirements and not
more than the maximum amount that can be deducted for U.S. income tax purposes.
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Postretirement Medical Plans — Our postretirement medical plans provide
medical and life insurance benefits principally to U.S. retirees and their dependents. Employees
are eligible for benefits if they meet age and service requirements and qualify for retirement
benefits. The plans are not funded and since 1993 have included retiree cost sharing. In 2004, we
merged our long-term disability medical plan with our postretirement medical plan. Our long-term
disability medical plan was amended to provide coverage for two years for participants becoming
disabled after January 1, 2005. Participants receiving benefits before January 1, 2005 remain
eligible under the existing benefits program which does not limit benefits to a two-year period.
The liabilities and respective costs associated with these participants have been added to our
postretirement medical plan.
The following table illustrates the incremental effect on individual line items of our
worldwide balance sheet for the changes to our additional minimum liability (“AML”) prior to
adoption of SFAS 158 and the impact of recording the funded status provision of SFAS 158 to each of
the pension and other postretirement medical plans we sponsor in the United States and other
similar plans we sponsor outside the United States.
Incremental Effects of Applying SFAS 158 on the Consolidated Balance Sheet at December 30, 2006:
Amounts
Recognized in AOCL at Fiscal Year End Related to U.S. Plans:
Estimated Amounts in AOCL to be Recognized in 2007 for U.S. Net Periodic Benefit Cost:
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Defined Contribution Benefits — Nearly all of our U.S. employees are also
eligible to participate in our 401(k) plans, which are defined contribution savings plans. We make
matching contributions to the 401(k) savings plans on behalf of participants eligible to receive
such contributions. Our match will equal $0.50 for each dollar the participant elects to defer up
to four percent of the participant’s pay. If the participant has 10 or more years of eligible
service, our match will equal $1.00 for each dollar the participant elects to defer up to four
percent of the participant’s pay. Corresponding with changes made to our defined benefit pension
plan for certain new hires, beginning on January 1, 2007 newly hired employees who are not eligible
for the defined benefit pension plan will instead receive an additional Company retirement
contribution equal to two percent of their compensation into their 401(k) account.
Changes in the Projected Benefit Obligations
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Changes in the Fair Value of Assets
Additional Plan Information
The accumulated and projected obligations for all plans exceed the fair value of assets.
Reconciliation of Funded Status at Fiscal Year End
Funded Status Recognized in the Consolidated Balance Sheets at Fiscal Year End
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Assumptions
The weighted-average assumptions used to measure net expense for years ended:
The weighted-average assumptions used to measure the benefit liability as of the end of the
year were as follows:
We have evaluated these assumptions with our actuarial advisors and we believe that they are
appropriate, although an increase or decrease in the assumptions or economic events outside our
control could have a material impact on reported net income.
Funding and Plan Assets
The table above shows the target allocation and actual allocation. Our target allocations of
our plan assets reflect the long-term nature of our pension liabilities. None of the assets are
invested directly in equity or debt instruments issued by PBG, PepsiCo or any bottling affiliates
of PepsiCo, although it is possible that insignificant indirect investments exist through our broad
market indices. Our equity investments are diversified across all areas of the equity market
(i.e., large, mid and small capitalization stocks as well as international equities). Our fixed
income investments are also diversified and consist of both corporate and U.S. government bonds. We
currently do not invest directly into any derivative investments. PBG’s assets are held in a
pension trust account at our trustee’s bank.
PBG’s pension investment policy and strategy are mandated by PBG’s Pension Investment
Committee (“PIC”) and are overseen by the PBG Board of Directors’ Compensation and Management
Development Committee. The plan assets are invested using a combination of enhanced and passive
indexing strategies. The performance of the plan assets is benchmarked against market indices and
reviewed by the PIC. Changes in investment strategies, asset allocations and specific investments
are approved by the PIC prior to execution.
Health Care Cost Trend Rates — We have assumed an average increase of eight percent
in 2007 in the cost of postretirement medical benefits for employees who retired before cost
sharing was introduced. This average increase is then projected to decline gradually to five
percent in 2013 and thereafter.
