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2006 PERFORMANCE WITH PURPOSE 267419_L01_CRVS.v3 3/5/07 6:16 PM Page 2

Common Stock Information Shareholder Information PepsiCo Stock Purchase Program – for Canadian employees: Fidelity Stock Plan Services Stock Trading Symbol — PEP Annual Meeting P.O. Box 5000 We believe Performance — achieving Contents Stock Exchange Listings The Annual Meeting of Shareholders will be held at Cincinnati, OH 45273-8398 Frito-Lay Corporate Headquarters, 7701 Legacy Drive, Telephone: 800-544-0275 PepsiCo at a Glance ...... 1 The New York Stock Exchange is the principal market for PepsiCo common stock, which is also listed on the Plano, Texas, on Wednesday, May 2, 2007, at 9 a.m. local Website: www.iStockPlan.com/ESPP financial results — matters most Letter to Shareholders ...... 2 Amsterdam, Chicago and Swiss Stock Exchanges. time. Proxies for the meeting will be solicited by an Please have a copy of your most recent statement Performance ...... 8 independent proxy solicitor. This Annual Report is not available when calling with inquiries. Shareholders part of the proxy solicitation. when it is combined with Purpose — Purpose ...... 16 At year-end 2006, there were approximately 190,000 If using overnight or certified mail send to: Corporate Officers and Principal Divisions . . . . 22 shareholders of record. Inquiries Regarding Your Stock Holdings Fidelity Investments PepsiCo Board of Directors ...... 23 Registered Shareholders (shares held by you in 100 Crosby Parkway improving people’s lives. Dividend Policy Mail Zone KC1F-L Advisory Boards your name) should address communications concerning We target an annual dividend payout of approximately transfers, statements, dividend payments, address changes, Covington, KY 41015 African American Advisory Board ...... 24 45% of prior year’s net income from continuing opera- lost certificates and other administrative matters to: Latino/Hispanic Advisory Board ...... 25 tions. Dividends are usually declared in January, May, July Shareholder Services and November and paid at the end of March, June and The Bank of New York Blue Ribbon Health and Wellness September and the beginning of January. The dividend Shareholder Services Department BuyDIRECT Plan Interested investors can make their initial purchase directly Advisory Board ...... 26 record dates for these payments are March 9, and, subject P.O. Box 11258 through The Bank of New York, transfer agent for PepsiCo, to approval of the Board of Directors, expected to be Church Street Station and Administrator for the Plan. A brochure detailing the Financial Highlights June 8, September 7 and December 7, 2007. We have New York, NY 10286-1258 Financial Review Plan is available on our website www..com or from paid quarterly cash dividends since 1965. Telephone: 800-226-0083 Management’s Discussion and Analysis and our transfer agent: PepsiCo, Inc. and Subsidiaries 212-815-3700 (Outside the U.S.) ($ in millions except per share amounts; all per share amounts assume dilution) Consolidated Financial Statements ...... 27 E-mail: [email protected] The Bank of New York Our Business ...... 28 Cash Dividends Declared Website: www.stockbny.com PepsiCo Plan Per Share (In $) 1.16 or Our Critical Accounting Policies ...... 37 Church Street Station 1.01 Manager Shareholder Relations P.O. Box 1958 Net Revenue Division Operating Profit Our Financial Results ...... 44 PepsiCo, Inc. Newark, NJ 07101-9774 Total: $35,137 Total: $7,172 Consolidated Statement of Income ...... 54 .850 700 Anderson Hill Road Telephone: 800-226-0083 Purchase, NY 10577 Consolidated Statement of Cash Flows ...... 55 212-815-3700 (Outside the U.S.) Telephone: 914-253-3055 Website: www.stockbny.com Consolidated Balance Sheet ...... 56 .630 PepsiCo .595 E-mail: [email protected] Quaker Foods In all correspondence or telephone inquiries, please PepsiCo Quaker Foods International Consolidated Statement of Common International North America mention PepsiCo, your name as printed on your stock 5% North America 27% 8% Shareholders’ Equity ...... 57 Other services include dividend reinvestment, optional 37% certificate, your Social Security number, your address and cash investments by electronic funds transfer or check PepsiCo Notes to Consolidated Financial Statements . . 58 telephone number. drawn on a U.S. bank, sale of shares, online account Frito-Lay Beverages Management’s Responsibility for access, and electronic delivery of shareholder materials. PepsiCo Frito-Lay SharePower Participants (employees with North America North America Beverages North America Financial Reporting ...... 78 SharePower options) should address all questions regard- North America 31% 29% Financial and Other Information 36% Management’s Report on Internal Control 02 03 04 05 06 ing your account, outstanding options or shares received PepsiCo’s 2007 quarterly earnings releases are expected 27% through option exercises to: over Financial Reporting ...... 79 to be issued the weeks of April 23, July 23, October 8, Report of Independent Registered Merrill Lynch/SharePower 2007, and February 4, 2008. Stock Option Unit Copies of PepsiCo’s SEC reports, earnings and other Public Accounting Firm ...... 80 Stock Performance 1600 Merrill Lynch Drive financial releases, corporate news and additional company Selected Financial Data ...... 81 Mail Stop 06-02-SOP information are available on our website www.pepsico.com. PepsiCo was formed through the 1965 merger of - Our CEO and CFO Certifications required under Reconciliation of GAAP and Company and Frito-Lay, Inc. A $1,000 investment in our Pennington, NJ 08534 (a) Telephone: 800-637-6713 (U.S., Puerto Rico Sarbanes-Oxley Section 302 were filed as an exhibit to our 2006 2005 % Chg Non-GAAP Information ...... 82 stock made on December 31, 2001 was worth about Form 10-K filed on February 20, 2007. Our 2006 Domestic $1,393 on December 31, 2006, assuming the reinvestment and Canada) Glossary ...... 82 609-818-8800 (all other locations) Company Section 303A CEO Certification was filed with Summary of Operations of dividends into PepsiCo stock. This performance the New York Stock Exchange (NYSE). represents a compounded annual growth rate of 7%. Total net revenue $35,137 $32,562 8 In all correspondence, please provide your account number If you have questions regarding PepsiCo’s financial The closing price for a share of PepsiCo common stock (for U.S. citizens, this is your Social Security number), your performance contact: Division operating profit(b) $7,172 $6,710 7 on the New York Stock Exchange was the price as reported address, your telephone number and mention PepsiCo by Bloomberg for the years ending 2002-2006. Past Jamie Caulfield Total operating profit $6,439 $5,922 9 SharePower. For telephone inquiries, please have a copy of Primary Websites performance is not necessarily indicative of future returns your most recent statement available. Vice President, Investor Relations Net income(c) $5,065 $4,536 12 PepsiCo, Inc. — www.pepsico.com on investments in PepsiCo common stock. PepsiCo, Inc. Purchase, NY 10577 (c) Employee Benefit Plan Participants Earnings per share $3.00 $2.66 13 Frito-Lay North America — www.fritolay.com PepsiCo 401(k) Plan & PepsiCo Stock Purchase Program Telephone: 914-253-3035 Year-end Market Price of Stock Pepsi-Cola North America — www.pepsiworld.com Based on calendar year-end (In $) The PepsiCo Savings & Retirement Center at Fidelity Independent Auditors P.O. Box 770003 KPMG LLP Other Data Tropicana North America — www.tropicana.com Cincinnati, OH 45277-0065 345 Park Avenue Management operating cash flow(d) $4,065 $4,204 (3) Quaker Foods — www.quakeroats.com Telephone: 800-632-2014 New York, NY 10154-0102 Net cash provided by 60 (Overseas: Dial your country’s AT&T Access Number Telephone: 212-758-9700 — www.gatorade.com +800-632-2014. In the U.S., access numbers are avail- operating activities $6,084 $5,852 4 able by calling 800-331-1140. From anywhere in the Corporate Headquarters Smart Spot — www.smartspot.com Capital spending $2,068 $1,736 19 40 world, access numbers are available online at PepsiCo, Inc. — www.walkers.co.uk www.att.com/traveler.) 700 Anderson Hill Road Common share repurchases $3,000 $3,012 – Website: www.netbenefits.fidelity.com Purchase, NY 10577 20 Dividends paid $1,854 $1,642 13 — www.sabritas.com.mx Telephone: 914-253-2000 Long-term debt $2,550 $2,313 10 — www.gamesa.com.mx PepsiCo Website: www.pepsico.com 0 Frito-Lay Canada — www.fritolay.ca 02 03 04 05 06 © 2007 PepsiCo, Inc. (a) Percentage changes above and in text are based on unrounded amounts. (b) Excludes corporate unallocated expenses. See page 82 for a reconciliation to the most directly When market or market share are referred to in this comparable financial measure in accordance with GAAP. report, the markets and share are defined by the PepsiCo’s Annual Report contains many of the valuable trademarks owned and/or used by PepsiCo and its subsidiaries and affiliates in the United States and internationally to distinguish products (c) In 2006, excludes restructuring and impairment charges and certain tax items. In 2005, excludes and services of outstanding quality. America On the Move™ is an initiative of the nonprofit organization, The Partnership to Promote Healthy Eating and Active Living (The Partnership: the impact of the American Jobs Creation Act (AJCA) tax charge, the 53rd week and restructuring sources of the information, primarily Information www.americaonthemove.org). Komen Race for the Cure is an initiative of the National Volunteer Recognition Program. charges. See page 82 for a reconciliation to the most directly comparable financial measure in Resources, Inc. and ACNielsen. The Measured accordance with GAAP. Channel Information excludes Wal*Mart, as Design: Eisenman Associates. Cover concept: Sondra Greenspan, Arcanna, Inc. Cover illustrations: 3DI Studio. Printing: L.P.Thebault. Photography: Stephen Wilkes, Ben Rosenthal, Grover Sterling, Steve Bonini, Kayte Deioma, PhotoBureau. Special thanks to . (d) Includes the impact of net capital spending. Also, see “Our Liquidity and Capital Resources” in Wal*Mart does not report volume to these services. Management’s Discussion and Analysis. This report is entirely recyclable. The cover and editorial pages are printed on Sterling Ultra Recycled Cover and Sterling Ultra Recycled Dull Text. That paper was manufactured by NewPage with wood procurement certified by the Sustainable Forestry Initiative®. The financial pages are printed on Plainfield Smooth Opaque Text. That paper was manufactured by Domtar Inc., using sustainable energy sources and wood procurement practices certified by the Forest Stewardship Council©. 267419_L01_P01.v3 3/5/07 11:15 PM Page 1

PepsiCo at a Glance ($ in Millions) Frito-Lay PepsiCo Beverages PepsiCo Quaker Foods North America North America International North America

2006 Volume Growth 9% 9%

4% Snacks Beverages 1% 1% FLNA PBNA PI QFNA

12000 12000 Net Revenue $12,959 $10,844 $10,322 12000 $11,376 10000 $9,560 10000 $9,565 $9,146 $9,862 $8,313 10000 8000 8000

8000

6000 6000 6000

4000 4000 4000 4000

2000 2000 2000 $1,718 $1,769 2000 $1,526

0 0 0 0 20042005 2006 20042005 2006 2004 2005 2006 20042005 2006 FLNA PBNA PI QFNA

$2,529 $2,615 Operating Profit 2500 $2,389 2500

$2,037 $2,055 2000 2000 $1,911 2000 2000 $1,948 1500 1500 1500 $1,607 1500 $1,323 1000 1000 1000 1000

$475 $537 $554 500 500 500 500

0 0 0 0 20042005 2006 20042005 2006 2004 2005 2006 20042005 2006 FLNA PBNA PI QFNA

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Dear Shareholders:

Generating healthy financial returns and making important strides in responsible corporate citizenship, PepsiCo delivered a very strong 2006: •Volume grew 5.5%. •Net revenue grew 8%. •Division operating profit grew 7%.* •Earnings per share grew 13%.* •Total return to shareholders was 8%. •Return on invested capital was 26%.* •Cash flow from operations was $6.1 billion and management operating cash flow was $4.1 billion.**

Indra Nooyi Chairman Elect and Chief Executive Officer

Steve Reinemund Executive Chairman and Chairman of the Board

These financial results tell only part of the PepsiCo story. As years, your company has led the industry with over 8% top we achieve success with profitable growth, we’re continuously line growth, double-digit EPS growth and approximately giving back to the communities we serve, delivering what we $26 billion in operating cash flow. During this period, we’ve call Performance with Purpose. returned approximately $20 billion to you, our shareholders. This annual report shows just how we’re achieving the balance What allows us to deliver these kinds of consistent results? between providing you with solid returns on your investments It’s an ideal match of PepsiCo people, capabilities and great and working to create a defining corporation for the new brands with opportunity. Specifically, this includes our structural millennium — one that strives to do better by doing better. advantages, capability advantages and our unique people Importantly, PepsiCo’s business performance in 2006 is culture. For example: consistent with very strong performance over the last several • We sit squarely in the sweet spot of the Food and years and — we believe — evidence of our ability to continue Beverage space — convenience. delivering strong results going forward. Over the last five • We have a big global reach — with tremendous opportunity for continued growth. • Our go-to-market systems provide us with a mosaic of 2006 Scorecard distribution arms that reach everywhere we operate cost effectively and with great efficiency and speed — ensuring 8% 7% 5.5% our products are always available. • We have demonstrated that we have the strategic acuity to spot shifting consumer interests, such as the move to Volume Net Revenue Division non-carbonated beverages and the increasing focus on Operating Profit* health and wellness. • We know how to build a brand’s personality and leverage 26% our mega-brands, not only into line extensions but also into entirely new platforms. • We have a track record of success in acquiring attractive tuck-in businesses and then integrating them quickly 13% and efficiently. • Our people provide an overwhelming advantage. They 8% are passionate about what they do and pride themselves on results. Add to this the diversity we cultivate and the personal ownership our associates take in the business, Earnings Per Total Return to Return on and you have a sense of our unique culture. Share* Shareholders Invested Capital* We, and all our associates across the globe, believe PepsiCo is delivering more than just financial performance. We are a * See page 82. ** See page 53. 2 267419_L01_P02_07.v3.qxd 3/3/07 11:41 PM Page 3

company with an increasingly deep sense of awareness of the world around us and the needs of its inhabitants. A Very Special Thanks We believe this is a company with a heart, and recognize In 2007, we celebrate a lifetime of leadership for a very prominent the role leading companies like ours play in society. It member of the PepsiCo family. Earning his place in PepsiCo inspires us to focus on delivering Performance with history as a world-class Chairman and Chief Executive Officer, Purpose — something we intend to continue doing. Steve Reinemund is leaving a legacy of growth through his Human Sustainability work in transforming our portfolio to address health and It’s not about growing a business for the next quarter or wellness consumer needs, building a diverse and inclusive the next year. It’s about growing a business profitably for environment for our people and driving the company’s Power the long term. of One capabilities. And as he’s done each of these, he’s We believe we can do this in ways directly related to reinforced a culture committed to driving business results the our business, beginning with our products. We have a right way: connected to clearly articulated values. It was under fundamental belief that humans need to be nourished in Steve’s leadership that PepsiCo defined our Values, so we now multiple dimensions — ranging from simple treats to have a common commitment and understanding of the principles healthier eats. that guide us. He’s been an excellent partner and superb mentor, We call this human sustainability, and we’re continuously as well as a great friend. We will all miss him when he steps transforming our portfolio of products to meet consumer down as Chairman in May, along with three other directors who needs. We’ve improved the nutritional profiles of our are retiring. Each has made a lasting contribution to our success. global, flagship brands by changing to healthier oils, reducing sugar and sodium content, and by expanding Steve Reinemund the range of products we offer. This includes products Steve began his career with PepsiCo in 1984 at Pizza Hut, ranging from indulgences — or treats — to good-for-you which was then part of our restaurant division. He served as products that offer functional benefits like hydration or Chief Executive Officer there before going on to lead Frito-Lay heart health. North America and then our worldwide snack operations. He In fact, our products that can contribute to healthier moved to headquarters as PepsiCo’s President and Chief lifestyles — what we call “Smart Spot” eligible products Operating Officer in 1999, and then served as Chairman and — represented over two-thirds of our growth in North Chief Executive Officer from 2001 to 2006. During this time, America in 2006. These products meet authoritative he increased PepsiCo revenues by more than $11 billion, and nutrition statements set by the National Academy of net income and earnings per share more than doubled. In the Sciences and the U.S. Food and Drug Administration process, the annual dividend doubled and the company’s or provide other functional benefits. And we’ve set a market capitalization surpassed $100 billion. goal of deriving 50% of all our U.S. revenues with Smart Spot eligible products by 2010. We’re supplementing our portfolio transformation Board of Directors with efforts to educate consumers about the importance Retiring this year are three members of the Board of Directors of active lifestyles and nutritional balance. We’ve who have been with us a total of 46 years combined: Bob Allen, committed to helping them understand that, along John Akers and Frank Thomas. Bob served on our Board for 17 with the calories they put in their bodies, they must years, and since 2000 he has been Presiding Director. He set a ensure they’re burning calories as well. high standard for this critical new role with his firm and steady And we’re proactively collaborating with policy direction. John joined our Board 16 years ago and was Chair of makers to help consumers live healthier lives. In 2006, our Compensation Committee and a continuous source of sage PepsiCo worked with the Clinton Foundation, the advice. Frank provided 13 years of service and was a chief American Heart Association and its partners in the contributor to our business strategies and people planning, and American Beverage Association to develop policies for was an invaluable source of counsel to all of us. Each of these selling beverages in U.S. schools, and followed up with a individuals has provided excellent counsel and perspective and has given us the full value of his experience. We shall miss them greatly. We’re pleased to have the depth of experience of Earnings Per Share* Management Operating Sharon Rockefeller, who will become Presiding Director. Cash Flow ** In addition, we announced in February that Cynthia Trudell left $3.00 $ in Millions our Board to become PepsiCo’s Senior Vice President and Chief $2.66 $4,204 $4,065 Personnel Officer, a role she has already assumed. We thank her $2.32 $3,705 for her years of service on the Board and look forward to her continued contributions to PepsiCo as she uses her experience to drive our business growth while motivating, developing and caring for the employees who make our businesses successful.

2004 2005 2006 2004 2005 2006

* See page 82. ** See page 53. 3 267419_L01_P02_07.v4.qxd 3/5/07 11:44 PM Page 4

similar agreement for snacks in U.S. schools. In fact, PepsiCo is Our focus on people has never been more critical; the the only company to have participated in the development of global competition for talent intensifies each year, and the both policies. companies that win will be those that provide the most We are introducing health and wellness programs in opportunity for personal and professional growth. markets around the world. And in countries such as Mexico, We firmly believe that PepsiCo’s commitment to diversity the United Kingdom and , we’ve established advisory and inclusion is creating that kind of environment. To attract boards to help guide our efforts. and retain the best and brightest, we’re working harder than No matter where we are, the safety and integrity of our ever to ensure our culture grows in its inclusive nature — that products is our single highest priority. It’s our duty as a it becomes known as a premier place to work because every responsible company. People buy our brands because they associate can bring his or her whole self to work. When that know they can count on consistent quality — every time. We happens, we unleash the power of our people on innovative follow very rigorous standards of safety and quality. Our solutions that will grow your company. standards are equally rigorous in New York, London and Beijing Looking ahead, our work plan is clear: we have a mandate as they are wherever else we operate. We stand behind each to deliver Performance with Purpose. We’re well positioned to and every product we sell. deliver financial performance, consistent with our guidance, and to do it with the goals of nourishing consumers, replenishing Environmental Sustainability the environment in which we operate and cherishing our The second way PepsiCo can give back to the global community people. Our capabilities and strategies to deliver on this priority it serves is through its work with environmental sustainability. are highlighted in the pages that follow. By fully understanding our environmental impact, we can find While we have much more to do, we’re making progress ways to conserve and replenish the planet’s natural resources. on delivering on our commitment to Purpose and are proud In doing what’s right for the business, we can do what’s right to share details with you in this publication. As a result of our for the global community. efforts, the Dow Jones Sustainability North American Index — PepsiCo has focused its environmental sustainability efforts an investment fund comprised of North American companies on water, energy and packaging — areas where we can make that excel in managing economic, environmental and social the biggest impact. Reducing waste water, establishing rainwater results — added PepsiCo to its list in 2006. collection capabilities, using more recyclable materials in our packaging and using alternative energy sources are just a few Our True North — Our Values of the priorities we’ve set for ourselves. Success with each of Of course, guiding our people and our culture is a set of values them translates into financial benefits for the business. that helps ensure we achieve all results with integrity — the Our accountability as a global corporate citizen extends to right way. We want PepsiCo to continue to be viewed as a other social issues as well. We’ve established programs to help high-integrity company, and we recognize and reward leaders our associates and communities combat HIV/AIDS. Our associates who deliver results in ways that are consistent with our True are volunteering in our communities, and PepsiCo continually North — our Values. responds to calls for humanitarian aid. Since PepsiCo was formed in 1965, each of the company’s leaders — beginning with Don Kendall, and including Wayne Talent Sustainability Calloway and Roger Enrico — has been passionately committed The third area of sustainability that we’ve chosen to focus to operating a business with integrity, one that delivers on is talent sustainability — reflecting our belief that people strong, sustainable financial returns. hold the key to PepsiCo’s success. Our company is known to As we have co-authored PepsiCo’s strategy over the last many as an academy company, a place where people grow several years, and conclude our own CEO transition, above all and business leaders develop. We are also committed to we share an equally passionate commitment to our Values building a work environment where all of our associates can and to running a business that does better by doing better, achieve a better quality of and know that, as a business, achieving financial results while addressing environmental we cherish them. and social needs. The transitions we announced this year, starting with the It’s a legacy we both intend to leave. And we believe CEO and including several other senior executive roles, show there’s no better, more honorable, or more strategic way to that we are not only committed to developing and retaining grow your company. deep bench strength, but that we’re equally passionate about ensuring seamless transitions. And while we certainly weren’t looking for external recognition, BusinessWeek bestowed its 2006 ”smoothest handover” honors to PepsiCo, saying, ”…the transition in October from Steven S Reinemund to Indra K. Nooyi at the $33 billion PepsiCo was noticeably angst-free.” Whether it’s managing transitions or running the business day-to-day, PepsiCo’s culture is renowned for its “can-do” spirit, something we consider part of our DNA. Look no further than Steve Reinemund the marketplace challenges of any year to see our level of Executive Chairman and Chairman Elect and commitment to getting the job done. In 2006, whether it was Chairman of the Board Chief Executive Officer skyrocketing fruit costs, or ever-increasing competitive activity in categories or markets across the globe, our people proved they’re among the world’s best.

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Questions & Answers U.S. Category Leaders Our Chairman and President & Chief Executive Officer Perspective The questions below reflect key questions shareholders often ask about our businesses, #2 Carbonated and are followed by joint responses from our Chairman, Steve Reinemund, and our Soft Drinks President and Chief Executive Officer, Indra Nooyi.

take to support consumers in their quest for PepsiCo’s product categories and Q: healthier lifestyles. This includes insights their impact on health continues to from PepsiCo’s Blue Ribbon Advisory Board, a capture media, consumer and regulatory group of leading health and wellness experts focus. How is PepsiCo’s portfolio faring and third-party advisors from across the in this environment? globe, as well as our Ethnic Advisory Boards who have provided insights relating to multi- As the transformation of PepsiCo’s #1 A: cultural consumers. Sports Drink portfolio continues, we’re able to add more Most recently, PepsiCo’s work in the choices for consumers to meet their needs United States with the Clinton Foundation, for products that can contribute to healthier the American Heart Association and the lifestyles, and we’re proud of each and every beverage industry, are examples of working choice we offer. proactively to set policies that put the right Our efforts are galvanized by three kinds of products in the right locations — in imperatives: continue making our fun-for- this case, schools. We’re working in our #1 you products more nutritious, develop new PET Water international markets in much the same way. Brand products that address the needs of the entire (non-jug) An advantaged portfolio of good- and food pyramid, and try to ensure consumers better-for-you products — products that are never have to trade off nutrition and taste. Smart Spot eligible — has provided, and will The range of product choices we offer continue to provide, growth opportunities at grows each year, as we develop or acquire what we call the intersection of business and new products or platforms that range from public interests. indulgent to good-for-you. At the same time, #1 we’re improving the nutritional profiles of our Chilled Juices How are you approaching innovation & Juice larger, core brands. For example, changing Q: Drinks cooking oils to sunflower oil for both Lay’s as a means to growth? and potato chips at FLNA and A: Innovation demands that we constantly Walkers crisps in the United Kingdom look around the next corner to ensure we’re reduces the saturated fat in these products providing products that our consumers and without sacrificing taste. And we’re working retail customers want. We have a relentless on developing new sweeteners and adding focus on innovation, as new products more nutritious ingredients to our products consistently deliver 15% to 20% of our total — such as fiber to foods and beverages and #1 growth. In 2006 alone, our North American Enhanced omega-3 fatty acids to juices. businesses introduced new products that Water Brand Our portfolio of more nutritious choices is totaled greater than $1 billion in retail sales. working well in this environment, evidenced More strategically said, we’re focused on by over two-thirds of our North America top game-changing innovation. Clearly, we need line growth in 2006 being driven by products to keep our existing big brands fresh while that are PepsiCo Smart Spot eligible — developing products and venturing into meaning they meet authoritative nutritional new categories. statements developed by the National Through a disciplined approach to innova- #1 Academy of Sciences or the U.S. Food and tion, we’ve developed a very strong pipeline Ready-to- Drug Administration. Drink for 2007 and beyond, including new products Coffee like Flat Earth vegetable and fruit crisps from Q: What, specifically, is PepsiCo doing Frito-Lay, and new beverage entries such as to address regulatory pressures relating Izze, a sparkling beverage made with 70% to health concerns across the globe? fruit juice, and , a line of all #1 natural juices and juice smoothies, acquired Ready-to- On the regulatory and policy side, we’re Drink A: in January 2007. And we’ll expand on our Tea firm believers in engaging a range of public successes, such as introducing Baked Walkers and private experts to come to workable crisps in the United Kingdom. solutions on such things as how and where As the lifeblood of any successful consumer our products are sold and marketed. We’re products company, we expect innovation actively engaged with policy and thought will continue to be a key tool for growth at leaders, as well as food and beverage industry PepsiCo going forward. leaders, to reach decisions on steps we can

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If anything, this series of moves underscores How are you addressing rising U.S. Category Leaders Q: the importance of continuously building input costs in your businesses? bench strength in our management group. A: Structural inflation is a reality we We continue to place a high priority on #1 believe will persist over the next few years. sustaining our pool of executive talent, and Potato Chips Agricultural commodities, energy and certain we clearly understand that in the global metals are in a period of protracted inflation competition for talent our people planning that’s unlikely to moderate until supply processes must be world class. catches up. Fortunately, over the years we’ve demon- Q: How will Indra Nooyi’s appointment strated the resilience of the PepsiCo portfolio to CEO change PepsiCo’s strategic focus to navigate through these headwinds or priorities? successfully. And we are confident we will find innovative solutions to cover rising input A: Our transition of the CEO role is as costs. It will mean pulling all available levers seamless a transition as any PepsiCo has to address inflation, as we’ve always done, ever done, largely reflecting the fact that we such as finding new productivity, strategically have co-authored the strategies the company #1 hedging our input costs, and executing is pursuing. Tortilla prudent and judicious pricing. There are no major new strategies that Chips have been put into place since the transition How are you addressing the took effect in October of 2006, and we Q: continue to aggressively pursue those carbonated (CSD) category strategies that have been driving the decline in North America? company’s growth. A: Rejuvenating the CSD category requires us to deliver new products, new packaging Q: How will PepsiCo’s work with and new benefits to re-engage consumers. diversity and inclusion, and its work 2007 has one of the strongest line-ups of with corporate social responsibility CSD innovation we’ve had in many years. In and corporate governance evolve under essence, we plan to build a new category for new leadership? us of “sparkling” beverages. #1 Whether it’s through Izze sparkling bever- A: Our commitment to diversity and inclu- Corn Chips ages, our new line, increased distribution sion as a means to drive our growth remains of throughout our system, new steadfast. We continue to see the impact of “choreography” packaging for Pepsi, or our efforts in our business results, as consumer other new product and packaging news for product offerings, promotions and customer , and , programming benefit from the diverse we believe we’ve got an impressive lineup and inclusive workforce and environment #1 ready for the marketplace. And we’re we’re building. Extruded supporting our new products as we continue Our focus on corporate responsibility has Snack to support our established core brands. always been strong and will even be stronger Looking ahead, we have increased our as we contribute to societal growth and help investment in truly breakthrough innovations address societal problems. Some would say to come, like new sweeteners that we we have a moral and social obligation. believe hold the power to restoring CSD Others would say it’s simply good business. category growth. Either way, we have a major role to play. Similarly for corporate governance, we #1 Q: You have had good success continue to find ways to strengthen our Multigrain promoting senior executives from within approach, our tools and our reporting in the Snack the company. What are you doing to name of transparency for our shareholders and the range of constituents who track our ensure you maintain a strong bench and business. For example, in 2006, PepsiCo good succession planning? participated in a pilot program at the SEC A: We announced a number of senior exec- to test a new electronic filing system. utive changes this year, ranging from CEO These kinds of priorities, which tie directly #2 to senior executive talent of our operating to our commitment to responsible corporate Pretzels divisions. Because of the deep bench strength, citizenship, will remain front and center. we were able to provide opportunities to current PepsiCo executives — ensuring smooth transitions and tapping into literally hundreds of years’ worth of experience within the company.

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Juice fruit beverages (acquired January 2, 2007). Where is PepsiCo in its investment Q: Each acquisition gives us a new opportunity U.S. Category Leaders in business process transformation, and for growth, whether through new product specifically its SAP implementation? categories or greater reach into emerging A: Business Process Transformation (BPT) is retail channels. a multi-year transformation effort to simplify Internationally, we completed the acquisi- #1 and synchronize our business processes and tions of Duyvis nuts in the Netherlands and Hot Cereal tools into one common platform. Star Foods snacks in Poland, as well as In 2006, we began implementing SAP. We Bluebird snacks in in early streamlined our indirect procurement system 2007. Here again, each provides opportunity across our U.S. divisions, and for Quaker, for growth through new geographies and Tropicana and Gatorade, we also streamlined new product lines internationally. customer orders, implemented a more efficient Before any acquisition is made, we apply system for assessing and tracking capital a disciplined approach to evaluating returns expenditures and advertising and marketing on the investment within a reasonable period spending, and provided common demand and focus on ensuring these businesses add forecasting capability. profitable growth to PepsiCo. We feel very The project has an attractive business case good about these acquisitions, and their #1 including both IT cost savings and operating integration is proceeding well. Grits productivity. Additionally, we expect benefits Going forward, you can expect us to from increased business information. continue acting on our stated strategy of smaller, tuck-in acquisitions as a means to Q: International has been a big help us grow. contributor to PepsiCo’s growth over the past few years. How do you plan to Q: What’s the next big Power of sustain this growth? One frontier? Our Power of One initiatives — those PepsiCo International continues to be A: A: directed at accelerating growth for PepsiCo the growth engine for the company — #1 and our retailers through the power of Rice Side delivering on our expectations to grow at Dish the entire PepsiCo portfolio — are most about twice the rate of our North American definitely moving to a new level. businesses. Growth internationally across a In 2006, we conducted “Innovation wide range of markets is strong. Summits” with our customers to share a We believe the strong growth achieved holistic view of how shopping and eating by our PepsiCo International business in 2006 habits are fragmenting. Using the insights reflects the work of a world-class management from these summits, we’ve worked with team, years of investment, and the imple- our retail partners and tailored our product mentation of a deliberate strategy to create offerings — by account — to maximize #1 scale in key international markets that will Brand the potential of our categories and boost deliver profitable growth. Pancake performance and results. Syrup The portfolio of international markets But our partnerships with customers go continues to broaden and strengthen as we beyond top-line driving initiatives. We’ve deliver exciting new products, tailored to expanded it to include end-to-end supply local tastes, to consumers in approximately chain efficiencies. We are refreshing our 200 countries. And in developing and selling and merchandising activities and emerging markets in particular, growth in critically reviewing all touch points with our per capita GDP levels continues to generate customers to eliminate inefficiencies like increased demand for our products. out-of-stocks and reduce “pain points,” if #2 Pancake any. This initiative extends beyond PepsiCo PepsiCo made a number of Mix Q: to include our bottling partners — members acquisitions in 2006 — both in North of the extended PepsiCo family who work America and internationally. How is hand in hand with us on all of our initiatives. the integration of these businesses going? And what kinds of mergers and acquisitions activity can we expect to see going forward? A: Our North American acquisitions within the last year included Stacy’s bagel and pita chips, Izze carbonated beverages and Naked

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Superior performance starts with a wide selection of powerful brands and the capability to build more of them.

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Performance

PepsiCo has a history of delivering strong financial performance. We strive to increase revenues, market share, volume, profits and earnings per share, while reducing costs and improving productivity. This, in turn, leads to strong returns for our shareholders. PepsiCo Our success in 2006 made PepsiCo the second–largest food and beverage company in the world. We believe our performance is the result of our unique competitive estimated strengths: our structural and capability advantages, supported by a culture that is uniquely our own. worldwide Our Structural Advantages retail sales: Our structural advantages reflect a presence in convenience categories that is both wide and $92 billion.* deep — with global operations that reach approximately 200 snack and beverage markets and an unmatched portfolio of leading brands. Combined with our flexible, multiple go-to-market systems, these structural advantages provide us with a solid base for growth.

Convenience juice, we offer consumers a Global Operations We have U.S. category delicious and portable way to leadership positions — either As consumers’ lives become We are the largest savory eat one to two servings of first or second position — in more time-starved, demand snack food business and the fruit per item. Starting in 18 categories of snacks, bever- for products that offer conven- largest sports drink producer 2007, consumers can choose ages and foods. In beverages ience continues to grow. This in the world. Our size gives us our breakthrough line of Flat — including carbonated plus “sweet spot” of convenience distinct advantages. No matter Earth fruit and vegetable non-carbonated — we have features categories that have where consumers live or crisps as a convenient snack the leading market share in been outgrowing the overall travel in the world, we’re option that provides a half the United States. food and beverage sector over working hard to ensure our serving of fruits or vegetables PepsiCo International has the past several years. brands are available. Our per ounce. delivered consistent growth Our innovation pipeline is reach provides a competitive Our growing beverage over the last three years, with being stoked to leverage our edge when introducing new portfolio offers consumers 18 businesses now generating growing presence in these products and distributing our choices from regular and diet revenues of at least $200 categories. Products such as brands. Retailers are eager carbonated soft drinks to million. We have a solid share Quaker Oatmeal-to-Go bars to stock our products because ready-to-drink teas and of snacks in major markets mean more people can enjoy they know our brands provide coffee, waters, sports drinks, such as Mexico, the United a heart-healthy breakfast. quality, variety, great taste and energy drinks, and juices Kingdom, Brazil, Australia, With Tropicana FruitWise, a move quickly off the shelves. and juice drinks — all in a and Russia. In developing line of fruit strips and bars variety of sizes for home or markets, such as China, Pepsi made from real fruit and on-the-go enjoyment.

*Includes estimated retail sales of all PepsiCo products, including those sold by our partners and franchised bottlers.

Top Branded Food and Beverage Manufacturers Cumulative Total Shareholder Return $ Net Sales in Billions % Return on PepsiCo stock investment, the S&P 500 and the S&P Average of Industry Groups. Food and beverage sales, excludes food ingredients, pet and agricultural products. Includes fruit and dairy. 150 Nestlé PepsiCo

Kraft Foods 125 Unilever

Coca-Cola 100 Groupe Danone Cadbury Diageo 75 PepsiCo Inc. Anheuser-Busch S&P 500® S&P® Average of Industry Groups 50 0 1020304050607080 12/2001 12/2002 12/2003 12/2004 12/2005 12/2006 PepsiCo is the world’s second largest food and beverage company. Shareholders purchasing PepsiCo stock at the end of 2001 and holding it to the end of 2006 received a higher cumulative return than the returns of the S&P 500 and our industry group.

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is the leading soft drink, and Big Brands We offer consumers an increasingly wide choice of products for we have also introduced every occasion. We have 17 mega-brands, many of our popular snacks each of which delivers retail such as Lay’s potato chips. sales of at least $1 billion. And we’re just getting Five of them generate retail started. We’re establishing sales of more than $5 billion our big, muscular brands in each. These brands are big — new markets every year. We and we continually foster now offer Gatorade sports their growth. Importantly, we drinks in 42 markets, and we have another 16 brands that are expanding into more. We generate retail sales between sell Tropicana juice and juice $250 million and $1 billion — drinks in 27 markets, and we and another 14 brands that see near-term opportunity to generate sales between $100 introduce these products into and $250 million. Our brands’ many other markets. We also size and popularity give us offer tea brands in the confidence to introduce many markets, with great new and launch potential to further expand. entirely new varieties with As we achieve scale in trusted brand names that global markets, we are deliver consistently great taste. introducing our Power of One initiatives — which Distribution Systems integrate business planning, Our delivery — or “go-to- merchandising and promotions market” — systems provide a Our most powerful support in-store promotions. and focused customer teams strong competitive advantage. distribution system is direct- DSD works well for popular across all our brands. For With optimum efficiency, store-delivery (DSD), where products we restock often, example, in Asia, Brazil, Russia we can deliver to retailers PepsiCo associates deliver our because it allows us to distrib- and Mexico, we are working and other customers who products to stores and place ute new products quickly. with our retail customers sell our products, virtually them on the shelves. Direct- Our DSD system reaches to create promotions and wherever they are and store-delivery allows us to hundreds of thousands of improve productivity across however they want. create maximum appeal and retail outlets this way, from our portfolio. visibility for our brands and neighborhood convenience

U.S. Convenient Food and U.S. Convenient Foods PepsiCo International Beverage Volume Growth by Region Beverage Sales % Retail Sales in Measured Channels. % System Volume by Region % Total Dollar Sales Snacks and Beverages Includes chips, pretzels, ready-to-eat pop- corn, crackers, dips, snack nuts/seeds, Europe/Middle East/Africa meat snacks, bars, cookies, candy, sweet and other snacks. Asia Procter & Gamble 1% Latin America Master Kraft Foods Foods 061218 7% PepsiCo 5% PepsiCo 25% General 21% Mills 2% Kellogg 6% PepsiCo International Snack Volume Growth by Region Others Coca-Cola All Others Hershey % System Volume by Region 37% 11% 57% 9% Europe/Middle East/Africa Private Label 7% Kraft Foods Asia 12% Latin America PepsiCo is the leading convenient Frito-Lay is the leading convenient food and beverage company in snack food business in measured 061218 the United States. channels in the United States. PepsiCo International beverages and snacks generated volume growth across all regions.

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stores to large-format super- Our Capability Advantages markets. The Frito-Lay North PepsiCo International America team services nearly Our capability advantages include the strategic acuity Snack Volume 440,000 retail outlets weekly. necessary to anticipate consumer needs and innovate to fulfill % System Volume by Region We handle less perishable them. Early on, we anticipated consumers moving from products — including Gatorade carbonated soft drinks to non-carbonated beverages, and we sports drinks, shelf-stable broadened our beverage portfolio to capture new growth in Tropicana juices and Quaker the non-carbonated segment. Similarly, we were among the Latin America 51% products — through our first food and beverage companies to anticipate increased warehouse distribution consumer interest in health and wellness and to recognize Asia system. We deliver Tropicana that we could help consumers live healthier lifestyles. Along 11% Pure Premium juices using with knowing our customers, we know our brands and how Europe/ Middle East/Africa either a refrigerated ware- to build and market them. Add to this our demonstrated 38% house system or chilled ability to pinpoint, acquire and integrate businesses — both direct-store-delivery system. big and small — and we believe our capability advantages will continue contributing to our strong performance. The success of these PepsiCo has the largest snack systems can be measured in business in the world. many ways. For example, Strategic Acuity — Move We recognized the need to seven of the 15 largest brands to Non-Carbonated broaden our portfolio early on and moved to extend our sold in U.S. supermarkets are Beverages PepsiCo brands. No other presence in non-carbonated Carbonated beverages remain company can make this claim. beverages in 1992, when we PepsiCo International the most popular beverage Our distribution systems formed a partnership with Beverage Volume category, with some 95% of are part of one of the world’s Thomas J. Lipton Co. to sell % System Volume by Region U.S. households purchasing most powerful supply chains. ready-to-drink tea brands. In Includes Pepsi-Cola, 7UP, Gatorade, them. However, non-carbon- Tropicana and other beverages. Worldwide, we own or lease 1994, we introduced ated beverages represent a nearly 300 factories, operate bottled water, and we also fast-growing category — a more than 3,000 distribution began a strategic partnership place where consumers are centers, and employ nearly with Starbucks to market Europe/ migrating. Today, in the Middle East/Africa 70,000 salespeople working ready-to-drink coffee. We 45% United States and Canada, to ensure our products are acquired Tropicana in 1998 non-carbonated beverages, available, merchandised and and we expanded the Dole which are 38% of our volume, sold in engaging ways every brand. We added SoBe, the generate 69% of our revenue. Asia Latin America hour of every day. producer of several varieties 26% 29% of tea and energy drinks, in 2001. Active thirst leaders, Gatorade Thirst Quencher sports drinks and Propel Our beverage portfolio is well- Fitness Water, became a part positioned to take advantage of our beverage business of rising consumption in developing markets. when we merged with Quaker in 2001. In 2006, we announced our alliance with PepsiCo International Ocean Spray to market, bot- Net Revenues tle and distribute single-serve % Net Revenues cranberry juice products and other product innovations. Now we’ve defined a new category within our beverage portfolio — sparkling Snacks and Foods 70% Beverages 30%

Gatorade Thirst Quencher is among our biggest brands and is being The major share of PepsiCo introduced in markets around the globe. International revenues are generated by snacks and foods.