Assumed health care cost trend rates have an impact on the amounts reported for postretirement
medical plans. A one-percentage point change in assumed health care costs would have the following
impact:
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Pension and Postretirement Cash Flow — Our contributions are made in accordance with
applicable tax regulations that provide us with current tax deductions for our contributions and
for taxation to the employee when the benefits are received. We do not fund our pension plan and
postretirement medical plans when our contributions would not be tax deductible or when benefits
would be taxable to the employee before receipt. Of the total U.S. pension liabilities at December
30, 2006, $62 million relates to plans not funded due to these unfavorable tax consequences.
Our 2007 expected contributions are intended to meet or exceed the IRS minimum requirements
and provide us with current tax deductions.
Expected Benefit — U.S. Plans — The expected benefit payments made from our pension and
postretirement medical plans (with and without the prescription drug
subsidy provided by the Medicare Prescription Drug, Improvement and Modernization Act of 2003) to
our participants over the next ten years are as follows:
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Note 15—Income Taxes
The details of our income tax provision are set forth below:
In 2006, our tax provision includes increased taxes on U.S. earnings and additional
contingencies related to certain historic tax positions, as well as the following significant
items:
In 2005, our tax provision includes increased taxes on U.S. earnings and additional
contingencies related to certain historic tax positions, as well as the following significant
items:
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In 2004, we had the following significant tax items, which decreased our tax expense by
approximately $4 million:
Our U.S. and foreign income before income taxes is set forth below:
Our reconciliation of income taxes calculated at the U.S. federal statutory rate to our
provision for income taxes is set forth below:
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The details of our 2006 and 2005 deferred tax liabilities (assets) are set forth below:
We have NOLs totaling $1,118 million at December 30, 2006, which are available to reduce
future taxes in the U.S., Spain, Greece, Russia, Turkey and Mexico. Of these NOLs, $26 million
expire in 2007 and $1,092 million expire at various times between 2008 and 2026. At December 30,
2006, we have tax credit carryforwards in the U.S. of $4 million with an indefinite carryforward
period and in Mexico of $27 million, which expires at various times between 2009 and 2016.
We establish valuation allowances for our deferred tax assets when the amount of expected
future taxable income is not likely to support the use of the deduction or credit. Our valuation
allowances, which reduce deferred tax assets to an amount that will more likely than not be
realized, decreased by $33 million in 2006 and decreased by $92 million in 2005.
Approximately $14 million of our valuation allowance relating to our deferred tax assets at
December 30, 2006, would be applied to reduce goodwill if reversed in future periods.
Deferred taxes have not been recognized on the excess of the amount for financial reporting
purposes over the tax basis of investments in foreign subsidiaries that are essentially permanent
in duration. This amount becomes taxable upon a repatriation of assets from the subsidiary or a
sale or liquidation of the subsidiary. The amount of such temporary difference totaled $858
million at December 30, 2006. Determination of the amount of unrecognized deferred income taxes
related to this temporary difference is not practicable.
Income taxes receivable from taxing authorities were $35 million and $39 million at December
30, 2006 and December 31, 2005, respectively. Such amounts are recorded within prepaid expenses
and other current assets and other long-term assets in our Consolidated Balance Sheets. Income
taxes payable to taxing authorities were $20 million and $34 million at December 30, 2006 and
December 31, 2005, respectively. Such amounts are recorded within accounts payable and other
current liabilities in our Consolidated Balance Sheets.
Income taxes receivable from related parties were $6 million and $4 million at December 30,
2006 and December 31, 2005, respectively. Such amounts are recorded within accounts receivable in
our Consolidated Balance Sheets. Amounts paid to taxing authorities and related parties for income
taxes were $203 million, $235 million and $172 million in 2006, 2005 and 2004, respectively.
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Under our tax separation agreement with PepsiCo, PepsiCo maintains full control and absolute
discretion for any combined or consolidated tax filings for tax periods ended on or before our
initial public offering that occurred in March 1999. However, PepsiCo may not settle any issue
without our written consent, which consent cannot be unreasonably withheld. PepsiCo has
contractually agreed to act in good faith with respect to all tax examination matters affecting us.
In accordance with the tax separation agreement, we will bear our allocable share of any risk or
benefit resulting from the settlement of tax matters affecting us for these periods.