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beverages — and we added a opportunity awaits us in the PepsiCo offers a variety of products that are delicious and nutritious. premium brand to help us world of non-carbonated capture the growth: Izze beverages, as we currently Beverage Co. Acquired in account for less than 2% of 2006, Izze is a maker of all- an international non-carbon- natural sparkling fruit juices. ated beverage industry that To extend our lead in non- we estimate to be about $70 carbonated beverages, we billion and growing. recently completed the acquisition of Naked Juice, a Strategic Acuity — premium juice producer in the Health and Wellness United States whose portfolio Providing consumers with includes fruit juices and choices has long been a part smoothies made without of our mindset. We introduced added sugars or preservatives. Diet Pepsi in 1964 and Reduced Internationally, we have a Fat Ruffles in the mid 80s. We variety of non-carbonated have historically supported products including Tropicana, active lifestyles as well. Gatorade and Lipton products, Throughout the world, PepsiCo plus local juices such as is a frequent sponsor of fruit juices and PJ sports and active lifestyles Smoothies in the United through our marketing and Kingdom, and Punica, a our charitable donations. leading German maker of Our increasing commitment fruit juices and juice drinks, to health and wellness is commitment is behind our We are pioneers in offering acquired in 2005. A huge reflected in the transformation creation of a Blue Ribbon consumers smart choices. In of our portfolio, such as Health and Wellness Advisory 2004, we introduced the through our acquisitions of Board, a group that provides Smart Spot symbol in the Tropicana and Quaker. That expert advice on a variety of United States, a first-of-its- initiatives including new kind designation that helps products, nutrition news and consumers identify PepsiCo exercise programs. And it has products that can contribute driven our work to improve to healthier lifestyles. Products the nutritional profile of our with the Smart Spot symbol existing product lines. In meet nutrition criteria based 2003, long before concerns on authoritative statements about trans fats became the from the U.S. Food and subject of mainstream media, Drug Administration and the PepsiCo removed trans fats National Academy of Sciences from , and or provide other functional in the United States benefits. More than 40% of and Canada, by converting to our revenues in the United corn oil — a vegetable oil States and Canada come high in good fats, mono- and from products that are Smart polyunsaturated fatty acids. Spot eligible. In 2006, we changed the oils in our Lay’s and Ruffles brand potato chips in the United States and internationally in Walkers crisps, moving to sunflower oil, which is lower in saturated fat.

Our goal is to make our products available wherever there are hungry or thirsty people.

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We have a growing portfolio we introduced SoBe Life Water, Brand Building ations, such as Lay’s Artesanas of brands marketed interna- a line of vitamin-enhanced and Lay’s Mediterraneas Brand building is about tionally that provide a clear water beverages. At Frito-Lay, made with olive oil. We offer extending a brand’s image. And nutrition or health benefit — we launched Tostitos Multigrain different kinds of chips, like we are adept at connecting what we call “Good for You.” to bring wholesome grains to hard-bite kettle style chips local preferences to our In Mexico, for example, we one of America’s favorite and, more recently, natural global brands, resulting in are pioneering new technol- tortilla chip brands, and we and organic varieties. overall growth. ogy to help preserve healthy introduced Baked! Cheetos We apply the same process Take Lay’s as an example: nutrients in our products. A and Doritos snacks in our line to our other snack and we’ve expanded it worldwide, current example is a baked of 100-Calorie Mini Bites, to beverage brands. The room tailoring it to local palates. potato stick called Nutritas, take the guesswork out of for growth is huge. We start with the well-known which includes vegetables and portion control. We introduced Recent examples of our “banner sun” brand, and we is produced by microwave whole grain side dishes as brand building prowess from cultivate the brand across our cooking, steaming and slow part of our Rice-A-Roni brand. our beverage portfolio international markets — baking. We’ve introduced We are addressing the needs include our 2006 U.S. intro- capitalizing on iconic names baked snacks in Mexico and of serious athletes as well, with duction of Jazz from Diet in their own right like Walkers the United Kingdom and will research-proven performance Pepsi, a low-calorie, indulgent in the United Kingdom, Sabritas continue to offer more beverages like Gatorade cola available in two flavors: in Mexico, and in choices across the world. Endurance Formula. And this Black Cherry French Vanilla , among others. Throughout 2006, we momentum has continued into and & Cream. Then we extend the brand continued adding products 2007, with the introduction of We launched Pepsi Limón in with flavors and seasonings that fit into healthier lifestyles. Gatorade AM Thirst Quencher, Peru, and in Argentina we geared to local tastes — chilies At the start of the year, we with flavors that appeal to introduce 7UP H2OH!, a drink in Latin America, beef and acquired Stacy’s Pita Chip morning exercisers. that bridges carbonated ketchup in Europe, and prawn Company, a U.S.-based water drinks with flavored in Asia, for example. Next, we premium natural-snacks com- water. In the United States, branch into entirely new vari- pany. In the water category,

U.S. PepsiCo Beverage Frito-Lay North America Largest PepsiCo Brands Distribution Channels Distribution Channels Estimated Worldwide Retail Sales $ in Billions % Volume % Volume Pepsi-Cola Convenience/ Gatorade Thirst Quencher Gas/Chilled DSD/ Mountain Dew (diet and regular) Other Small Format Canada 17% 8% Diet Pepsi Lay’s Potato Chips Doritos Tortilla Chips Mass Tropicana Pure Premium Juice Merchandiser/ Other 8% Supercenters/ Supermarket/ Cheetos Cheese Flavored Snacks Club/Drug/Other Grocery 37% Aquafina Bottled Water 23% Convenience 11% 7UP (outside U.S.) Grocery Restaurant/ Lipton Teas Foodservice/ 33% Vending Quaker Cereals 27% Mass Merchandiser/ Ruffles Potato Chips Warehouse/ Club 27% Tostitos Tortilla Chips Foodservice/ Vending 9% Sierra Mist (diet and regular) Corn Chips 0 5 10 15 20

PepsiCo beverages are distributed Frito-Lay North America distributes PepsiCo has 17 mega-brands that generate $1 billion or more by a powerful go-to-market system to nearly 440,000 retail outlets each in annual retail sales. that includes company-owned each week. operations, independently-owned franchised bottlers and warehouse delivery systems.

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we’ve recently extended and bold . We reformu- in Poland, PepsiCo Beverages North Aquafina with vitamin- lated in New Zealand and Duyvis America Carbonated fortified Aquafina Alive, and and gave consumers a taste nuts in the Netherlands Soft Drink Volume vs. we’re now offering Tropicana during the largest single-day and Belgium. Non-Carbonated Soft Organics and Tropicana We are disciplined buyers, Drink Volume sampling event in Pepsi history. Essentials, juices with omega- Similarly, we kicked off the with a rigorous process for 3’s, the fatty acids known for biggest marketing campaign due diligence to ensure that helping to promote heart for Cheetos in the brand’s any potential acquisition health. Our Propel enhanced history. And keep your eyes makes complete sense from Non- brand, which was on Fritos corn chips as we both a business and culture Soft Drinks 38% among the first entries into celebrate the brand’s 75th standpoint. As diligent the enhanced water category, anniversary in 2007 with integrators, we have a special continues to meet consumer understanding of the entre- Carbonated Soft Drinks special retro packaging. 62% desires for more healthful preneurial nature of smaller options through brand Mergers and “tuck-in” acquisitions and extensions like Propel Calcium. Acquisitions exercise a thoughtful Through our North American Our people have the skills to approach to helping these Carbonated soft drinks Coffee Partnership with pinpoint, acquire and seam- new businesses preserve and generate the largest volumes. Starbucks, we introduced lessly integrate businesses — build upon their unique Starbucks Iced Coffee as well big and small. This has capabilities, such as the high as Strawberries and Crème enabled us to successfully add level of involvement Stacy’s and Starbucks large companies, like Quaker has with its consumers. We DoubleShot Light. and Tropicana, and regularly not only sign the deals, but Creating new products is add smaller “tuck-in” deals we are committed to making not the only way we build that enhance and expand our them work. brands. We are experts at existing operations. These capturing consumer attention PepsiCo Beverages North include our recent acquisitions America Carbonated with our brands. In 2006, we of Izze Beverage Co., Naked Soft Drink Revenue vs. solidified Pepsi’s popularity Juice, and Stacy’s Pita Chip Non-Carbonated Soft among music fans when Company in the United Drink Revenue Grammy award-winning artist States, as well as Star Foods Mariah Carey wrote and recorded original ringtones for the Pepsi Cool Tones and Motorola Phones promotion. Carbonated In international markets, a Soft Drinks Non-Carbonated 31% Pepsi advertising campaign Soft Drinks 69% included an engaging theme song called “DaDaDa” that caught on by connecting soccer fans around the world. We give our brands special attention. For example, in 2006 Non-carbonated beverages we unveiled new packaging generate the largest revenue. and a new logo for Doritos tortilla chips to communicate the brand’s powerful crunch

Quaker Oatmeal and Tropicana Pure Premium are important brands in our health and wellness portfolio of products.

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Our products are known by trusted brand names in each region of the world, such as Sabritas in Mexico. U.S. Liquid Refreshment Beverage Market Share % Volume in Measured Channels

Other PepsiCo 19% 26%

Nestlé Private Label 8% 14%

Coca-Cola 23% Cadbury Schweppes 10% PepsiCo has the leading share of the liquid refreshment beverage market.

Our Unique Culture PepsiCo’s most important advantage resides in our people and the way we operate. We PepsiCo Net Revenues from work hard to recruit, train, develop and — most of all — retain a diverse team of the best Smart Spot Eligible Products U.S. and Canada and brightest. We emphasize results, personal ownership and operational excellence. % Net Revenue

Our People and doing what it takes to example, the BPT efforts will exceed their expectations. help us provide one invoice Our people represent Most of all, we share a to our customers, rather than PepsiCo’s ultimate competitive set of PepsiCo Values — multiple invoices from our advantage. Diversity and represented in a commitment various businesses. Smart Spot inclusion are fundamental to 43% to deliver sustained growth PepsiCo’s Power of One our success. We recognize through empowered people, initiatives continue to bring that a diverse workforce and Non-Smart Spot operating with responsibility new efficiencies to our 57% a diverse supplier base help and building trust. relationships with customers. us understand and meet the For example, through needs of our diverse consumer The Way We Operate “Innovation Summits” with base. An inclusive atmosphere We make, move and sell millions our customers, we deepen our allows everyone to contribute A wide variety of PepsiCo of products every day, which understanding of their needs fully, generating new ideas products carry the Smart Spot is why day-to-day operational and can build on the benefits and driving innovation. symbol to identify choices that can excellence is so critical. we bring, with both our Our “ownership culture” contribute to healthier lifestyles. Our Business Process products and delivery systems empowers our associates. We Transformation (BPT) is across the entire supply chain. are a big company that thinks simplifying and accelerating like a small enterprise. Our the speed of our information associates fundamentally see technology processes. Our their jobs as finding solutions goal is to make it easier for for customers and consumers our retail and other customers to do business with us. For

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In 2006, PepsiCo associate volunteers and KABOOM, a not–for–profit organization, built 12 playgrounds in inner cities to encourage children to be more physically active.

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Purpose

Today’s consumers increasingly view their spending decisions as a way to make a Our Mission difference in the world. They want to see their values reflected in the products they buy We aspire to make PepsiCo and their communities strengthened by the businesses they support. At PepsiCo, we the world’s premier consumer believe we are in a perfect position to meet these needs. We strive to do better by doing better. In delivering on this commitment, we’ve identified three areas where we believe products company, focused on we can have the most impact: human sustainability, environmental sustainability and convenient foods and talent sustainability. beverages. We seek to produce healthy financial rewards for Human Sustainability investors as we provide People need to be nourished in many ways, ranging from what they eat to how they live. We opportunities for growth and call this human sustainability, and the areas where we can make the greatest difference are enrichment to our employees, through the products we offer consumers and through our efforts to encourage consumers to our business partners and the adopt more active lifestyles. As we pursue these priorities, we tap into the deep expertise and communities in which we counsel of our Blue Ribbon Health and Wellness Advisory Board, established to help us operate. And in everything address health and wellness opportunities. we do, we strive to act with Products consumers see the green Active Lifestyles honesty, openness, fairness Smart Spot symbol that says and integrity. In the United States, our Smart We’re committed to helping “Smart Choices Made Easy.” Spot symbol makes it easier for consumers fight obesity and live And on the back of the pack- consumers to identify our healthier lives by supporting aging we describe what makes products that are nutritious, programs that help them each product a better choice. can contribute fiber, vitamins engage in more active lifestyles. As new technologies and or other important nutrients, Among the programs we’re ingredients become available, or are reduced in fat, sugar or proud to sponsor is America we’re committed to making sodium. Products with the On the Move (AOM), a national our core products better Smart Spot symbol meet effort in the United States choices. For example, Frito-Lay nutrition criteria based on dedicated to helping North America’s Ruffles and authoritative statements individuals, families and Lay’s potato chips and Walkers from the U.S. Food and Drug communities make positive United Kingdom’s snacks Administration and the changes in their health and reduced the saturated fat in National Academy of Sciences quality of life. AOM recom- their leading potato crisp and or provide other functional mends making small changes, chip brands by switching to benefits. Today, more than 250 such as walking 2,000 more sunflower oil, which delivers of our products carry the Smart steps and consuming 100 nine million youths. We have improved nutrition without Spot symbol. On the front fewer calories per day, as programs on the local level sacrificing taste. panel of the product packaging a way for consumers to as well. For example, in incorporate healthy habits Chicago through the Chicago into their everyday lives and Communities in Schools and avoid weight gain. The the Consortium to Lower African American and Latino Obesity in Chicago Children communities face some of the (CLOCC) we are collaborating greatest health risks. That’s on an effort to pilot, test and why in partnership with the deliver a health promotion National Urban League and program in six Chicago the National Council of La Raza, communities and schools. we're using the messages Outside the United States, and methods of AOM to we support initiatives such as promote healthier living the Gatorade Schools program among these constituencies. in Brazil, which encourages We believe it is important to good nutrition and physical develop the habit of exercising activity. In Mexico, we support early in life so we have many a program to construct recre- programs for young people. In ational areas in indigenous the United States, our alliance shelters in order to promote with the YMCA, the largest sports in these communities. provider of fitness programs, is The PepsiCo Smart Spot symbol helps consumers select products such expected to reach more than as Baked! Cheetos, which are lower in calories.

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School Programs breakthrough step to adopt a practical policy for snack, We recognize the critical food and beverage offerings importance of helping children in U.S. schools. learn to make healthy food choices. In 2006, PepsiCo was Marketing the only company to be part We have begun to enlist our of two historic agreements — products in promoting key one for beverages and one issues. Through the North for snacks — to provide schools American Coffee Partnership, in the United States with our joint venture with products that can contribute Starbucks Coffee Company, to healthier lifestyles. we entered into an agreement Through our partnership to increase distribution of with the Alliance for a to retail stores in Healthier Generation — a the United States. For each joint initiative of the William bottle of Ethos Water that is J. Clinton Foundation and the sold, a $0.05 donation is American Heart Association made to help children and — we will offer U.S. schools their communities around the products that meet specific world get access to clean nutritional guidelines. Under drinking water. Environmental Sustainability the beverage guidelines, we Frito-Lay’s SunChips no longer will offer full-calorie Environmental sustainability means replenishing resources we brand sponsored the Komen soft drinks, juice drinks or use — on our planet and in the communities we serve. We have Race for the Cure National teas in any K-12 schools, and defined our focus areas to be water, packaging and energy. In Volunteer Recognition we’ll limit the calories and our communities we are supporting the fight against HIV/AIDS Program in the United States. portion sizes of beverages, as well as other philanthropic and volunteer activities. The partnership included including sports drinks and SunChips’ “Crunch for the sure the communities in juices. On the snacks side, Water Cure” pink bags, with part of which we operate have access we helped set the first-ever Our water program goals the proceeds going to the to sufficient water. For voluntary guidelines for what begin with making sure our Susan G. Komen Breast Cancer example, in India, PepsiCo is will be offered in U.S. schools. practices are responsible. We Foundation to support the supporting The Energy and Both agreements represent a work closely with governments, fight against breast cancer. Resources Institute (TERI) to municipalities and technical help improve water processes experts when locating our and management. These facilities to ensure adequate projects include an evaluation quantity and quality of water of water resources and supply. We have programs preparation of area-wide to reduce our use of water management plans, including and reuse water whenever the rejuvenation of traditional possible. Gatorade, for exam- water systems. ple, is reducing its water use The PepsiCo Foundation is by installing waterless rinsing working with the China systems to clean its bottles. Women’s Development We are focused on finding Foundation on a research new opportunities to save initiative to expand availability water. For example, across of safe drinking water for the Frito-Lay North America our people of Western and Central water conservation initiatives China. PepsiCo China’s work have reduced the quantity of with the Mothers’ Water Cellar water used in processing Project has already brought snack chips by more than one- water to thousands of families third since 1999. in remote locations by building Where water shortages are water storage wells and the an issue, we recognize our capability to harvest rainwater. responsibility to help make Through our North American Coffee Partnership, our joint venture with Starbucks, PepsiCo is working to increase distribution of Ethos Water, which will donate $0.05 for every bottle sold to help children around the world get clean drinking water. 18 267419_L01_P16_21.v3.qxd 3/5/07 10:51 PM Page 19

Programs with the National Council of La Raza and the National Urban League encourage physical activity and healthier eating and Selected 2006 address health concerns of African American and Latino consumers. Environmental Honors For decades, our snack food PepsiCo China: four operations have recovered awards for Mothers’ starch released in the potato Water Cellar Project. chip making process. In 2006, PepsiCo: Vision for our United Kingdom snack America Award from Keep food operation received America Beautiful. government approval for a Frito-Lay North America: process that creates food- Energy Star Partner of the grade level starch, much Year from the Environmental of which can be used in our Protection Agency (EPA) own products. and the Department of Recycling is a way of life at Energy (DOE). PepsiCo. The Frito-Lay direct- Frito-Lay San Antonio, Texas: store-delivery system enables WaterSaver Award. our associates to recover delivery cartons after use. A Frito-Lay California: typical carton makes about six Bakersfield and Modesto facilities won the state trips, eliminating some 60 WRAP award for outstand- billion pounds of solid waste a ing performance in reducing Our Ethos Water distribu- We begin with our year. We helped found the solid waste. tion agreement has a goal operations. For example, in National Recycling Partnership, of contributing at least $10 the United States today a an initiative to increase recy- million by the end of 2010 20-ounce Gatorade Thirst cling across the United States. to help children and their Quencher bottle weighs And we have supported Keep communities recycle more communities around the world 10% less and uses 70% less America Beautiful’s (KAB) Great than 36 million beverage get clean drinking water. Our packaging to deliver the American Cleanup, the nation’s bottles. Sam’s Clubs provided support of The Safe Water product than the same largest voluntary clean-up school grants, as well as Network, a not-for-profit size bottle sold in 1998. program, since its inception. fleece jackets made with organization we helped estab- Tropicana re-engineered the In 2006, Pepsi-Cola North recycled plastic, for needy lish, is focused on developing way it delivers apple juice America partnered with Sam’s children in the area. and deploying new affordable concentrate in the United Club and KAB in an innova- Helping to reduce waste is water purification technology States. Its move to recyclable tive program called “Return just as important in our to provide safe water to “flexi” bags eliminated nearly the Warmth.” KAB helped markets outside the United communities in need. 43,000 steel drums annually. States. In India, for example, We also share our water we convert packaging film expertise. In India, for example, waste to boards, building and we’ve shown farmers tech- furniture material. niques that save water by directly seeding rice paddies, Energy rather than growing the rice In 2006, Frito-Lay was through highly water-intensive recognized by the United States conventional seeding. Environmental Protection Agency (EPA) and the U.S. Packaging Department of Energy (DOE) We are committed to reducing, for energy conservation. reusing and recycling our pack- The EPA and DOE conferred aging and waste. To help us Partner-of-The-Year in Energy achieve our goals, we have Management to Frito-Lay established a Sustainable North America for its Packaging Team. Its objectives voluntary efforts to reduce include developing alternative greenhouse gas emissions packaging material technolo- through energy efficiency. gies and supporting responsible At Tropicana we reduced A Pepsi-Cola North America program with Keep America Beautiful disposal practices. and Sam’s Club encouraged recycling by providing grants to schools our electricity demand by that recycled the most beverage containers and donating fleece eliminating some refrigeration jackets made with recycled plastic to needy children in the community.

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and instead storing juice more and more. For example, annual report was made with In-kind donations include blends in aseptic tanks at in Cupar, Scotland, our Quaker recycled paper and “Green food and beverages donated above freezing temperatures. oat mill is using electricity Power,” which means that the to food banks. Our commu- The operation also co-gener- from 100% renewable sources. power used in the creation of nity outreach programs ates power and heat to meet And at our Frito-Lay plant in some of the paper was not include community service most of our on-site electricity Modesto, California, we’re from fossil fuel. weeks. During our 2006 needs. Three of our Gatorade building a production line in Global Week of Community plants capture and reuse which nearly three-quarters HIV/AIDS Service, more than 1,000 biogas, a by-product of water of the heat needed to HIV/AIDS poses a major threat associates provided volunteer treatment operations, as produce SunChips brand in many places where we work in their communities in boiler fuel. multigrain snacks will come operate, especially in high the United States, Mexico and One way we are reducing from solar thermal energy. risk countries such as South South Africa. In Mexico City, greenhouse gas emissions is Our focus extends to the Africa, India, Russia, China for example, Sabritas associ- by using alternative power pages you are reading. This and Thailand. Our global ates repaired the “Casa de los HIV/AIDS policy provides a Niños de Palo Solo,” a health template to help fight the development center serving pandemic, and our associates approximately 260 children. have joined in the fight. For Our associates are active in example, in South Africa our their communities in innova- Simba associates serve as Peer tive ways. In Brazil, an Elma Educators in the community. Chips truck has been turned into a roving library for Contributions and children. In Vietnam, through Community Service the Poor Patient’s Association, Through the PepsiCo our associates help economi- Foundation, and our corporate cally disadvantaged people and divisional contributions, receive medical care. In Egypt we provide financial support and Lebanon, our businesses for not-for-profit organizations support scholarships to help across the globe. Focus areas young people continue include health and wellness, their education. diversity and inclusion, the In India, we’re promoting environment, employee seaweed farming as a local community engagement and employment opportunity for humanitarian aid in the event women in remote coastal of disaster. Groups looking for communities, who would PepsiCo water programs reach into communities to help address water support can apply on-line at otherwise have to travel shortages. In India, programs are bringing water to drought stricken www.pepsico.com. great distances to find work. areas and developing water management programs in areas where monsoons are common.

Sustainability Time Line Selected 2006 Community 2006 Contribution Summary and Sustainability Honors 1999 Frito-Lay North America 2004 Sustainability Task PepsiCo begins formal resource Force formed. International Corporate Foundation $21.9 Million conservation program. Courage Award: AIDS 2005 Environmental Management Responsibility Project (ARP). Corporate 2001 PepsiCo Environmental Task System developed. Contributions 5.2 Million Force formed. Gamesa — Quaker, Mexico: 2006 Dow Jones Sustainability Empresa Socialmente Divisions 4.2 Million 2002 Carbonated beverage Index North America names Responsible. packaging goal of 10% PepsiCo to list. Estimated In-Kind recycled content in 100 Best Corporate Donations 27.2 Million Pepsi-Cola North Citizens from Business Total $58.5 Million America adopted. Ethics magazine. 2003 Global Reporting Initiative America’s Most-Admired Guidelines adopted. Companies from FORTUNE magazine. Dow Jones Sustainability Index North America.

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Associates like Israel Perez, a Frito-Lay route sales representative in the Talent Sustainability New York City area, are the reason for PepsiCo’s success. Our approximately 168,000 PepsiCo associates around the world are the reason for our success. Recruiting, training and retaining our associates and building a culture of equality, diversity and inclusion allow us to achieve Talent Sustainability and demonstrate to our associates that we cherish them.

Associates wellness coaching. Our SharePower program provides Our commitment to our stock options to associates associates is formalized in our around the world and Human Rights Policy which encourages them to act like was introduced in 2006. Our owners of the company. goal is to make PepsiCo the company that hires, develops Diversity and Inclusion and retains the best people To attract and retain the best — irrespective of race, people, we seek to create a color, creed, gender or diverse and inclusive culture lifestyle orientation. where everyone has equal There are many ways we opportunity to contribute are making this a reality — and to succeed. We have Our focus on diversity is ranging from how we train, several initiatives to help us Spending with U.S. equally strong in our procure- reward and compensate our in this area. Our Diversity and minority–owned and ment processes. We have associates to our robust and Inclusion Governance Council, women–owned suppliers teams dedicated to increasing historic diversity and inclusion formed in 2005, is a cross- the diversity of our supplier programs. Company programs surpassed $1 billion for divisional, cross-functional base. In 2006, for the help associates manage their the first time. group composed of internal first time, we surpassed careers, train for advancement, and external thought leaders. $1 billion in purchases from increase their knowledge and Its mission is to raise the bar of programs to promote U.S. minority-owned and skills, and participate in lifestyle on diversity and inclusion. diversity and inclusion and women-owned suppliers. and personal development Our Ethnic Advisory Boards support employees. In the opportunities. HealthRoads, provide counsel and advice United Kingdom and Ireland offered in North America, is a on business issues ranging Times, for example, we were For more information, read our health benefits program that from marketing our brands to rated as one of the ”Top 50 sustainability report, visit the promotes healthier lifestyles supporting our employees. Places Where Women Want Corporate Citizenship section and for our associates and their Outside North America to Work.“ see our environmental programs families through information, we have a growing number in action at www.pepsico.com. online tools and personalized

Selected 2006 Diversity and Inclusion Honors U.S. Diversity and Inclusion Statistics America’s Top Corporations for Women’s Business Enterprises: Total Women % Minority % Women’s Business Enterprise National Council (WBENC). Board of Directors 14 3 21 4 29 Top 50 Companies for Diversity: Diversity, Inc. Senior Executives 23 4 17 6 26 40 Best Companies for Diversity: Black Enterprise. Executives 2,165 696 32 422 19 National Association of Asian American Professionals All Managers 12,903 3,919 30 2,903 22 Convention: NAAAP Convention Excellence award. All Employees 62,251 15,169 24 18,573 30 Latina Style magazine: The 50 Best Companies for Latinas to At year-end we had approximately 168,000 associates worldwide. Work for in the U.S. Hispanic Business magazine: Top 50 Companies for Hispanics. Our Board of Directors is pictured on page 23. Our Senior Executives include Corporate and Division Officers based in the United States. United Kingdom and Ireland Times: Top 50 Places Where Women The list appears on page 22. Beginning this year, we are including Want to Work. Professionals in the All Managers category to better capture our PepsiCo scores 100% on the Corporate Equality Index. executive talent pool.

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Corporate Officers and Principal Divisions

Executive Offices PepsiCo, Inc. PepsiCo North America 700 Anderson Hill Road 700 Anderson Hill Road Purchase, NY 10577 Purchase, NY 10577 914-253-2000 914-253-2000 John C. Compton Co–founder of PepsiCo Chief Executive Officer 45. 23 years. Donald M. Kendall Over 55 years of PepsiCo experience. Division Officers Frito-Lay North America QTG (Quaker Foods/ 7701 Legacy Drive Tropicana/Gatorade) Corporate Officers Plano, TX 75024 QTG Plaza 972-334-7000 555 West Monroe Street Steven S Reinemund Chicago, IL 60661 Executive Chairman and Chairman of the Board of Directors Albert P. Carey 312-821-1000 58. 22 years. President and Chief Executive Officer 55. 25 years. Charles I. Maniscalco Indra K. Nooyi President and Chief Executive Officer Chairman Elect and Chief Executive Officer Pepsi-Cola North America 53. 26 years. 51. 13 years. 700 Anderson Hill Road Purchase, NY 10577 PepsiCo Sales Mitch Adamek Margaret D. Moore 914-253-2000 700 Anderson Hill Road Senior Vice President and Chief Senior Vice President, Purchase, NY 10577 Dawn Hudson 914-253-2000 Procurement Officer Human Resources President and Chief Executive Officer 45. 17 years. 59. 33 years. 49. 10 years. Tom Greco Peter A. Bridgman Lionel L. Nowell III President, Sales Senior Vice President and Senior Vice President 48. 20 years. Controller and Treasurer 54. 21 years. 52. 15 years. PepsiCo International 700 Anderson Hill Road Richard Goodman Ronald C. Parker Purchase, NY 10577 Chief Financial Officer Senior Vice President, 914-253-2000 58. 13 years. Human Resources, PepsiCo North America Michael D. White Wahid Hamid and Senior Vice President, Chief Executive Officer, PepsiCo International and Vice Chairman, PepsiCo Senior Vice President, Corporate Global Diversity, PepsiCo Strategy and Development 53. 24 years. Division Officers 48. Less than one year. PepsiCo Asia PepsiCo Latin America Sabritas & Gatorade Clay G. Small Hugh F. Johnston 20th Floor Region Foods & Bosques de Duraznos No. 67 Senior Vice President, Caroline Center Col. Bosques de las Lomas Executive Vice President, Managing Attorney Beverages Operations 28 Yun Ping Road Av. Lázaro Cárdenas 2404 Pte. 11700 Mexico D.F. 57. 25 years. Causeway Bay Mexico 45. 19 years. Col. Residencial San Agustín Hong Kong 52-55-2582-3000 Larry D. Thompson Garza García, NL 852-2839-0288 66270 Antonio Lucio Senior Vice President, Pedro Padierna Chief Health and Wellness Government Affairs Mexico Ron McEachern 52-81-8399-5151 President Innovation Officer General Counsel and Secretary President 56. 19 years. 47. 11 years. 61. 2 years. 54. 22 years. Salvador Alva President PepsiCo United Tod J. MacKenzie Cynthia M. Trudell PepsiCo Europe 56. 23 years. Kingdom Senior Vice President, Senior Vice President and Chief 50, rue du Rhône 1600 Arlington Business Park Corporate Communications Personnel Officer CH – 124 Geneva PepsiCo Middle Theale, Reading 49. 19 years. 53. Less than one year. Switzerland East & Africa Berkshire 41-22-818-6900 Matthew M. McKenna Michael D. White Khalid Ibn Al Waleed Road RG7 4SA UK Senior Vice President, Finance Chief Executive Officer, Zein Abdalla Bank of Fujairah Building, 44-118-930-6666 3rd Floor 56. 13 years. PepsiCo International President PO Box 11330 Salman Amin and Vice Chairman, PepsiCo 47. 11 years. Dubai President 55. 17 years. United Arab Emirates 47. 11 years. 971-4-397-1666 PepsiCo International Saad Abdul–Latif Commercial President 700 Anderson Hill Road 53. 25 years. Purchase, NY 10577 914-253-2000 Massimo d’Amore Executive Vice President 51. 12 years. 22 267419_L01_P22_26.v3.qxd 3/5/07 11:07 PM Page 23

PepsiCo Board of Directors

Back row, left to right: Robert E. Allen, John F. Akers, Victor J. Dzau, M. D., Sharon Percy Rockefeller, Daniel Vasella. Second row, left to right: Franklin A. Thomas, Alberto Ibargüen, Michael D. White, Ray L. Hunt, Arthur C. Martinez. Front row, left to right: Steven S Reinemund, , James J. Schiro, Indra K. Nooyi.

PepsiCo Board of Directors John F. Akers Victor J. Dzau, M.D. Arthur C. Martinez James J. Schiro Former Chairman of the Board and Chancellor for Health Affairs, Duke Former Chairman of the Board, Chief Executive Officer, Chief Executive Officer, University and President & CEO, Duke President and Chief Executive Officer, Zurich Financial Services International Business Machines University Health Systems Sears, Roebuck and Co. 61. Elected 2003. Corporation 61. Elected 2005. 67. Elected 1999. 72. Elected 1991. Franklin A. Thomas Ray L. Hunt Indra K. Nooyi Consultant, Robert E. Allen Chief Executive Officer, Chairman Elect and The Study Group Former Chairman of the Board and Hunt Oil Company, and Chief Executive Officer, 72. Elected 1994. Chief Executive Officer, Chairman, Chief Executive Officer PepsiCo AT&T Corp. and President 51. Elected 2001. Daniel Vasella 72. Elected 1990. Hunt Consolidated, Inc. Chairman of the Board and 63. Elected 1996. Steven S Reinemund Chief Executive Officer, Dina Dublon Executive Chairman, Novartis AG Consultant, Alberto Ibargüen and Chairman of the Board 53. Elected 2002. Former Executive Vice President and President and Chief of Directors, Chief Financial Officer, Executive Officer, PepsiCo Michael D. White JPMorgan Chase & Co. John S. and James L. Knight 58. Elected 1996. Chief Executive Officer, 53. Elected 2005. Foundation PepsiCo International 63. Elected 2005. Sharon Percy Rockefeller and Vice Chairman of PepsiCo President and Chief 55. Elected 2006. Executive Officer, WETA Public Stations 62. Elected 1986. PepsiCo announced on Feb. 5, 2007, the election of Indra K. Nooyi as Chairman of the Board, effective when current Chairman Steven S Reinemund retires on May 2, 2007. Listings include age and year elected a PepsiCo director. 23 267419_L01_P22_26.v4.qxd 3/6/07 8:54 AM Page 24

Ethnic Advisory Boards

Our Ethnic Advisory Boards provide management with external viewpoints on issues related to diversity and inclusion, especially in the marketplace. Board membership is established for external individuals • Marketing to targeted communities. based on their diverse backgrounds, experiences and points of • Building alliances with retailers. view. These boards provide counsel and advice on a range of • Creating products for a more diverse consumer base. business areas including: • Developing a more diverse supplier base and other business relationships.

Back row, left to right: Kweisi Mfume, Keith Clinkscales, Roderick D. Gillum, Reverend Al Sharpton, Earl G. Graves, Jr., Robert Holland, Jerri DeVard, Warren M. Thompson. Front row, left to right: Darlene Williamson, Ph.D., Ray M. Robinson, Reverend Dr. W. Franklyn Richardson, Glenda McNeal, Amy Hilliard, Earl G. Graves, Sr., Dawn Hudson, Benaree Pratt Wiley, Johnny F. Johnson, Clarence Avant. African American Advisory Board

Clarence Avant Earl G. Graves, Sr. Dawn Hudson Ray M. Robinson Chairman, Chairman and Publisher, President and President, Interior Music Earl G. Graves Ltd. Chief Executive Officer, East Lake Golf Joined 1999. Black Enterprise Magazine Pepsi-Cola North America Joined 1999. Joined 1999. Joined 1999. Keith Clinkscales Chairman of the Advisory Board Reverend Al Sharpton Senior Vice President and Johnny F. Johnson President, General Manager, Earl G. Graves, Jr. Chief Executive Officer, National Action Network ESPN Publishing President and KA Management Joined 1999. Joined 1999. Chief Executive Officer, Joined 1999. Black Enterprise Magazine Warren M. Thompson Jerri DeVard Joined 2006. Glenda McNeal Chairman and Former Senior Vice President, Brand Senior Vice President Global Chief Executive Officer, Management and Marketing Amy Hilliard Partnerships, American Express Thompson Hospitality Communications, President and Chief Joined 1999. Corporation, Inc. Verizon Communications Executive Officer, Joined 2002. Joined 2002. The Hilliard Group & Kweisi Mfume The ComfortCake Co. Former President and Benaree Pratt Wiley Roderick D. Gillum Joined 1999. Chief Executive Officer, Retired President and Vice President, Corporate National Association for the Chief Executive Officer, Responsibility and Diversity, Robert Holland Advancement of Colored The Partnership General Motors Partner, People (NAACP) Joined 2002. Joined 2005. Williams Capital Joined 2005. Joined 1999. Darlene Williamson, Ph.D. Reverend Dr. W. Franklyn Former President and Richardson Chief Executive Officer, Senior Minister, Performax Consulting Services Grace Baptist Church Joined 1999. Joined 1999.

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• Promoting PepsiCo’s diversity and inclusion efforts. Our African American Advisory Board was formed in 1999. The • Recommending diverse talent for open positions. Latino/Hispanic Advisory Board was established in 2000. Our • Encouraging the expansion of diversity representation Canada business convened an Asian Advisory Council in 2006. among PepsiCo employees. We welcome Earl Graves, Jr. to the African American • Providing a perspective on diversity and inclusion Advisory Board. We regret the passing of our esteemed issues or questions. member, Darwin Davis, Sr., who served the board since 1999. To our Latino/Hispanic Advisory Board, we welcome Cid Wilson.

Left to right: Isabel Valdés, Cid Wilson, Carlos H. Arce, Ph.D., Deborah Rosado Shaw, Raúl Yzaguirre, Albert P. Carey, Raquel Malo, Douglas X. Patiño, Ph.D., Maria Contreras-Sweet, Carlos A. Saladrigas, Victor Arias, Jr., Ricardo R. Fernández, Ph.D., Gilbert Aranza

Latino/Hispanic Advisory Board

Gilbert Aranza Ricardo R. Fernández, Ph.D. Carlos A. Saladrigas Cid Wilson President, President, Chairman, Director of Equity Research, Star Concessions Lehman College, Premier American Bank Kevin Dann and Partners, LLC The MultiRestaurant Group The City University of New York Joined 2003. Joined 2006. Joined 2000. Joined 2003. Deborah Rosado Shaw Raúl Yzaguirre Carlos H. Arce, Ph.D. Raquel Malo Partner, Presidential Professor, President and Founder, Senior Vice President, Multi-ethnic Success Ventures, LLC Center for Community Development NuStats High Performance Nutrition, Joined 2000. and Civil Rights Joined 2000. Human Performance Institute Arizona State University Joined 2004. Maria Contreras-Sweet Joined 2000. Victor Arias, Jr. Chairwoman, Chairman of the Advisory Board Partner, Douglas X. Patiño, Ph.D. Proamerica Bank Heidrick & Struggles Vice Chancellor Emeritus and Joined 2005. Joined 2000. Professor, California State University Isabel Valdés Albert P. Carey Joined 2000. Consultant, Author, Public Speaker President and Chief Executive Officer, Joined 2001. Frito-Lay North America Joined 2006.

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Blue Ribbon Health and Wellness Advisory Board

PepsiCo’s Blue Ribbon Health and Wellness Advisory Board provides advice and expertise on a variety of health and wellness initiatives. The initiatives include: • Connecting us to thought leaders and policy makers in • Improving the healthfulness of our existing products. the area of health and wellness. • Evaluating our efforts to develop new better-for-you and good-for-you products. Some of our international businesses are seeking advice in a • Providing access to resources that promote health and similar manner. For example, our Brazilian business has encourage active lifestyles. created the PepsiCo Panel of Experts. We welcome Dr. William • Identifying emerging opportunities in the area of health Sears to our Board this year. and wellness.

Front row, left to right: Brock H. Leach, Kristy F. Woods, M.D., M.P.H., James O. Hill, Ph.D., Gro Harlem Brundtland, M.D., Susan Love, M.D. Second row, left to right: David Heber, M.D., Ph.D., Pamela Peeke, M.D., M.P. H., Antonio Lucio (PepsiCo), Antonia Demas, Ph.D., Mario Maranhão, M.D., Janet Taylor, M.D. Back row, left to right: Kenneth Cooper, M.D., M.P.H., Fernando M. Treviño, Ph.D., M.P.H., James B. Hunt, Jr., Dean Ornish, M.D. Ambassador Thomas Foley, David A. Kessler, M.D., J.D., Samuel Ward Casscells, M.D., William Sears, M.D.