Note 16—Segment Information
We operate in one industry, carbonated soft drinks and other ready-to-drink beverages and all
of our segments derive revenue from these products. We conduct business in all or a portion of the
United States, Mexico, Canada, Spain, Russia, Greece and Turkey. Beginning with the fiscal quarter
ended March 25, 2006, PBG changed its financial reporting methodology to three reportable segments
— U.S. & Canada, Europe (which includes Spain, Russia, Greece and Turkey) and Mexico. The
operating segments of the U.S. and Canada are aggregated into a single reportable segment due to
their economic similarity as well as similarity across products, manufacturing and distribution
methods, types of customers and regulatory environments.
Operationally, the Company is organized along geographic lines with specific regional
management teams having responsibility for the financial results in each reportable segment. We
evaluate the performance of these segments based on operating income or loss. Operating income or
loss is exclusive of net interest expense, minority interest, foreign exchange gains and losses and
income taxes.
The Company has restated prior periods’ segment information presented in the tables below to
conform to the current segment reporting structure.
Net revenues in the U.S. were $8,901, $8,438 and $7,818 in 2006, 2005 and 2004, respectively. In
2006, 2005 and 2004, the Company did not have one individual customer that represented 10% of total
revenues.
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For the fiscal year ended 2006, operating income includes the impact of adopting SFAS
123R. The comparable period in 2005 has not been restated as described in Note 4.
Long-lived assets in the U.S. were $6,108, $6,129 and $5,875 in 2006, 2005 and 2004,
respectively.
Note 17—Related Party Transactions
PepsiCo is considered a related party due to the nature of our franchise relationship and its
ownership interest in our Company. The most significant agreements that govern our relationship
with PepsiCo consist of:
The Master Bottling Agreement provides that we will purchase our entire requirements of
concentrates for the cola beverages from PepsiCo at prices, and on terms and conditions, determined
from time to time by PepsiCo. Additionally, we review our annual marketing, advertising,
management and financial plans each year with PepsiCo for its approval. If we fail to submit these
plans, or if we fail to carry them out in all material respects, PepsiCo can terminate our beverage
agreements. If our beverage agreements with PepsiCo are terminated for this or for any other
reason, it would have a material adverse effect on our business and financial results.
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The following income (expense) amounts are considered related party transactions as a result
of our relationship with PepsiCo and its affiliates:
(a) Bottler Incentives and Other Arrangements — In order to promote PepsiCo beverages,
PepsiCo, at its discretion, provides us with various forms of bottler incentives. These incentives
cover a variety of initiatives, including direct marketplace support and advertising support. We
record most of these incentives as an adjustment to cost of sales unless the incentive is for
reimbursement of a specific, incremental and identifiable cost. Under these conditions, the
incentive would be recorded as an offset against the related costs, either in revenue or selling,
delivery and administrative expenses. Changes in our bottler incentives and funding levels could
materially affect our business and financial results.
(b) Purchase of Concentrate and Finished Product — As part of our franchise
relationship, we purchase concentrate from PepsiCo, pay royalties and produce or distribute other
products through various arrangements with PepsiCo or PepsiCo joint ventures. The prices we pay for
concentrate, finished goods and royalties are determined by PepsiCo at its sole discretion.
Concentrate prices are typically determined annually. In February 2006, PepsiCo increased the
price of U.S. concentrate by two percent. PepsiCo has recently announced a further increase of
approximately 3.7 percent, effective February 2007 in the United States. Significant changes in
the amount we pay PepsiCo for concentrate, finished goods and royalties could materially affect our
business and financial results. These amounts are reflected in cost of sales in our Consolidated
Statements of Operations.
(c) Fountain Service Fee — We manufacture and distribute fountain products and
provide fountain equipment service to PepsiCo customers in some territories in accordance with the
Pepsi beverage agreements. Amounts received from PepsiCo for these transactions are offset by the
cost to provide these services and are reflected in selling, delivery and administrative expenses
in our Consolidated Statements of Operations.