Gro Harlem Brundtland, M.D. Ambassador Thomas Foley Brock H. Leach William Sears, M.D. Former Director-General Akin Gump Strauss Hauer & Feld, LLP Seminary Student & Associate Clinical Professor World Health Organization, Former Speaker of the U.S. House of Community Volunteer of Pediatrics United Nations Representatives and Former U.S. PepsiCo Chief Innovation and Health & University of California, Irvine, Former Prime Minister, Norway Ambassador to Japan Wellness Officer, Retired School of Medicine Joined 2004. Joined 2003. Joined 2003. Joined 2006. Samuel Ward Casscells, M.D. David Heber, M.D., Ph.D. Susan Love, M.D. Janet E. Taylor, M.D. John Edward Tyson Distinguished Professor of Medicine & Public Health President and Medical Director Clinical Instructor of Psychiatry Professor of Medicine & Public Health Director, UCLA Center for Dr. Susan Love Research Foundation Columbia University and Vice President for Biotechnology Human Nutrition Joined 2003. Joined 2004. The University of Texas Health & Joined 2003. Science Center at Houston Mario Maranhão, M.D. Fernando M. Treviño, Ph.D., Joined 2003. James O. Hill, Ph.D. Former President M.P.H. Professor of Pediatrics & Medicine World Heart Federation Professor and Founding Dean of the Kenneth H. Cooper, M.D., University of Colorado Health Joined 2004. School of Public Health M.P.H. Sciences Center University of North Texas President & Founder Founder, America On the Move Dean Ornish, M.D. Joined 2004. The Cooper Aerobics Center Joined 2003. Founder & Director Joined 2003. Preventive Medicine Research Kristy F. Woods, M.D., Governor James B. Hunt, Jr. Institute (PMRI) M.P.H. Antonia Demas, Ph.D. Former Governor of North Carolina Joined 2003. Former Director, Maya Angelou Center Director Joined 2003. Chairman of the Advisory Board Wake Forest University Food Studies Institute Joined 2005. Joined 2003. David A. Kessler, M.D., J.D. Pamela Peeke, M.D., M.P.H. Dean, School of Medicine Assistant Professor of Medicine Vice Chancellor for Medical Affairs University of Maryland School University of California, San Francisco of Medicine Joined 2003. Joined 2003.

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Management’s Discussion and Analysis

OUR BUSINESS NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Our Operations...... 28 Note 1 — Basis of Presentation and Our Divisions...... 58 Our Customers ...... 29 Note 2 — Our Significant Accounting Policies ...... 60 Our Distribution Network ...... 30 Note 3 — Restructuring and Impairment Charges ...... 62 Our Competition...... 30 Note 4 — Property, Plant and Equipment and Intangible Assets ...... 62 Other Relationships ...... 30 Note 5 — Income Taxes ...... 64 Our Business Risks...... 31 Note 6 — Stock-Based Compensation ...... 65 OUR CRITICAL ACCOUNTING POLICIES Note 7 — Pension, Retiree Medical and Savings Plans..... 67 Revenue Recognition ...... 37 Note 8 — Noncontrolled Bottling Affiliates...... 71 Brand and Goodwill Valuations ...... 38 Note 9 — Debt Obligations and Commitments...... 72 Income Tax Expense and Accruals...... 39 Note 10 — Risk Management ...... 73 Stock-Based Compensation Expense...... 40 Note 11 — Net Income per Common Share from Pension and Retiree Medical Plans ...... 42 Continuing Operations ...... 75 Note 12 — Preferred and Common Stock ...... 76 OUR FINANCIAL RESULTS Note 13 — Accumulated Other Comprehensive Loss...... 76 Items Affecting Comparability...... 44 Note 14 — Supplemental Financial Information...... 77 Results of Continuing Operations — Consolidated Review...... 45 MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING ...... 78 Results of Continuing Operations — Division Review...... 47 MANAGEMENT’S REPORT ON INTERNAL CONTROL Frito-Lay North America ...... 48 OVER FINANCIAL REPORTING...... 79 PepsiCo Beverages North America...... 49 REPORT OF INDEPENDENT REGISTERED PUBLIC PepsiCo International...... 50 ACCOUNTING FIRM...... 80 Quaker Foods North America...... 51 SELECTED FINANCIAL DATA ...... 81 Our Liquidity and Capital Resources...... 52 RECONCILIATION OF GAAP AND NON-GAAP INFORMATION...... 82 CONSOLIDATED STATEMENT OF INCOME ...... 54 GLOSSARY ...... 82 CONSOLIDATED STATEMENT OF CASH FLOWS...... 55 CONSOLIDATED BALANCE SHEET...... 56 CONSOLIDATED STATEMENT OF COMMON SHAREHOLDERS’ EQUITY ...... 57

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Our Business Our discussion and analysis is an integral part of understanding our financial results. Definitions of key terms can be found in the glossary on page 82. Tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts.

Our Operations

We are a leading global snack and popcorn, Chester’s fries, Stacy’s pita PepsiCo International beverage company. We manufacture, chips and Quaker Fruit & Oatmeal bars. PepsiCo International (PI) manufactures market and sell a variety of salty, conve- FLNA branded products are sold to through consolidated businesses as well nient, sweet and grain-based snacks, independent distributors and retailers. as through noncontrolled affiliates, a carbonated and non-carbonated bever- number of leading salty and sweet snack PepsiCo Beverages North America ages and foods. We are organized into brands including Lay’s, Walkers, PepsiCo Beverages North America four divisions: Cheetos, Doritos, Ruffles, Gamesa and (PBNA) manufactures or uses contract Sabritas. Further, PI manufactures or manufacturers, mar- uses contract manufacturers, markets kets and sells and sells many Quaker brand snacks. PI Our Divisions beverage also manufactures, markets and sells • Frito-Lay North America (FLNA) concentrates, foun- beverage concentrates, fountain syrups tain syrups and • PepsiCo Beverages North America (PBNA) and finished goods under the brands finished goods, • PepsiCo International (PI) Pepsi, 7UP, Mirinda, Gatorade, Tropicana under various bever- and Mountain Dew. These brands are • Quaker Foods North America (QFNA) age brands including sold to authorized bottlers, independent Pepsi, Mountain distributors and retailers. However, in Dew, Gatorade, Our North American divisions oper- certain markets, PI operates its own bot- Tropicana Pure Premium, Lipton, Sierra ate in the United States and Canada. tling plants and distribution facilities. PI Mist, Tropicana juice drinks, Propel, Our international division operates in also licenses the Aquafina water brand Dole and SoBe. PBNA also manufactures approximately 200 countries, with our to certain of its authorized bottlers. PI or uses contract manufacturers, markets largest operations in Mexico and the reports two measures of volume. Snack and sells ready-to-drink tea, coffee and United Kingdom. Additional informa- volume is reported on a system-wide water products through joint ventures tion concerning our divisions and basis, which includes our own volume with Unilever (under the Lipton brand geographic areas is presented in Note 1. and the volume sold by our name) and Starbucks. In addition, PBNA noncontrolled affiliates. Beverage Frito-Lay North America licenses the Aquafina water brand to its volume reflects Company-owned and Frito-Lay North America (FLNA) manu- bottlers and markets this brand. PBNA authorized bottler sales of beverages factures or uses contract manufacturers, sells concentrate and finished goods for bearing our trademarks to independent markets, sells and distributes branded some of these brands to authorized distributors and retailers. snacks. These snacks include Lay’s bottlers, and some of these branded potato chips, Doritos tortilla chips, products are sold directly by us to inde- Quaker Foods North America Tostitos tortilla chips, Cheetos cheese pendent distributors and retailers. The Quaker Foods North America (QFNA) flavored snacks, Fritos corn chips, bottlers sell our brands as finished manufactures or uses contract manufac- branded dips, Ruffles potato chips, goods to independent distributors and turers, markets and sells cereals, rice, Quaker Chewy bars, SunChips retailers. PBNA’s volume reflects sales to pasta and other branded products. multigrain snacks, pretzels, its independent distributors and retail- QFNA’s products include Quaker Santitas tortilla chips, Frito-Lay nuts, ers, as well as the sales of beverages oatmeal, mixes and Grandma's cookies, Munchies snack bearing our trademarks that bottlers syrups, Cap’n Crunch cereal, Quaker mix, Gamesa cookies, Lay’s Stax potato have reported as sold to independent grits, Life cereal, Rice-A-Roni, Pasta Roni crisps, onion flavored rings, distributors and retailers. and Near East side dishes. These Quaker Quakes corn and rice snacks, branded products are sold to indepen- Miss Vickie’s potato chips, branded dent distributors and retailers. crackers, Quaker snack mix,

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Our Customers

Our customers include authorized support includes targeted consumer by them to these retailers. In addition, bottlers and independent distributors, and retailer incentives and direct mar- sales to (PBG) including foodservice distributors, and ketplace support, such as represented approximately 10% of our retailers. We normally grant our bot- point-of-purchase materials, product total net revenue. See “Our Related tlers exclusive contracts to sell and placement fees, media and advertising. Party Bottlers” and Note 8 for more manufacture certain beverage products Vending and cooler equipment place- information on our anchor bottlers. bearing our trademarks within a spe- ment programs support the acquisition Our Related Party Bottlers cific geographic area. These and placement of vending machines We have ownership interests in certain arrangements specify the amount to be and cooler equipment. The nature and of our bottlers. Our ownership is less paid by our bottlers for concentrate, type of programs vary annually. The than 50%, and since we do not control finished goods and Aquafina royalties, level of bottler funding is at our these bottlers, we do not consolidate as well as the manufacturing process discretion because these incentives their results. We include our share of required for product quality. are not required by the terms of our their net income based on our percent- Since we do not sell directly to the bottling contracts. age of economic ownership in our consumer, we rely on and provide income statement as bottling equity financial incentives to our customers to income. We have designated three assist in the distribution and promotion Since we do not sell directly to related party bottlers, PBG, of our products. For our independent the consumer, we rely on and PepsiAmericas, Inc. (PAS) and Pepsi distributors and retailers, these incen- provide financial incentives to Bottling Ventures LLC (PBV), as our tives include volume-based rebates, our customers to assist in the anchor bottlers. Our anchor bottlers product placement fees, promotions distribution and promotion of distribute approximately 60% of our and displays. For our bottlers, these our products. North American beverage volume and incentives are referred to as bottler approximately 18% of our international funding and are negotiated annually beverage volume. Our anchor bottlers with each bottler to support a variety of Retail consolidation continues to participate in the bottler funding pro- trade and consumer programs, such as increase the importance of major cus- grams described above. Approximately consumer incentives, advertising sup- tomers. In 2006, sales to Wal-Mart 8% of our total 2006 sales incentives are port, new product support, and represented approximately 9% of our related to these bottlers. See Note 8 for vending and cooler equipment place- total net revenue; and our top five retail additional information on these related ment. Consumer incentives include customers represented approximately parties and related party commitments coupons, pricing discounts and promo- 26% of our 2006 North American net and guarantees. tions, such as sweepstakes and other revenue, with Wal-Mart representing promotional offers. Advertising support approximately 13%. These percentages is directed at advertising programs and include concentrate sales to our bottlers supporting bottler media. New product which are used in finished goods sold

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Our Distribution Network

Our products are brought to market bottlers. Direct-store-delivery enables us have lower turnover, and are less likely through direct-store-delivery, broker- to merchandise with maximum visibility to be impulse purchases. warehouse and foodservice and and appeal. Direct-store-delivery is Foodservice and Vending vending distribution networks. The dis- especially well-suited to products that Our foodservice and vending sales force tribution system used depends on are restocked often and respond to distributes snacks, foods and beverages customer needs, product characteristics in-store promotion and merchandising. to third-party foodservice and vending and local trade practices. Broker-Warehouse distributors and operators. Our foodser- Direct-Store-Delivery Some of our products are delivered vice and vending sales force also We, our bottlers and our distributors from our manufacturing plants and distributes certain beverages through operate direct-store-delivery systems that warehouses to customer warehouses our bottlers. This distribution system deliver snacks and beverages directly to and retail stores. These less costly sys- supplies our products to schools, retail stores where the products are tems generally work best for products businesses, stadiums, restaurants and merchandised by our employees or our that are less fragile and perishable, similar locations.

Our Competition

Our businesses operate in highly com- America. Further, our snack brands hold tors, as well as national and global petitive markets. We compete against significant leadership positions in the snack competitors, and compete on global, regional, local and private label issues related to price, quality, product manufacturers on the basis of price, variety and distribution. Success in this quality, product variety and distribution. We believe that the strength of our competitive environment is dependent In measured channels, our chief bever- brands, innovation and marketing, on effective promotion of existing age competitor, The Coca-Cola coupled with the quality of our products and the introduction of new Company, has a slightly larger share of products and flexibility of our products. We believe that the strength carbonated soft drink (CSD) consump- distribution network, allow us to of our brands, innovation and market- tion in the U.S., while we have a larger compete effectively. ing, coupled with the quality of our share of chilled juices and isotonics. In products and flexibility of our addition, The Coca-Cola Company main- distribution network, allow us to tains a significant CSD share advantage snack industry worldwide. Our snack compete effectively. in many markets outside North brands face local and regional competi-

Other Relationships

Certain members of our Board of transactions with these vendors and anchor bottlers and other affiliated Directors also serve on the boards of cer- customers are in the normal course of companies and do not receive tain vendors and customers. Those business and are consistent with terms incremental compensation for their Board members do not participate in negotiated with other vendors and cus- Board services. our vendor selection and negotiations tomers. In addition, certain of our nor in our customer negotiations. Our employees serve on the boards of our

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Our Business Risks

We are subject to risks in the normal course of business due to adverse advertising campaigns and marketing developments with respect to: programs. In addition, both the launch and ongoing success of new products • product demand, and advertising campaigns are inherently • our reputation, uncertain, especially as to their appeal to consumers. Our failure to successfully • information technology, launch new products could decrease demand for our existing products by • supply chain, negatively affecting consumer percep- • retail consolidation, the loss of major customers tion of existing brands, as well as result in inventory write-offs and other costs. and failure to maintain good relationships with our bottling partners, Any damage to our reputation • global, economic, environmental and political conditions, could have an adverse effect on our business, financial condition and • the regulatory environment, results of operations. • workforce retention and outsourcing, Maintaining a good reputation globally is critical to selling our branded • raw materials and other supplies, products. If we fail to maintain high • competition, and standards for product quality, safety • market risks. Maintaining a good reputation globally is critical to selling our Demand for our products may be a variety of factors, including the aging branded products. adversely affected by changes in of the general population, changes in consumer preferences and tastes social trends, changes in travel, vacation or if we are unable to innovate or or leisure activity patterns, weather, and integrity, our reputation could be market our products effectively. negative publicity resulting from regu- jeopardized. Adverse publicity about latory action or litigation against these types of concerns or the incidence We are a consumer products company companies in the industry, or a down- of product contamination or tamper- operating in highly competitive markets turn in economic conditions. Any of ing, whether or not valid, may reduce and rely on continued demand for our these changes may reduce consumers’ demand for our products or cause pro- products. To generate revenues and willingness to purchase our products. duction and delivery disruptions. If any profits, we must sell products that Our continued success is also depen- of our products becomes unfit for con- appeal to our customers and to dent on our product innovation, sumption, misbranded or causes injury, consumers. Any significant changes in including maintaining a robust pipeline we may have to engage in a product consumer preferences and any inability of new products, and the effectiveness recall and/or be subject to liability. A on our part to anticipate and widespread product recall or a react to such changes could significant product liability judg- result in reduced demand for Our continued success is dependent on our ment could cause our products our products and erosion of product innovation, including maintaining a to be unavailable for a period of our competitive and financial robust pipeline of new products, and the time, which could further reduce position. Our success depends effectiveness of our advertising campaigns consumer demand and brand on our ability to respond to and marketing programs. equity. Failure to maintain high consumer trends, such as con- ethical, social and environmental sumer health concerns about standards for all of our opera- obesity, product attributes and of our advertising campaigns and mar- tions and activities or adverse publicity ingredients. In addition, changes in keting programs. There can be no regarding our responses to health con- product category consumption or con- assurance as to our continued ability cerns, our environmental impacts, sumer demographics could result in either to develop and launch successful including agricultural materials, pack- reduced demand for our products. new products or variants of existing aging, energy and water use and waste Consumer preferences may shift due to products, or to effectively execute management, or other sustainability

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issues, could also jeopardize our reputa- information or disrupting business programs to our customers could tion. Failure to comply with local laws processes. Such unauthorized access reduce our ability to secure adequate and regulations, to maintain an effec- could disrupt our business and could shelf space at our retailers and adversely tive system of internal controls or to result in the loss of assets. affect our financial performance. provide accurate and timely financial Retail consolidation continues to statement information could also hurt Disruption of our supply chain increase the importance of major cus- our reputation. Damage to our reputa- could have an adverse effect on our tomers. Sales to Wal-Mart represent tion or loss of consumer confidence in business, financial condition and approximately 9% of our total net rev- our products for any of these reasons results of operations. enue; and our top five retail customers could have a material adverse effect on currently represent approximately 26% Our ability and that of our suppliers, our business, financial condition business partners, including bottlers, and results of operations, as well as contract manufacturers, independent require additional resources to rebuild We must maintain mutually distributors and retailers, to make, our reputation. beneficial relationships with move and sell products is critical to our our key customers, including success. Damage or disruption to our or If we are not able to build and our retailers and bottling sustain proper information their manufacturing or distribution capabilities due to weather, natural dis- partners, to effectively technology infrastructure, our aster, fire or explosion, terrorism, compete. business could suffer. pandemics such as avian flu, strikes or We depend on information technology other reasons, could impair our ability of our 2006 North American net as an enabler to improve the effective- to manufacture or sell our products. revenue, with Wal-Mart representing ness of our operations and to interface Failure to take adequate steps to miti- approximately 13%. These percentages with our customers, as well as to main- gate the likelihood or potential impact include concentrate sales to our bottlers tain financial accuracy and efficiency. If of such events, or to effectively manage which are used in finished goods sold we do not allocate and effectively man- such events if they occur, could by them to these retailers. Loss of any age the resources necessary to build adversely affect our business, financial of our key customers, including Wal- and sustain the proper technology condition and results of operations, as Mart, could have an adverse effect on infrastructure, we could be subject to well as require additional resources to our business, financial condition and transaction errors, processing inefficien- restore our supply chain. results of operations. cies, the loss of customers, business Furthermore, if we are unable to disruptions, or the loss of or damage Trade consolidation, the loss of any provide an appropriate mix of incen- to intellectual property through key customer, or failure to maintain tives to our bottlers through a security breach. good relationships with our bottling combination of advertising and market- We have embarked on a multi-year partners could adversely affect our ing support, they may take actions that, Business Process Transformation (BPT) financial performance. while maximizing their own short-term initiative that includes the delivery of We must maintain mutually beneficial profit, may be detrimental to us or our an SAP enterprise resource planning relationships with our key customers, brands. Such actions could have an application, as well as the migration to including our retailers and bottling adverse effect on our profitability. See common business processes across our partners, to effectively compete. There “Our Customers,” “Our Related Party operations. There can be no certainty is a greater concentration of our cus- Bottlers” and Note 8 to our that these programs will deliver the tomer base around the world generally consolidated financial statements for expected benefits. The failure to deliver due to the continued consolidation of more information on our customers, our goals may impact our ability to retail trade. As retail ownership including our anchor bottlers. (1) process transactions accurately and becomes more concentrated, retailers efficiently and (2) remain in step with demand lower pricing and increased the changing needs of the trade, which promotional programs. Further, as could result in the loss of customers. In larger retailers increase utilization of addition, the failure to either deliver their own distribution networks and the application on time, or anticipate private label brands, the competitive the necessary readiness and training advantages we derive from our go-to- needs, could lead to business disruption market systems and brand equity may and loss of customers and revenue. be eroded. Failure to appropriately Our information systems could also respond to these trends or to offer be penetrated by outside parties intent effective sales incentives and marketing on extracting information, corrupting

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Our business may be adversely interpretations may alter the environ- ating results could be adversely affected impacted by unfavorable economic ment in which we do business and, by increased costs due to increased or environmental conditions or therefore, may impact our results or competition for employees, higher political or other developments increase our costs or liabilities. employee turnover or increased and risks in the countries in which In particular, governmental bodies in employee benefit costs. Any unplanned we operate. jurisdictions where we operate may turnover could deplete our institutional impose new labeling, product or pro- knowledge base and erode our compet- Unfavorable global economic or envi- duction requirements, or other itive advantage. ronmental changes, political conditions restrictions. For example, Proposition 65 In addition, we have outsourced cer- or other developments may result in in California requires that a warning be tain information technology support business disruption, supply constraints, given for any product that exposes con- services and administrative functions, foreign currency devaluation, inflation, sumers to a substance listed by the state such as payroll processing and benefit deflation or decreased demand. Un- as having been found to cause cancer or plan administration, to third-party ser- stable economic and political conditions birth defects. If we were required to vice providers and may outsource other or civil unrest in the countries in which label any of our products or place warn- functions in the future to achieve cost we operate could have adverse impacts ings in locations where our products are savings and efficiencies. If the service on our business results or financial con- sold in California under Proposition 65, providers that we outsource these func- dition. Our operations outside of the tions to do not perform U.S. accounted for 41% and 36% of our effectively we may not be able net revenue and operating profit, Our operations outside of the U.S. to achieve the expected cost respectively, for the year ended accounted for 41% and 36% of our net savings and may have to incur December 30, 2006. Our continued suc- revenue and operating profit, additional costs to correct cess depends on our ability to broaden respectively, for the year ended errors made by such service and strengthen our presence in emerg- December 30, 2006. providers. Depending on the ing markets, such as Brazil, Russia, India function involved, such errors and China, and to create scale in key may also lead to business dis- international markets. sales of those products could suffer not ruption, processing inefficiencies or the only in California but elsewhere as a loss of or damage to intellectual prop- Regulatory decisions and changes in result of the adverse publicity. erty through security breach, or harm the legal and regulatory environment In many jurisdictions, compliance employee morale. could increase our costs and liabilities with competition laws is of special or limit our business activities. importance to us due to our competi- Our operating results may be The conduct of our businesses, and the tive position in those jurisdictions. adversely affected by increased production, distribution, sale, advertis- Regulatory authorities under whose costs, disruption of supply or ing, labeling, safety, transportation and laws we operate may also have enforce- shortages of raw materials and use of many of our products, are subject ment powers that can subject us to other supplies. actions such as product recall, seizure of to various laws and regulations adminis- We and our business partners use vari- products or other sanctions, which tered by federal, state and local ous raw materials and other supplies in could have an adverse effect on our governmental agencies in the United our business, including , sales or damage our reputation. States, as well as to foreign laws and cocoa, corn, corn sweeteners, regulations administered by If we are unable to hire or retain flavorings, flour, grapefruits and other government entities and agencies in fruits, juice and juice concentrates, oats, markets in which we operate. These key employees or outsource certain functions effectively, it could have a oranges, potatoes, rice, seasonings, laws and regulations may change, sucralose, sugar, vegetable and essential negative impact on our business. sometimes dramatically, as a result of oils, and wheat. Our key packaging political, economic or social events. Our continued growth requires us to materials include aluminum used for Such regulatory environment changes develop our leadership bench and to cans, PET resin used for plastic bottles, include changes in food and drug laws, implement programs, such as our long- film packaging used for snack foods, laws related to advertising and decep- term incentive program, designed to and cardboard. Fuel and natural gas are tive marketing practices, accounting retain talent. However, there is no also important commodities due to standards, taxation requirements, com- assurance that we will continue to be their use in our plants and in the trucks petition laws and environmental laws, able to hire or retain key employees. delivering our products. Some of these including laws relating to the regula- We compete to hire new employees, raw materials and supplies are available tion of water rights and treatment. and then must train them and develop from a limited number of suppliers. We Changes in laws, regulations or govern- their skills and competencies. Our oper- are exposed to the market risks arising mental policy and the related

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from adverse changes in commodity ners may face disruption of supply or Forward-Looking and Cautionary prices, affecting the cost of our raw increased costs to obtain the water Statements materials and energy. The raw materials needed to produce our products. We discuss expectations regarding and energy which we use for the pro- our future performance, such as our duction of our products are largely Our business could suffer if we are business outlook, in our annual and commodities that are subject to price unable to compete effectively. quarterly reports, press releases, and volatility and fluctuations in availability Our businesses operate in highly com- other written and oral statements. caused by changes in global supply and petitive markets. We compete against These “forward-looking statements” demand, weather conditions, agricul- global, regional and private label are based on currently available tural uncertainty or governmental manufacturers on the basis of price, competitive, financial and economic controls. We purchase these materials quality, product variety and effective data and our operating plans. They and energy mainly in the open market. distribution. Increased competition are inherently uncertain, and investors If commodity price changes result in and anticipated actions by our competi- must recognize that events could turn unexpected increases in raw materials tors could lead to downward pressure out to be significantly different from and energy costs, we may not be able on prices and/or a decline in our mar- our expectations. We undertake no to increase our prices to offset these ket share, either of which could obligation to update any forward-look- increased costs without suffering adversely affect our results. See “Our ing statement. The above discussion of reduced volume, revenue and operat- Competition” for more information risks is by no means all inclusive but is ing income. about our competitors. designed to highlight what we believe Our profitability may also be are important factors to consider when adversely impacted due to water evaluating our trends and future results. scarcity and regulation. Water is a lim- ited resource in many parts of the world. As demand for water continues to increase, we and our business part-

Market Risks ther discussion of these derivatives and our hedging policies. See “Our Critical We are exposed to the market risks arising from adverse changes in: Accounting Policies” for a discussion of • commodity prices, affecting the cost of our raw materials the exposure of our pension plan assets and pension and retiree medical liabili- and energy, ties to risks related to stock prices and • foreign exchange rates, discount rates. Inflationary, deflationary and • interest rates, recessionary conditions impacting these market risks also impact the demand • stock prices, and for and pricing of our products. • discount rates affecting the measurement of our pension Commodity Prices and retiree medical liabilities. Our open commodity derivative contracts that qualify for hedge accounting had a face value of In the normal course of business, we ignated as either cash flow or fair value $55 million at December 30, 2006 and manage these risks through a variety of hedges and qualify for hedge account- $89 million at December 31, 2005. The strategies, including productivity initia- ing treatment, while others do not open derivative contracts that qualify tives, global purchasing programs and qualify and are marked to market for hedge accounting resulted in net hedging strategies. Ongoing productiv- through earnings. We do not use deriv- unrealized gains of less than $1 million ity initiatives involve the identification ative instruments for trading or at December 30, 2006 and $39 million and effective implementation of mean- speculative purposes, and we limit our at December 31, 2005. We estimate that ingful cost saving opportunities or exposure to individual counterparties to a 10% decline in commodity prices efficiencies. Our global purchasing pro- manage credit risk. The fair value of our would have reduced our unrealized grams include fixed-price purchase derivatives fluctuates based on market gains on open contracts to $2 million of orders and pricing agreements. Our rates and prices. The sensitivity of our unrealized losses in 2006 and $35 mil- hedging strategies include the use of derivatives to these market fluctuations lion of unrealized gains in 2005. derivatives. Certain derivatives are des- is discussed below. See Note 10 for fur-

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Our open commodity derivative con- may enter into derivatives to manage investments and prepaid forward con- tracts that do not qualify for hedge our exposure to foreign currency trans- tracts for the purchase of our stock. The accounting had a face value of action risk. Our foreign currency combined gains or losses on these $196 million at December 30, 2006 and derivatives had a total face value of investments are substantially offset by $129 million at December 31, 2005. The $1.0 billion at December 30, 2006 and changes in our deferred compensation open derivative contracts that do not $1.1 billion at December 31, 2005. The liability. qualify for hedge accounting resulted in contracts that qualify for hedge Our Approach to Managing Risks net losses of $28 million in 2006 and accounting resulted in net unrealized The achievement of our strategic and $3 million in 2005. We estimate that a losses of $6 million at December 30, operating objectives will necessarily 10% decline in commodity prices would 2006 and $9 million at December 31, involve taking risks. Our risk manage- have increased our net losses on open 2005. We estimate that an unfavorable ment process is intended to ensure that contracts to $31 million in 2006 and 10% change in the exchange rates risks are taken knowingly and purpose- $4 million in 2005. would have resulted in unrealized losses fully. As such, we leverage an We expect to be able to continue to of $86 million in 2006 and $81 million in integrated risk management reduce the impact of increases in our 2005. The contracts not meeting the framework to identify, assess, prioritize, raw material and energy costs through criteria for hedge accounting resulted manage, monitor and communicate our hedging strategies and ongoing in net losses of $10 million in 2006 and risks across the Company. This frame- productivity initiatives. net gains of $14 million in 2005. All work includes: losses and gains were offset by changes Foreign Exchange in the underlying hedged items, result- • the PepsiCo Executive Risk Council Financial statements of foreign ing in no net impact on earnings. (PERC), comprised of a cross- subsidiaries are translated into U.S. dol- functional, geographically diverse, lars using period-end exchange rates for Interest Rates senior management group which assets and liabilities and weighted-aver- We centrally manage our debt and identifies, assesses, prioritizes and age exchange rates for revenues and investment portfolios considering addresses strategic and reputational expenses. Adjustments resulting from investment opportunities and risks, tax risks; translating net assets are reported as a consequences and overall financing separate component of accumulated strategies. We may use interest rate and • Division Risk Committees (DRCs), other comprehensive loss within share- cross currency interest rate swaps to comprised of cross-functional senior holders’ equity under the caption manage our overall interest expense management teams which meet reg- currency translation adjustment. and foreign exchange risk. These instru- ularly each year to identify, assess, Our operations outside of the U.S. ments effectively change the interest prioritize and address division-specific generate approximately 40% of our net rate and currency of specific debt operating risks; revenue, with Mexico, the United issuances. These swaps are entered into • PepsiCo’s Risk Management Office, Kingdom and Canada comprising concurrently with the issuance of the which manages the overall risk man- approximately 20% of our net revenue. debt that they are intended to modify. agement process, provides ongoing As a result, we are exposed to foreign The notional amount, interest payment guidance, tools and analytical support currency risks, including unforeseen and maturity date of the swaps match to the PERC and the DRCs, identifies economic changes and political unrest. the principal, interest payment and and assesses potential risks, and facili- During 2006, net favorable foreign cur- maturity date of the related debt. Our tates ongoing communication rency, primarily due to appreciation in counterparty credit risk is considered between the parties, as well as to the Canadian dollar and Brazilian real, low because these swaps are entered PepsiCo’s Audit Committee and Board into only with strong creditworthy of Directors; and counterparties, are generally settled on We do not use derivative a net basis and are of relatively short • PepsiCo Corporate Audit, which con- duration. firms the ongoing effectiveness of the instruments for trading or Assuming year-end 2006 and 2005 risk management framework through speculative purposes. variable rate debt and investment lev- periodic audit and review procedures. els, a 1-percentage-point increase in interest rates would have decreased net In 2006, we continued to focus our contributed almost 1 percentage point interest expense by $10 million in 2006 mitigation efforts where it was deter- to net revenue growth. Currency and $8 million in 2005. mined that actions were necessary and declines which are not offset could Stock Prices appropriate to further reduce PepsiCo’s adversely impact our future results. A portion of our deferred compensa- exposure to risks, integrating those Exchange rate gains or losses related tion liability is tied to certain market efforts in our businesses’ operating to foreign currency transactions are rec- indices and our stock price. We manage plans and budgets, where accountabil- ognized as transaction gains or losses in these market risks with mutual fund our income statement as incurred. We

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ity is assigned and performance mea- application systems by upgrading our practices across our customers, to sured. Some highlights include: networks and updating or retiring deliver value-added product innova- older infrastructure and systems. We tion and differentiation, to achieve • To address certain risks related to the signed a multi-year managed services the most effective trade spend across demand for our products, such as contract to consolidate PI’s technol- customers and channels through pro- consumer health concerns about ogy infrastructure into three data ductivity programs, and to more product attributes and ingredients, centers and another multi-year ser- effectively communicate to our cus- we continued to focus on the devel- vices contract to provide and manage tomers the economic advantages of opment of products that respond to PI’s data network. The data center our direct-store-delivery (DSD) system. consumer trends, including formulat- services will provide full system and ing products to lower sugar, fats, and • To address risks relating to legal and data protection and backup and sodium and adding ingredients and regulatory issues, we have launched recovery capabilities, and the data new products that can deliver nutri- an enhanced PepsiCo Code of network services will enhance tional benefits. For example, at FLNA Conduct training program in multiple security and provide 24x7x365 we introduced a new portion control languages. We also improved the monitoring and response capabilities. line of 100-calorie offerings, and we functionality of our employee hotline We expect to fully implement both of also switched to NuSun sunflower oil, to better enable reporting of compli- these service contracts over the next an oil containing 90% mono- and ance and ethics concerns and three years. polyunsaturated fats and less enhanced our process for handling saturated fat than most other cook- reported incidents and ensuring ing oils, for our Lay’s and Ruffles appropriate corrective action. We continued to focus on potato chips. Internationally, we Furthermore, we completed environ- reduced the amount of saturated fats leveraging diversity and mental and health & safety audits in our Walkers crisps in the United inclusion, ensuring we have the that will help focus our mitigation Kingdom by 70% and the amount of talent base necessary to lead efforts in these areas going forward. salt by 25%. Beyond providing more our growing businesses. • As part of our ongoing efforts to nutritious product choices, and in an maintain a talented workforce, we effort to help address the growing continued to focus on leveraging concerns regarding childhood obesity • With respect to our BPT initiative, we diversity and inclusion, designing the trends in the U.S., we joined with the continue to build on our learnings right organizational model to meet Alliance for a Healthier Generation — and incorporate these into the met- our business needs and ensuring we a joint initiative of the William J. rics used to monitor the project. have the talent base necessary to lead Clinton Foundation and the American Specific actions taken this year our growing businesses. Tactically, we Heart Association — to set voluntary include revising the overall project worked to expand the breadth and beverage guidelines for U.S. schools structure, project resources and time- depth of our succession plans and that limit portion sizes and establish lines. We also continue to invest in reinforced our focus on managing voluntary guidelines for snacks and process and control resources to build our people through an increased side items in U.S. schools. a more automated control environ- emphasis on people development as ment that remains compliant with the • To help ensure that we maintain our part of our performance manage- Sarbanes-Oxley Act. reputation for providing safe conve- ment process. nient foods and beverages, we • To address supply chain risks, we • To manage our risks related to raw enhanced the coordination of our continued to assess our capability to materials, we continued to reduce division-led product integrity efforts mitigate potential business our input cost volatility across our through the PepsiCo Product Integrity disruptions and increased the coordi- total portfolio by employing various Council (PPIC), a cross-functional nation of our efforts across IT disaster hedging strategies where appropriate forum to share leading practices and recovery, crisis management and busi- and as market opportunities arose. confer about areas of potential risk. ness continuity. Having recognized We also continued to utilize our scale Through the PPIC, we completed a the potentially significant impact of a to achieve maximum value across our third-party review of our food safety pandemic such as avian influenza on commodity portfolio and to ensure and food security programs which our employees and our business, we adequate supply. In addition, we have helped identify opportunities to bet- formed a cross-functional, cross-divi- developed strategic global supplier ter leverage internal best practices sional Pandemic Planning Team that solutions to help minimize volatility. across all of our businesses. worked to develop strategies and Furthermore, we enhanced our prod- tactics to mitigate that impact. uct sampling and testing protocols. • Against a challenging trade environ- • We continued to enhance our infor- ment, we continued to work to mation technology infrastructure and ensure consistent and equitable trade

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Our Critical Accounting Policies An appreciation of our critical accounting policies is necessary to understand our financial results. These Our critical accounting policies arise in policies may require management to make difficult conjunction with the following: and subjective judgments regarding uncertainties, • revenue recognition, and as a result, such estimates may significantly impact • brand and goodwill valuations, our financial results. The precision of these estimates and the likelihood of future changes depend on a number of • income tax expense and accruals, underlying variables and a range of possible outcomes. • stock-based compensation expense, and Other than our accounting for pension plans, our critical • pension and retiree medical plans. accounting policies do not involve the choice between alternative methods of accounting. We applied our critical accounting policies and estimation methods consistently in all material respects, and for all periods presented, and have discussed these policies with our Audit Committee. In connection with our ongoing BPT initiative, we aligned certain accounting policies across our divisions in 2005. We conformed our methodology for calculating our bad debt reserves and modified our policy for recognizing revenue for products shipped to customers by third–party carriers. Additionally, we conformed our method of accounting for certain costs, primarily warehouse and freight. These changes reduced our net revenue by $36 million and our operating profit by $60 million in 2005.

Revenue Recognition

Our products are sold for cash or on Our policy is to provide customers 2006, $8.9 billion in 2005 and $7.8 bil- credit terms. Our credit terms, which with product when needed. In fact, our lion in 2004. Sales incentives include are established in accordance with local commitment to freshness and product payments to customers for performing and industry practices, typically require dating serves to regulate the quantity of merchandising activities on our behalf, payment within 30 days of delivery in product shipped or delivered. In addition, such as payments for in-store displays, the U.S., and generally within 30 to 90 DSD products are placed on the shelf by payments to gain distribution of new days internationally, and may allow dis- our employees with customer shelf products, payments for shelf space and counts for early payment. We recognize space limiting the quantity of product. discounts to promote lower retail prices. revenue upon shipment or delivery to For product delivered through our A number of our sales incentives, such as our customers based on written sales other distribution networks, customer bottler funding and customer volume terms that do not allow for a right of inventory levels are monitored. rebates, are based on annual targets, return. However, our policy for DSD and and accruals are established during the chilled products is to remove and year for the expected payout. These replace damaged and out-of-date prod- Our credit terms typically accruals are based on contract terms and ucts from store shelves to ensure that require payment within 30 days our historical experience with similar consumers receive the product quality of delivery in the U.S., and programs and require management and freshness they expect. Similarly, generally within 30 to 90 days judgment with respect to estimating our policy for warehouse-distributed internationally. customer participation and performance products is to replace damaged and levels. Differences between estimated out-of-date products. Based on our his- expense and actual incentive costs are torical experience with this practice, we As discussed in “Our Customers,” we normally insignificant and are have reserved for anticipated damaged offer sales incentives and discounts recognized in earnings in the period and out-of-date products. Our bottlers through various programs to customers such differences are determined. The have a similar replacement policy and consumers. Sales incentives and dis- terms of most of our incentive arrange- and are responsible for the products counts are accounted for as a reduction ments do not exceed a year, and they distribute. of revenue and totaled $10.1 billion in therefore do not require highly uncer-

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tain long-term estimates. For interim than the contract period as a reduction method of determining the reserves reporting, we estimate total annual of revenue, and the remaining balances was conformed across our divisions in sales incentives for most of our prog- of $297 million at year-end 2006 and connection with our BPT initiative, as rams and record a pro rata share in $321 million at year-end 2005 are discussed above. Bad debt expense is proportion to revenue. Certain arrange- included in current assets and other classified within selling, general ments, such as fountain pouring rights, assets on our balance sheet. and administrative expenses in our may extend beyond one year. The costs We estimate and reserve for our bad income statement. incurred to obtain incentive arrange- debt exposure based on our experience ments are recognized over no longer with past due accounts. In 2005, our