(d) Frito-Lay Purchases — We purchase snack food products from Frito-Lay, Inc. (“Frito”), a
subsidiary of PepsiCo, for sale and distribution in Russia primarily to accommodate PepsiCo with
the infrastructure of our distribution network. Frito would otherwise be required to source
third-party distribution services to reach their customers in Russia. We make payments to PepsiCo
for the cost of these snack products and retain a minimal net fee
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based on the gross sales price of
the products. Payments for the purchase of snack products are reflected in selling, delivery and
administrative expenses in our Consolidated Statements of Operations.
(e) Shared Services — We provide to and receive various services from PepsiCo and PepsiCo
affiliates pursuant to a shared services agreement and other arrangements. In the absence of
these agreements, we would have to obtain such services on our own. We might not be able to obtain
these services on terms, including cost, which are as favorable as those we receive from PepsiCo.
Total expenses incurred and income generated is reflected in selling, delivery and administrative
expenses in our Consolidated Statements of Operations.
(f) High Fructose Corn Syrup (“HFCS”) Settlement — On June 28, 2005, Bottling LLC and PepsiCo
entered into a settlement agreement related to the allocation of certain proceeds from the
settlement of the HFCS class action lawsuit. The lawsuit related to purchases of high fructose
corn syrup by several companies, including bottling
entities owned and operated by PepsiCo, during the period from July 1, 1991 to June 30, 1995
(the “Class Period”). Certain of the bottling entities owned by PepsiCo were transferred to PBG
when PepsiCo formed PBG in 1999 (the “PepsiCo Bottling Entities”). Under the settlement agreement
with PepsiCo, the Company ultimately received 45.8 percent (or approximately $23 million) of the
total recovery related to HFCS purchases by PepsiCo Bottling Entities during the Class Period.
Total proceeds are reflected in selling, delivery and administrative expenses in our Consolidated
Statements of Operations.
(g) Income Tax Benefit — Under our tax separation agreement with PepsiCo, PepsiCo maintains
full control and absolute discretion for any combined or consolidated tax filings for tax periods
ended on or before our initial public offering that occurred in March 1999. However, PepsiCo may
not settle any issue without our written consent, which consent cannot be unreasonably withheld.
PepsiCo has contractually agreed to act in good faith with respect to all tax examination matters
affecting us. In accordance with the tax separation agreement, we will bear our allocable share of
any risk or benefit resulting from the settlement of tax matters affecting us for these periods.
Total settlements are recorded in income tax expense in our Consolidated Statements of Operations.
We paid PepsiCo $1 million during 2004 for distribution rights relating to the SoBe brand in
certain PBG-owned territories in the U.S. and Canada.
Bottling
LLC will distribute pro-rata to PepsiCo and PBG, based upon membership interest,
sufficient cash such that aggregate cash distributed to us will enable us to pay our income taxes
and interest on our $1 billion 7% senior notes due 2029. PepsiCo’s pro-rata cash distribution
during 2006, 2005 and 2004 from Bottling LLC was $19 million, $12 million and $13 million,
respectively.
In accordance with our tax separation agreement with PepsiCo, in 2006 PBG reimbursed PepsiCo
$5 million for our obligations with respect to certain IRS matters relating to the tax years 1998
through March 1999.
We also entered into a capital lease arrangement for $25 million with PepsiCo to lease
marketing equipment. The balance outstanding as of December 30, 2006, was $25 million, with $23
million recorded in our long-term debt and $2 million recorded in our current portion of long-term
debt.
There are certain manufacturing cooperatives whose assets, liabilities and results of
operations are consolidated in our financial statements. Concentrate purchases from PepsiCo by
these cooperatives for the years ended 2006, 2005 and 2004 were $72 million, $25 million and $27
million, respectively.
As of December 30, 2006 and December 31, 2005, the receivables from PepsiCo and its affiliates
were $168 million and $143 million, respectively. Our receivables from PepsiCo are shown as part
of accounts receivable in our Consolidated Financial Statements. The payables to PepsiCo and its
affiliates were $234 million and $176 million, respectively. Our payables to PepsiCo are shown as
part of accounts payable and other current liabilities in our Consolidated Financial Statements.
Two of our board members are employees of PepsiCo. Neither of these board members serves on
our Audit and Affiliated Transactions Committee, Compensation and Management Development Committee
or Nominating and
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Corporate Governance Committee. In addition, one of the managing directors of
Bottling LLC is an employee of PepsiCo.
Note 18—Contingencies
We are subject to various claims and contingencies related to lawsuits, taxes, environmental
and other matters arising out of the normal course of business. We believe that the ultimate
liability arising from such claims or contingencies, if any, in excess of amounts already
recognized is not likely to have a material adverse effect on our results of operations, financial
position or liquidity.
Note 19—Accumulated Other Comprehensive Loss
The year-end balances related to each component of AOCL were as follows:
Note 20—Selected Quarterly Financial Data (unaudited)
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of
The Pepsi Bottling Group, Inc. Somers, New York We have audited the accompanying consolidated balance sheets of The Pepsi Bottling Group, Inc. and
subsidiaries (the “Company”) as of December 30, 2006 and December 31, 2005, and the related
consolidated statements of operations, changes in shareholders’ equity, and cash flows for
the years then ended. These financial statements are the
responsibility of the Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits. The financial statements of the Company for
the year ended December 25, 2004, before the effects of the
retrospective adjustments to the disclosures for a change in the
composition of reportable segments described in Note
16 to the consolidated financial statements, were audited by other auditors whose report, dated February 25,
2005, expressed an unqualified opinion on those statements.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our
opinion, such 2006 and 2005 consolidated financial statements present fairly, in all material respects,
the financial position of the Company as of December 30, 2006 and December 31, 2005, and the
results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 4 to the consolidated financial statements, in 2006 the Company adopted
Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” as revised,
effective January 1, 2006.
As discussed in Note 14 to the consolidated financial statements, in 2006 the Company adopted
Statement on Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and
132(R),” effective December 30, 2006 related to the
requirement to recognize the funded status of a benefit plan.
We also
have audited
the adjustments to the 2004 consolidated financial statements to
retrospectively adjust the disclosures for a change in the
composition of reportable segments during 2006, as discussed in
Note 16 to the consolidated financial statements. Our procedures included (1) comparing the
adjustment amounts of segment revenues, operating income and assets to the Company’s underlying
analysis obtained from management, and (2) testing the mathematical accuracy of the reconciliation
of segment amounts to the consolidated financial statements. In our
opinion, such retrospective adjustments are appropriate and have
been properly applied. However, we were not engaged to audit, review, or apply any procedures to
the 2004 consolidated financial statements of the Company other than
with respect to the retrospective adjustments and,
accordingly, we do not express an opinion or any other form of
assurance on the 2004 consolidated financial
statements taken as a whole.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the effectiveness of the Company’s internal control over financial reporting
as of December 30, 2006, based on the criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated
February 27, 2007 expresses an unqualified opinion on management’s assessment of the effectiveness
of the Company’s internal control over financial reporting and an unqualified opinion on the
effectiveness of the Company’s internal control over financial reporting.
/s/ Deloitte & Touche LLP
New York, New York
February 27, 2007 71
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
The Pepsi Bottling Group, Inc.: We have audited, before the effects of the change in The Pepsi Bottling Group, Inc.’s segmentation
described in Note 16, the accompanying consolidated statements of operations, cash flows, and
changes in shareholders’ equity of The Pepsi Bottling Group, Inc. and subsidiaries for the fiscal
year ended December 25, 2004 (the fiscal 2004 financial statements before the effects of the change
in segmentation
discussed in Note 16 are not presented herein). These consolidated financial statements are the
responsibility of the Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above, before the effects of the
change in segmentation described in Note 16, present fairly, in all material respects, the results
of operations and cash flows of The Pepsi Bottling Group, Inc. and subsidiaries for the fiscal year
ended December 25, 2004, in conformity with U.S. generally accepted accounting principles.
We were not engaged to audit, review, or apply any procedures to the change in segmentation
described in Note 16 and, accordingly, we do not express an opinion or any other form of assurance
about whether such adjustments are appropriate and have been properly applied. Those adjustments
were audited by Deloitte and Touche LLP.
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Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Included in Item 7, Management’s Financial Review – Market Risks and Cautionary Statements.
Item 8. Financial Statements and Supplementary Data
Included
in Item 7, Management’s Financial Review – Financial Statements.