Brand and Goodwill Valuations

We sell products under a number of by its discounted cash flows, an nomic environment. If an evaluation of brand names, many of which were impairment loss is recognized in an the undiscounted future cash flows developed by us. The brand develop- amount equal to that excess. Goodwill indicates impairment, the asset is writ- ment costs are expensed as incurred. is evaluated using a two-step impair- ten down to its estimated fair value, We also purchase brands and goodwill ment test at the reporting unit level. A which is based on its discounted future in acquisitions. Upon acquisition, the reporting unit can be a division or busi- cash flows. purchase price is first allocated to iden- ness within a division. The first step Considerable management judgment tifiable assets and liabilities, including compares the book value of a reporting is necessary to evaluate the impact of brands, based on estimated fair value, unit, including goodwill, with its fair operating and macroeconomic changes with any remaining purchase price value, as determined by its discounted and to estimate future cash flows. recorded as goodwill. cash flows. If the book value of a Assumptions used in our impairment We believe that a brand has an reporting unit exceeds its fair value, we evaluations, such as forecasted growth indefinite life if it has significant market complete the second step to determine rates and our cost of capital, are based share in a stable macroeconomic envi- the amount of goodwill impairment on the best available market informa- ronment and a history of strong loss that we should record. In the sec- tion and are consistent with our internal revenue and cash flow performance ond step, we determine an implied fair forecasts and operating plans. These that we expect to continue for the fore- assumptions could be adversely seeable future. If these perpetual brand impacted by certain of the risks criteria are not met, brands are amor- We did not recognize any discussed in “Our Business Risks.” tized over their expected useful lives, impairment charges for We did not recognize any which generally range from five to 40 perpetual brands or goodwill in impairment charges for perpetual years. Determining the expected life of the years presented. brands or goodwill in the years a brand requires considerable manage- presented. As of December 30, 2006, we ment judgment and is based on an had $5.8 billion of perpetual brands evaluation of a number of factors, and goodwill, of which approximately including the competitive environment, value of the reporting unit’s goodwill 65% related to Tropicana and Walkers. market share, brand history and the by allocating the fair value of the macroeconomic environment of the reporting unit to all of the assets and countries in which the brand is sold. liabilities other than goodwill (including Perpetual brands and goodwill, any unrecognized intangible assets). including the goodwill that is part of The amount of impairment loss is equal our noncontrolled bottling investment to the excess of the book value of the balances, are not amortized. Perpetual goodwill over the implied fair value of brands and goodwill are assessed for that goodwill. impairment at least annually. If the car- Amortizable brands are only evalu- rying amount of a perpetual brand ated for impairment upon a significant exceeds its fair value, as determined change in the operating or macroeco-

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Income Tax Expense and Accruals

Our annual tax rate is based on our of PBG, as well as the restructuring of vested outside the U.S. and recorded income, statutory tax rates and tax our international snack foods income tax expense of $460 million planning opportunities available to us operations during that audit period. related to this repatriation. Other than in the various jurisdictions in which we Tax law requires items to be included the earnings repatriated, we intend to operate. Significant judgment is in our tax returns at different times than continue to reinvest earnings outside required in determining our annual tax the items are reflected in our financial the U.S. for the foreseeable future and, rate and in evaluating our tax positions. statements. As a result, our annual tax therefore, have not recognized any U.S. We establish reserves when, despite our rate reflected in our financial state- tax expense on these earnings. At belief that our tax return positions are ments is different than that reported in December 30, 2006, we had approxi- fully supportable, we believe that cer- our tax returns (our cash tax rate). Some mately $10.8 billion of undistributed tain positions are subject to challenge of these differences are permanent, international earnings. and that we may not succeed. We such as expenses that are not deductible In 2006, our annual tax rate was adjust these reserves, as well as the in our tax return, and some differences 19.3% compared to 36.1% in 2005 as related interest, in light of changing reverse over time, such as depreciation discussed in “Other Consolidated facts and circumstances, such as the expense. These temporary differences Results.” The tax rate in 2006 decreased progress of a tax audit. See Note 5 for create deferred tax assets and liabilities. 16.8 percentage points primarily reflect- additional information regarding our Deferred tax assets generally represent ing the 2006 Tax Adjustments, the tax reserves. items that can be used as a tax deduc- absence of the 2005 AJCA tax charge An estimated effective tax rate for a tion or credit in our tax returns in future and the resolution of certain state year is applied to our quarterly operat- years for which we have already income tax audits in the current year. In ing results. In the event there is a recorded the tax benefit in our income 2007, our annual tax rate is expected to significant or unusual item recognized statement. We establish valuation be 27.7%, primarily reflecting the in our quarterly operating results, the allowances for our deferred tax assets absence of the 2006 Tax Adjustments. tax attributable to that item is when we believe expected future tax- separately calculated and recorded at able income is not likely to support the the same time as that item. We consider use of a deduction or credit in that tax the tax benefits from the resolution of jurisdiction. Deferred tax liabilities gen- prior year tax matters to be such items. erally represent tax expense recognized In 2006, we recognized non-cash tax in our financial statements for which benefits of $602 million (the “2006 Tax payment has been deferred, or expense Adjustments”), substantially all of for which we have already taken a which related to the Internal Revenue deduction in our tax return but have not Service’s (IRS) examination of our con- yet recognized as expense in our finan- solidated income tax returns for the cial statements. years 1998 through 2002. The IRS issued The American Jobs Creation Act of a Revenue Agent’s Report (RAR), and 2004 (AJCA) created a one-time incen- we are in agreement with their conclu- tive for U.S. corporations to repatriate sion, except for one matter which we undistributed international earnings by continue to dispute. The agreed adjust- providing an 85% dividends received ments relate to transfer pricing and deduction. In 2005, we repatriated various other transactions, including approximately $7.5 billion in earnings certain acquisitions, the public offering previously considered indefinitely rein-

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Stock–Based Compensation Expense

We believe that we will achieve our for senior officers is contingent upon recognized in excess of tax benefits pre- best results if our employees act and are the achievement of pre-established per- viously established upon grant are rewarded as business owners. There- formance targets. reported as a financing cash inflow. fore, we believe stock ownership and We also continued, as we have since Prior to adoption, such excess tax bene- stock-based incentive awards are the 1989, to grant an annual award of stock fits were reported as an operating best way to align the interests of options to all eligible employees, based cash inflow. employees with those of our sharehold- on job level or classification, under our Our divisions are held accountable ers. A majority of our employees broad-based stock option program, for stock-based compensation expense participate in our stock-based compen- SharePower. SharePower awards gener- and, therefore, this expense is allocated sation programs. Stock option grants ally have a 10-year term and vest over to our divisions as an incremental are made at the current stock price, three years. employee compensation cost. The allo- meaning each employee’s exercise price cation of stock-based compensation Method of Accounting is equivalent to our stock price on the expense in 2006 was approximately We account for our employee stock date of grant. Employees must gener- 28% to FLNA, 19% to PBNA, 32% to PI, options, which include grants under ally provide three additional years of 4% to QFNA and 17% to corporate our executive program and broad- service to earn the grant, referred to as unallocated expenses. The expense based SharePower program, under the the vesting period. Our options gener- allocated to our divisions excludes any fair value method of accounting using ally have a 10-year term, which means impact of changes in our Black-Scholes a Black-Scholes valuation model to our employees would have up to seven assumptions during the year which measure stock option expense at the years after the vesting period to elect to reflect market conditions over which date of grant. All stock grants have an pay the exercise price to purchase one division management has no control. exercise price equal to the fair market share of our stock for each option exer- Therefore, any variances between allo- value of our common stock on the date cised. Employees benefit from stock cated expense and our actual expense of grant. The fair value of stock option options to the extent our stock price are recognized in corporate grants is amortized to expense over the appreciates above the exercise price unallocated expenses. vesting period. after vesting and during the term of the grant. There have been no reduc- tions to the exercise price of previously On January 1, 2006, we adopted SFAS 123R, issued awards, and any repricing of awards would require approval of Share-Based Payment. Since we had previously our shareholders. accounted for our stock-based compensation Executives who are awarded long- under the fair value method, our adoption did term incentives based on their not significantly impact our financial position or performance are offered the choice of our results of operations. stock options or restricted stock units (RSUs). Executives who elect RSUs receive one RSU for every four stock On January 1, 2006, we adopted options that would have otherwise Statement of Financial Accounting been granted. Senior officers do not Standards (SFAS) 123R, Share-Based have a choice and are granted 50% Payment, under the modified prospec- stock options and 50% RSUs. RSU tive method. Since we had previously expense is based on the fair value of accounted for our stock-based compen- PepsiCo stock on the date of grant and sation plans under the fair value is amortized over the vesting period, provisions of SFAS 123, our adoption did generally three years. Each RSU is set- not significantly impact our financial tled in a share of our stock after the position or our results of operations. vesting period. Vesting of RSU awards Under SFAS 123R, actual tax benefits

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The expected life is a significant Our Assumptions assumption as it determines the period Our Black-Scholes model estimates the expected value our employees will for which the risk free interest rate, receive from the options based on a number of assumptions, such as interest volatility and dividend yield must be rates, employee exercises, our stock price and dividend yield. Our weighted- applied. The expected life is the period average fair value assumptions include: over which our employee groups are Estimated 2007 2006 2005 2004 expected to hold their options. It is Expected life 6 yrs. 6 yrs. 6 yrs. 6 yrs. based on our historical experience with Risk free interest rate 5.7% 4.5% 3.8% 3.3% similar grants. The risk free interest rate Expected volatility 18% 18% 23% 26% is based on the expected U.S. Treasury Expected dividend yield 1.9% 1.9% 1.8% 1.8% rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated divi- dend policy and forecasts of net income, share repurchases and stock price.

If the expected life were assumed to 2007 Estimated Expense and Sensitivity of Assumptions be one year longer, our estimated 2007 Our stock-based compensation expense, including RSUs, is as follows: stock-based compensation expense Estimated 2007 2006 2005 would increase by $7 million. If the Stock-based compensation expense $271 $270 $311 expected life were assumed to be one year shorter, our estimated 2007 stock- based compensation expense would If we assumed a 100-basis-point change in the following assumptions, our estimated decrease by $8 million. As noted, chang- 2007 stock-based compensation expense would increase/(decrease) as follows: ing the assumed expected life impacts 100-Basis-Point Increase 100-Basis-Point Decrease all of the Black-Scholes valuation Risk free interest rate $6 $(6) assumptions as the risk free interest Expected volatility $1 $(1) rate, expected volatility and expected Expected dividend yield $(9) $10 dividend yield are estimated over the expected life.

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Pension and Retiree Medical Plans

Our pension plans cover full-time assumptions to estimate the amount of use the Moody’s Aa Corporate Index employees in the U.S. and certain inter- the benefits that employees earn while yield and adjust for differences national employees. Benefits are working, as well as the present value of between the average duration of the determined based on either years of those benefits. Annual pension and bonds in this Index and the average service or a combination of years of ser- retiree medical expense amounts are duration of our benefit liabilities, based vice and earnings. U.S. and Canada principally based on four components: upon a published index. retirees are also eligible for medical and 1) the value of benefits earned by The expected return on pension plan life insurance benefits (retiree medical) employees for working during the year assets is based on our historical experi- if they meet age and service (service cost), 2) increase in the liability ence, our pension plan investment requirements. Generally, our share of due to the passage of time (interest strategy and our expectations for long- retiree medical costs is capped at speci- cost), and 3) other gains and losses as term rates of return. Our pension plan fied dollar amounts that vary based discussed below, reduced by 4) expect- investment strategy is reviewed annu- upon years of service, with retirees con- ed return on plan assets for our ally and is established based upon plan tributing the remainder of the cost. funded plans. liabilities, an evaluation of market con- On December 30, 2006, we adopted Significant assumptions used to mea- ditions, tolerance for risk, and cash SFAS 158, Employers’ Accounting for sure our annual pension and retiree requirements for benefit payments. We Defined Benefit Pension and Other medical expenses include: use a third-party advisor to assist us in Postretirement Plans — an amendment • the interest rate used to determine determining our investment allocation of FASB Statements No. 87, 88, 106, and the present value of liabilities and modeling our long-term rate of 132(R) (SFAS 158). SFAS 158 requires (discount rate); return assumptions. Our current invest- that we recognize the overfunded or • certain employee-related factors, ment allocation target for our U.S. underfunded status of our pension and such as turnover, retirement age plans is 60% in equity securities, with retiree medical plans (our Plans) as an and mortality; the balance in fixed income securities. asset or liability on our December 30, • for pension expense, the expected Our expected long-term rate of return 2006 balance sheet. Subsequent return on assets in our funded plans on U.S. plan assets is 7.8%, reflecting changes in the funded status will be and the rate of salary increases for estimated long-term rates of return of recognized in comprehensive income in plans where benefits are based on 9.3% from equity securities and 5.8% the year in which they occur. SFAS 158 earnings; and from fixed income securities. We use a also requires that, beginning in 2008, • for retiree medical expense, health market-related value method that rec- our assumptions used to measure our care cost trend rates. ognizes each year’s asset gain or loss annual pension and retiree medical over a five-year period. Therefore, it expenses be determined as of the bal- Our assumptions reflect our historical takes five years for the gain or loss from ance sheet date, and all plan assets and experience and management’s best any one year to be fully included in the liabilities be reported as of that date. judgment regarding future expectations. other gains and losses calculation Currently, the assumptions used to mea- Due to the significant management described below. sure our annual Other gains and losses resulting from pension and retiree actual experience differing from our medical expenses are SFAS 158 requires that we recognize the assumptions and from changes in our determined as of overfunded or underfunded status of our pension assumptions are also determined at September 30 (mea- and retiree medical plans as an asset or liability each measurement date. If this net surement date) and on our December 30, 2006 balance sheet. accumulated gain or loss exceeds 10% all plan assets and of the greater of plan assets or liabili- liabilities are gener- ties, a portion of the net gain or loss is ally reported as of that date. In judgment involved, our assumptions included in expense for the following accordance with SFAS 158, prior year could have a material impact on the year. The cost or benefit of plan amounts have not been adjusted. For measurement of our pension and changes that increase or decrease bene- further information regarding the impact retiree medical benefit expenses fits for prior employee service (prior of our adoption of SFAS 158, see Note 7. and obligations. service cost/(credit)) is included in earn- At each measurement date, the dis- ings on a straight-line basis over the Our Assumptions count rate is based on interest rates for average remaining service period of The determination of pension and high-quality, long-term corporate debt those employees expected to benefit, retiree medical plan obligations and securities with maturities comparable to which is approximately 11 years for related expenses requires the use of those of our liabilities. In the U.S., we pension expense and approximately 13 years for retiree medical.

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would increase pension expense. The Weighted-average assumptions for pension and retiree medical expenses are estimated impact of a 25-basis-point as follows: decrease in the discount rate on 2007 2007 2006 2005 pension expense is an increase of Pension approximately $37 million. The Expense discount rate 5.7% 5.6% 6.1% estimated impact on 2007 pension Expected rate of return on plan assets 7.7% 7.7% 7.8% expense of a 25-basis-point decrease in Expected rate of salary increases 4.5% 4.4% 4.3% the expected rate of return is an increase of approximately $16 million. Retiree medical See Note 7 regarding the sensitivity Expense discount rate 5.8% 5.7% 6.1% of our retiree medical cost assumptions. Current health care cost trend rate 9.0% 10.0% 11.0% Future Funding Future Expense We make contributions to pension The estimated changes in pension and retiree medical expense are as follows: trusts maintained to provide plan bene- Pension Retiree Medical fits for certain pension plans. These contributions are made in accordance 2006 expense $417 $127 with applicable tax regulations that Increase in discount rate (15) (2) provide for current tax deductions for (Decrease)/Increase in experience loss amortization (1) 1 our contributions, and taxation to the Impact of contributions (2) – employee only upon receipt of plan Other (3) 4 benefits. Generally, we do not fund our 2007 estimated expense $396 $130 pension plans when our contributions would not be currently deductible. Pension and retiree medical service Based on our current assumptions, Our pension contributions for 2006 costs, measured at a fixed discount rate which reflect our prior experience, cur- were $59 million, all of which were but including the effect of demographic rent plan provisions and expectations for non-discretionary. In 2007, we expect to assumption changes, as well as the future experience, we expect our pension make contributions of up to $150 mil- effects of gains and losses due to demo- expense to decrease slightly in 2008, lion with up to $75 million expected to graphics, are reflected in division results declining to approximately $360 million be discretionary. Our cash payments for for North American employees. Division by 2012 as unrealized losses are amor- retiree medical are estimated to be results also include interest costs, mea- tized. If our assumptions and our plan approximately $85 million in 2007. As sured at a fixed discount rate, for provisions for retiree medical costs our retiree medical plans are not retiree medical plans. Interest costs for remain unchanged and our experience subject to regulatory funding require- the pension plans, measured at a fixed mirrors these assumptions, we expect our ments, we fund these plans on a discount rate, and the effect of changes annual retiree medical expense beyond pay-as-you-go basis. For estimated in discount rates, gains and losses other 2007 to approximate $130 million. future benefit payments, including our than those due to demographics, pen- pay-as-you-go payments as well as Sensitivity of Assumptions sion asset returns and the impact of those from trusts, see Note 7. A decrease in the discount rate or in the pension funding are all reflected in cor- expected rate of return assumptions porate unallocated expenses.

Recent Accounting Pronouncements In July 2006, the Financial Accounting ciple recorded as an adjustment to Standards Board (FASB) issued FASB opening retained earnings. We do not In September 2006, the SEC issued Staff Interpretation No. 48, Accounting for expect our adoption of FIN 48 to materi- Accounting Bulletin No. 108, Considering Uncertainty in Income Taxes—an inter- ally impact our financial statements. the Effects of Prior Year Misstatements pretation of FASB Statement No. 109 In September 2006, the FASB issued when Quantifying Misstatements in (FIN 48), which clarifies the accounting SFAS 157, Fair Value Measurements Current Year Financial Statements (SAB for uncertainty in tax positions. FIN 48 (SFAS 157), which defines fair value, 108), to address diversity in practice in requires that we recognize in our finan- establishes a framework for measuring quantifying financial statement cial statements, the impact of a tax fair value, and expands disclosures about misstatements. SAB 108 requires that position, if that position is more likely fair value measurements. The provisions we quantify misstatements based on than not of being sustained on audit, of SFAS 157 are effective as of the begin- their impact on each of our financial based on the technical merits of the ning of our 2008 fiscal year. We are statements and related disclosures. On position. The provisions of FIN 48 are currently evaluating the impact December 30, 2006, we adopted SAB effective as of the beginning of our of adopting SFAS 157 on our 108. Our adoption of SAB 108 did not 2007 fiscal year, with the cumulative financial statements. impact our financial statements. effect of the change in accounting prin-

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Our Financial Results

Items Affecting Comparability

The year-over-year comparisons of our financial results are affected by the following items: 2006 2005 Net revenue 53rd week...... – $418 Operating profit 2006 restructuring and impairment charges...... $(67) – 53rd week...... – $75 2005 restructuring charges...... – $(83) Net income 2006 restructuring and impairment charges...... $(43) – 2006 Tax Adjustments...... $602 – PepsiCo share of PBG tax settlement...... $18 – AJCA tax charge ...... – $(460) 53rd week...... – $57 2005 restructuring charges...... – $(55) Net income per common share — diluted 2006 restructuring and impairment charges...... $(0.03) – 2006 Tax Adjustments...... $0.36 – PepsiCo share of PBG tax settlement...... $0.01 – AJCA tax charge ...... – $(0.27) 53rd week...... – $0.03 2005 restructuring charges...... – $(0.03) For the items affecting our 2004 results, see Notes 3 and 5, as well as our 2005 Annual Report.

53rd week 2005 Restructuring Charges non-cash benefit of $21 million was In 2005, we had an additional week of In 2005, we incurred restructuring included in bottling equity income as results (53rd week). Our fiscal year ends charges of $83 million to reduce costs in part of recording our share of PBG’s on the last Saturday of each December, our operations, principally through financial results. resulting in an additional week of headcount reductions. AJCA Tax Charge results every five or six years. 2006 Tax Adjustments In 2005, we repatriated approximately 2006 Restructuring and In 2006, we recognized non-cash tax $7.5 billion in earnings previously con- Impairment Charges benefits of $602 million, substantially sidered indefinitely reinvested outside In 2006, we incurred a charge of all of which related to the IRS’s exami- the U.S. in connection with the AJCA $67 million in conjunction with consoli- nation of our consolidated tax returns and recorded income tax expense of dating the manufacturing network at for the years 1998 through 2002. $460 million related to this repatriation. FLNA by closing two plants in the U.S., PepsiCo Share of PBG Tax Settlement and rationalizing other assets, to In 2006, the IRS concluded its examina- increase manufacturing productivity tion of PBG’s consolidated income tax and supply chain efficiencies. returns for the years 1999 through 2000 (PBG’s Tax Settlement). Consequently, a

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Results of Continuing Operations — Consolidated Review

In the discussions of net revenue and Servings In 2006, total servings increased operating profit below, effective net Since our divisions each use different 5.5% over the prior year, as servings for pricing reflects the year–over–year measures of physical unit volume (i.e., beverages worldwide grew over 6% and servings for snacks worldwide grew impact of discrete pricing actions, kilos, gallons, pounds and case sales), a common servings metric is necessary to 5%. All of our divisions positively con- sales incentive activities and mix reflect our consolidated physical unit tributed to the total servings growth. In resulting from selling varying volume. Our divisions’ physical volume 2005, total servings increased 7% com- products in different package sizes measures are converted into servings pared to 2004, as servings for beverages and in different countries. based on U.S. Food and Drug worldwide grew over 7% and servings Administration guidelines for single- for snacks worldwide grew 6%. serving sizes of our products.