Bottling LLC’s Annual Report on Form
10-K for the fiscal year ended December 30, 2006 is attached hereto as Exhibit 99.1 as required
by the SEC as a result of Bottling LLC’s guarantee of up to $1,000,000,000 aggregate principal
amount of our 7% Senior Notes due in 2029.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
PBG’s management carried out an evaluation, as required by Rule 13a-15(b) of the Securities
Exchange Act of 1934 (the “Exchange Act”), with the participation of our Chief Executive Officer
and our Chief Financial Officer, of the effectiveness of our disclosure controls and procedures, as
of the end of our last fiscal quarter. Based upon this evaluation, the Chief Executive Officer and
the Chief Financial Officer concluded that our disclosure controls and procedures were effective,
as of the end of the period covered by this Annual Report on Form 10-K, such that the information
relating to PBG and its consolidated subsidiaries required to be disclosed in our Exchange Act
reports filed with the SEC (i) is recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms, and (ii) is accumulated and communicated to PBG’s
management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to
allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
PBG’s management is responsible for establishing and maintaining adequate internal control
over financial reporting for PBG. Internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements in accordance with generally accepted accounting principles and
includes those policies and procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and dispositions of PBG’s assets,
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation
of financial statements in accordance with generally accepted accounting principles, and that PBG’s
receipts and expenditures are being made only in accordance with authorizations of PBG’s management
and directors, and (3) provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of PBG’s assets that could have a material effect on
the financial statements.
As required by Section 404 of the Sarbanes-Oxley Act of 2002 and the related rule of the SEC,
management assessed the effectiveness of PBG’s internal control over financial reporting using the
Internal Control-Integrated Framework developed by the Committee of Sponsoring Organizations of the
Treadway Commission.
Based on this assessment, management concluded that PBG’s internal control over financial
reporting was effective as of December 30, 2006. Management has not identified any material
weaknesses in PBG’s internal control over financial reporting as of December 30, 2006.
Our independent auditors, Deloitte & Touche, LLP (“D&T”), who have audited and reported on our
financial statements, issued an attestation report on our management’s assessment of PBG’s internal
control over financial reporting. D&T’s reports are included in this annual report.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of
The Pepsi Bottling Group, Inc. Somers, New York We have audited management’s assessment, included in the accompanying Management’s Report on
Internal Control over Financial Reporting, that The Pepsi Bottling Group, Inc. and subsidiaries
(the “Company”) maintained effective internal control over financial reporting as of December 30,
2006, based on criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is
responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an opinion on the effectiveness of the
Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management’s assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the
supervision of, the company’s principal executive and principal financial officers, or persons
performing similar functions, and effected by the company’s board of directors, management, and
other personnel to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the
possibility of collusion or improper management override of controls, material misstatements due to
error or fraud may not be prevented or detected on a timely basis. Also, projections of any
evaluation of the effectiveness of the internal control over financial reporting to future periods
are subject to the risk that the controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over
financial reporting as of December 30, 2006, is fairly stated, in all material respects, based on
the criteria established in Internal Control—Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained,
in all material respects, effective internal control over financial reporting as of December 30,
2006, based on the criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), the consolidated financial statements as of and for the year ended December
30, 2006 of the Company and our report dated February 27, 2007
expresses an unqualified opinion on those financial statements and
includes explanatory paragraphs referring to the Company’s
adoption of Statements of Financial Accounting Standards No. 123(R),
“Share-Based Payment,” and No. 158, “Employers’ Accounting for Defined Benefit
Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and
132(R),” related to the requirement to recognize the funded
status of a benefit plan.
/s/ Deloitte & Touche LLP
New York, New York
February 27, 2007 74
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Changes in Internal Controls
PBG’s management also carried out an evaluation, as required by Rule 13a-15(d) of the Exchange
Act, with the participation of our Chief Executive Officer and our Chief Financial Officer, of
changes in PBG’s internal control over financial reporting. Based on this evaluation, the Chief
Executive Officer and the Chief Financial Officer concluded that there were no changes in our
internal control over financial reporting that occurred during our last fiscal quarter that have
materially affected, or are reasonably likely to materially affect, our internal control over
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