Net Revenue and Operating Profit

2006 Change Net revenue increased 8% primarily reflecting higher volume and positive 2006 2005 2004 2006 2005 effective net pricing across all divisions. The volume gains and the effective net Total net revenue $35,137 $32,562 $29,261 8% 11% pricing each contributed 3 percentage Operating profit points to net revenue growth. Acquisi- FLNA $2,615 $2,529 $2,389 3% 6% tions contributed 1 percentage point PBNA 2,055 2,037 1,911 1% 7% and foreign exchange contributed PI 1,948 1,607 1,323 21% 21% almost 1 percentage point to net rev- QFNA 554 537 475 3% 13% enue growth. The absence of the prior Corporate unallocated (733) (788) (689) (7)% 14% year’s additional week reduced net rev- Restructuring and enue by over 1 percentage point and impairment charges – – (150) reduced volume growth by almost Total operating profit $6,439 $5,922 $5,259 9% 13% 1 percentage point. Total operating Total operating profit increased 9% profit margin 18.3% 18.2% 18.0% 0.1 0.2 and margin increased 0.1 percentage points. The operating profit gains reflect the net revenue growth, partially offset Total operating profit increased 13% as our BPT initiative in North America, by the impact of higher raw material and margin increased 0.2 percentage unallocated insurance and benefit pro- and energy costs across all divisions. The points. The operating profit gains pri- grams, foreign exchange transaction absence of the prior year’s additional marily reflect leverage from the revenue gains and losses, and certain commodity week reduced operating profit growth growth, partially offset by higher sell- derivative gains and losses, as well as by over 1 percentage point. ing and distribution (S&D) expenses and profit-in-inventory elimination adjust- increased cost of sales, largely due to ments for our noncontrolled bottling 2005 higher raw materials, energy and S&D affiliates and certain other items. Net revenue increased 11% reflecting, labor costs, as well as higher advertising In 2006, corporate unallocated across all divisions, increased volume, and marketing expenses. Total operat- expenses decreased $55 million primar- favorable effective net pricing and net ing profit margin also benefited from a ily reflecting the absence of a favorable foreign currency movements. favorable comparison to prior year non-recurring charge of $55 million in The volume gains contributed 6 percent- restructuring and impairment charges. the prior year to conform our method age points, the effective net pricing The additional week in 2005 contributed of accounting across all divisions, pri- contributed 3 percentage points and over 1 percentage point to total operat- marily for warehouse and freight costs. the net favorable foreign currency ing profit growth. Higher costs associated with our BPT movements contributed over 1 percent- initiative of $35 million, as well as the Corporate Unallocated Expenses age point. The 53rd week contributed unfavorable comparison to the prior Corporate unallocated expenses include over 1 percentage point to revenue year’s $25 million gain in connection the costs of our corporate headquar- growth and almost 1 percentage point with the settlement of a class action to volume growth. ters, centrally-managed initiatives, such

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lawsuit related to our purchases of high increased support behind health and accounting across all divisions, primarily fructose corn syrup from 1991 to 1995, wellness and innovation initiatives for warehouse and freight costs, and a were offset by the favorable impact of which contributed 5 percentage points, gain of $25 million in connection with certain other corporate items. and Corporate departmental expenses the settlement of a class action lawsuit In 2005, corporate unallocated and restructuring charges which each related to our purchases of high fruc- expenses increased 14%. This increase contributed 2 percentage points to the tose corn syrup from 1991 to 1995. In primarily reflects higher costs associated increase. In 2005, items of a non-recur- 2004, we recorded a charge of $50 mil- with our BPT initiative which ring nature included charges of lion for the settlement of a contractual contributed 7 percentage points, $55 million to conform our method of dispute with a former business partner.

Other Consolidated Results

Bottling equity income includes our Change share of the net income or loss of our noncontrolled bottling affiliates as 2006 2005 2004 2006 2005 described in “Our Customers.” Our interest in these bottling investments Bottling equity income $616 $557 $380 11% 46% may change from time to time. Any Interest expense, net $(66) $(97) $(93) (33)% 4% gains or losses from these changes, as Annual tax rate 19.3% 36.1% 24.7% well as other transactions related to our Net income — continuing bottling investments, are also included operations $5,642 $4,078 $4,174 38% (2)% on a pre-tax basis. We continue to sell Net income per common shares of PBG stock to reduce our own- share — continuing operations — diluted $3.34 $2.39 $2.41 40% (1)% ership to the level at the time of PBG’s initial public offering, since our owner- ship has increased as a result of PBG’s The tax rate decreased 16.8 percent- of income tax benefits of $266 million share repurchase program. We sold age points compared to prior year recorded in 2004 related to a reduction 10.0 million and 7.5 million shares of primarily reflecting the 2006 Tax in foreign tax accruals following the PBG stock in 2006 and 2005, Adjustments, the absence of the 2005 resolution of certain open tax items respectively. The resulting lower owner- AJCA tax charge and the resolution of with foreign tax authorities and a ship percentage reduces the equity certain state income tax audits in the refund claim related to prior U.S. tax income from PBG that we recognize. current year. settlements. This increase was partially 2006 Net income increased 38% and the offset by increased international profit Bottling equity income increased 11% related net income per share increased which is taxed at a lower rate. primarily reflecting a $186 million pre- 40%. These increases primarily reflect Net income from continuing opera- tax gain on our sale of PBG stock, which the 2006 Tax Settlement, the absence of tions decreased 2% and the related net compared favorably to a $126 million the AJCA tax charge and our solid oper- income per common share from contin- pre-tax gain in the prior year. The non- ating profit growth. uing operations decreased 1%. These decreases reflect the impact of the tax cash gain of $21 million from our share 2005 of PBG’s Tax Settlement was fully offset items discussed above, partially offset Bottling equity income increased 46% by lower equity income from our by our operating profit growth, reflecting $126 million of pre-tax gains anchor bottlers in the current year, increased bottling equity income, which on our sales of PBG stock, as well as primarily resulting from the impact of includes the gain on our PBG stock sale, stronger bottler results. their respective adoptions of SFAS 123R the impact of the 53rd week, a favor- Net interest expense increased 4% in 2006. able comparison to prior year reflecting the impact of higher debt Net interest expense decreased 33% restructuring and impairment charges, levels, substantially offset by higher primarily reflecting higher average and for net income per share, the investment rates and cash balances. rates on our investments and lower impact of our share repurchases. The tax rate increased 11.4 percent- debt balances, partially offset by lower age points reflecting the $460 million investment balances and the impact of AJCA tax charge, as well as the absence higher average rates on our borrowings.

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Results of Continuing Operations — Division Review

The results and discussions below are based on how our Chief Executive Officer monitors the performance of our divisions. For additional information on these items and our divisions, see Note 1.

FLNA PBNA PI QFNA Total Net Revenue, 2006 ...... $10,844 $9,565 $12,959 $1,769 $35,137 Net Revenue, 2005...... $10,322 $9,146 $11,376 $1,718 $32,562 % Impact of: Volume ...... 1% 3%(a) 6%(a) 1% 3% Effective net pricing ...... 31423 Foreign exchange ...... 0.5 – 1 1 1 Acquisitions/divestitures...... 0.5 – 3 – 1 % Change(b) ...... 5% 5% 14% 3% 8%

FLNA PBNA PI QFNA Total Net Revenue, 2005...... $10,322 $9,146 $11,376 $1,718 $32,562 Net Revenue, 2004...... $9,560 $8,313 $9,862 $1,526 $29,261 % Impact of: Volume ...... 4.5% 4%(a) 8%(a) 9% 6% Effective net pricing ...... 3 5 2.5 3 3 Foreign exchange ...... 0.5 – 3 1 1 Acquisitions/divestitures...... – – 2 – 0.5 % Change(b) ...... 8% 10% 15% 13% 11% (a) For beverages sold to our bottlers, volume growth is based on our concentrate shipments and equivalents. (b) Amounts may not sum due to rounding.

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Frito–Lay North America

% Change 2006 2005 2004 2006 2005 Net revenue $10,844 $10,322 $9,560 5 8 Operating profit $2,615 $2,529 $2,389 3 6

2006 closure of two plants and rationaliza- volume growth of 1%. Other macro Net revenue grew 5% reflecting volume tion of other manufacturing assets. The snacks products revenue benefited from growth of 1% and positive effective net absence of the prior year’s additional favorable mix. The additional week pricing due to salty snack pricing week, which reduced operating profit contributed 2 percentage points to vol- actions and favorable mix. Pound vol- growth by 2 percentage points, was ume and net revenue growth. ume grew primarily due to double-digit largely offset by the impact of restruc- Operating profit grew 6% reflecting growth in SunChips, Multipack and turing charges in the prior year to positive effective net pricing actions and Quaker Rice Cakes. These volume gains reduce costs in our operations, princi- volume growth. This growth was offset pally through headcount reductions. by higher S&D costs resulting from Smart Spot eligible products repre- increased labor and benefit charges and In 2006, FLNA volume grew sented approximately 15% of net fuel costs; higher cost of sales, driven by primarily due to double-digit revenue. These products experienced raw materials, natural gas and freight; growth in SunChips, Multipack double-digit revenue growth, while the and increased advertising and market- and Quaker Rice Cakes. balance of the portfolio had low-single- ing costs. Operating profit was also digit revenue growth. 2005 Net revenue grew 8% FLNA’s Smart Spot eligible products were partially offset by low-single-digit reflecting volume experienced double-digit revenue growth in declines in trademark Lay’s and Doritos. growth of 4.5% and both 2006 and 2005. Overall, salty snacks revenue grew 5% positive effective net with volume growth of 1%, and other pricing driven by salty macro snacks revenue grew 9% with snack pricing actions and favorable mix volume growth of 6%. The Stacy’s Pita negatively impacted by more than on both salty and convenience foods Chip Company acquisition contributed 1 percentage point as a result of fourth products. Pound volume grew primarily approximately 0.5 percentage points to quarter charges to reduce costs in our due to mid-single-digit growth in trade- both revenue and volume growth. The operations, principally through head- mark Lay’s potato chips, absence of the prior year’s additional count reductions. The additional week high-single-digit growth in salty trade- week reduced volume and net revenue contributed 2 percentage points to mark Tostitos, double-digit growth in growth by 2 percentage points. operating profit growth. Santitas, mid-single-digit growth in Operating profit grew 3% reflecting Smart Spot eligible products repre- trademark Cheetos, high-single-digit the net revenue growth. This growth sented approximately 13% of net growth in Dips and Fritos, and double- was partially offset by higher commod- revenue. These products experienced digit growth in SunChips. These gains ity costs, primarily cooking oil and double-digit revenue growth, while were partially offset by the discontinu- energy. Operating profit was also nega- the balance of the portfolio had high- ance of Toastables and Doritos Rollitos. tively impacted by almost 3 percentage single-digit revenue growth. Overall, salty snacks revenue grew 8% points as a result of a fourth quarter with volume growth of 5%, and other charge for the consolidation of the macro snacks revenue grew 13% with manufacturing network, including the

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PepsiCo Beverages North America

% Change 2006 2005 2004 2006 2005 Net revenue $9,565 $9,146 $8,313 5 10 Operating profit $2,055 $2,037 $1,911 1 7

2006 operating profit increase. Total market- Across the brands, a low-single-digit Bottler case sales (BCS) volume grew place spending for the year increased, decline in regular CSDs was partially 4%. The volume increase was driven by reflecting a shift from advertising and offset by low-single-digit growth in diet a 14% increase in non-carbonated bev- marketing spending to trade spending. CSDs. The additional week in 2005 had erages, partially offset by a 2% decline Additionally, the impact of more-favor- no significant impact on volume growth in CSDs. The non-carbonated portfolio able settlements of trade spending as bottler volume is reported based on performance was driven by double-digit accruals in 2005 was mostly offset by a a calendar month. growth in trademark Aquafina, favorable insurance settlement of Net revenue also benefited from Gatorade, Lipton ready-to-drink teas, $29 million in 2006. The absence of the 5 percentage points of favorable Tropicana juice drinks and Propel. prior year’s additional week, which effective net pricing, reflecting the con- Tropicana Pure Premium experienced a reduced operating profit growth by tinued migration from CSDs to low-single-digit decline in volume. The 1 percentage point, was fully offset by non-carbonated beverages and price decline in CSDs reflects a low-single- the impact of charges taken in the increases taken in the first quarter, digit decline in trademark Pepsi, fourth quarter of 2005 to reduce costs primarily on concentrate and Tropicana partially offset by a mid-single-digit in our operations, principally through Pure Premium, partially offset by headcount reductions. increased trade spending in 2005. The Smart Spot eligible products repre- additional week in 2005 contributed In 2006, Smart Spot eligible sented over 70% of net revenue. These 1 percentage point to net revenue products grew to over 70% of products experienced high-single-digit growth. PBNA’s total net revenue. revenue growth, while the balance of Operating profit increased nearly the portfolio declined in the low-single- 7%, primarily reflecting net revenue digit range. growth. This increase was partially off- increase in trademark Sierra Mist and a set by higher raw material, energy and 2005 low-single-digit increase in trademark transportation costs, as well as Net revenue grew 10% and BCS volume Mountain Dew. Across the brands, reg- increased advertising and marketing grew 4%. The volume increase was ular CSDs experienced a low-single-digit expenses. The additional week in 2005 driven by a 16% increase in non-carbon- decline and diet CSDs declined slightly. contributed 1 percentage point to oper- ated beverages, partially offset by a 1% The additional week in 2005 had no sig- ating profit growth and was fully offset decline in CSDs. Within non-carbonated nificant impact on volume growth as by a 1-percentage-point decline related beverages, Gatorade, trademark bottler volume is reported based on a to charges taken in 2005 to reduce costs Aquafina, Tropicana juice drinks, Propel calendar month. in our operations, principally through and SoBe all experienced double-digit Net revenue grew 5%. Positive mix headcount reductions. growth. Above average contributed to the revenue growth, summer temperatures reflecting the strength of non-carbon- across the country, as well ated beverages. Price increases taken in Aquafina, Gatorade, Tropicana juice drinks as the launch of new prod- 2006, primarily on concentrate, and Propel all experienced double-digit ucts such as Aquafina Tropicana Pure Premium and fountain, volume growth in both 2006 and 2005. FlavorSplash and Gatorade were offset by overall higher trade Lemonade earlier in the spending. The absence of the prior year, drove Gatorade and year’s additional week reduced net rev- Smart Spot eligible products repre- trademark Aquafina growth. Tropicana enue growth by 1 percentage point. sented almost 70% of net revenue. Pure Premium experienced a low-single- Operating profit increased 1% pri- These products experienced double- digit decline resulting from price marily reflecting the net revenue digit revenue growth, while the increases taken in the first quarter. The growth and lower advertising and mar- balance of the portfolio grew in the low- decline in CSDs reflects low-single-digit keting expenses. Higher raw material single-digit range. declines in trademark Pepsi and trade- costs, primarily oranges, increased sup- mark Mountain Dew, slightly offset by ply chain costs in Gatorade and higher low-single-digit growth in Sierra Mist. energy costs substantially offset the

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PepsiCo International

% Change 2006 2005 2004 2006 2005 Net revenue $12,959 $11,376 $9,862 14 15 Operating profit $1,948 $1,607 $1,323 21 21

2006 Foreign currency contributed 1 percent- Pacific region and 6% in the Latin International snacks volume grew 9%, age point of growth. The absence of the America region. Acquisitions had no sig- reflecting double-digit growth in Russia, prior year’s additional week reduced net nificant impact on the reported total , Egypt and India, and single-digit revenue growth by 1 percentage point. PepsiCo International beverage volume growth at Sabritas in Mexico. Overall, the Operating profit grew 21%, driven growth rate. Broad-based increases were Europe, Middle East & Africa region grew primarily by the net revenue growth, led by double-digit growth in the Middle 17%, the Latin America region grew partially offset by increased raw material East, China, Argentina, Venezuela and 2.5% and the Asia Pacific region grew and energy costs. The net impact of Russia. Carbonated soft drinks and non- 12%. Acquisitions of two businesses in acquisitions and divestitures had no carbonated beverages both grew at a Europe in 2006 increased the Europe, impact on the growth rate. Foreign double-digit rate. The additional week Middle East & Africa region volume currency contributed 1 percentage point had no impact on beverage volume growth by nearly 6 percentage points. of growth. The absence of the prior growth as volume is reported based on a The acquisition of a business in Australia year's additional week, which reduced calendar month. increased the Asia Pacific region volume the operating profit growth rate by Net revenue grew 15%, primarily as a growth by 1 percentage point. In 1 percentage point, was fully offset by result of the broad-based volume growth aggregate, acquisitions contributed the impact of charges taken in 2005 to and favorable effective net pricing. 2 percentage points to the reported total reduce costs in our operations and Foreign currency contributed almost PepsiCo International snack volume rationalize capacity. 3 percentage points of growth reflecting growth rate. The absence of the prior the favorable Mexican peso and Brazilian 2005 year’s additional week reduced the real, partially offset by the unfavorable International snacks volume grew 7%, growth rate by 1 percentage point. British pound. Acquisitions and divesti- reflecting growth of 11% in the Europe, Beverage volume grew 9%, reflecting tures contributed almost 2 percentage Middle East & Africa region, 5% in the broad-based increases led by double- points of growth. The additional week Latin America region and 6% in the Asia digit growth in the Middle East, China, contributed 1 percentage point to rev- Pacific region. Acquisition and divestiture Argentina, Russia and Venezuela. The enue growth. Cumulatively, the impact of activity, principally the divestiture in 2004 foreign currency, acquisitions and divesti- of our interest in a South Korea joint ven- tures, and the additional week on net ture, reduced Asia Pacific region volume International snack volume and revenue was 5 percentage points. by 11 percentage points. The acquisition beverage volume each grew 9% Operating profit grew 21% driven of a business in Romania late in 2004 in 2006. largely by the broad-based volume increased the Europe, Middle East & growth and favorable effective net pric- Africa region volume growth by 3 per- ing, partially offset by increased energy centage points. Cumulatively, our Europe, Middle East & Africa region grew and raw material costs. Foreign currency divestiture and acquisition activities did 11%, the Asia Pacific region grew 9% contributed 4 percentage points of not impact the reported total PepsiCo and the Latin America region grew 7%. growth based on the favorable Mexican International snack volume growth rate. Acquisitions contributed 1 percentage peso and Brazilian real. The net favorable The overall gains reflected mid-single- point to the Europe, Middle East & Africa impact from acquisition and divestiture digit growth at Sabritas in Mexico, region volume growth rate and activity, primarily the acquisition of double-digit growth in India, Turkey, contributed slightly to the reported total General Mills’ minority interest in Snack Russia, Australia and China, partially off- PepsiCo International beverage volume Ventures Europe in the first quarter of set by a low-single-digit decline at growth rate. CSDs grew at a high-single- 2005, contributed 2 percentage points of Walkers in the United Kingdom. The digit rate while non-carbonated growth. The additional week contributed decline at Walkers is due principally to beverages grew at a double-digit rate. 1 percentage point to operating profit marketplace pressures. The additional Net revenue grew 14%, primarily as a growth which was fully offset by a 1-per- week contributed 1 percentage point to result of the broad-based volume growth centage-point decline in operating profit international snack volume growth. and favorable effective net pricing. The growth related to fourth quarter charges Beverage volume grew 11%, reflect- net impact of acquisitions and to reduce costs in our operations and ing growth of 14% in the Europe, Middle divestitures contributed nearly 3 percent- rationalize capacity. East & Africa region, 11% in the Asia age points to net revenue growth. 50 267419_L01_P27_81.v5.qxd 3/6/07 2:55 PM Page 51

Quaker Foods North America

% Change 2006 2005 2004 2006 2005 Net revenue $1,769 $1,718 $1,526 3 13 Operating profit $554 $537 $475 3 13

2006 Smart Spot eligible products repre- approximately 2 percentage points to Net revenue grew 3% and volume sented approximately 55% of net both net revenue and volume growth. increased 1%. The volume increase revenue and had mid-single-digit net Operating profit increased 13% reflects mid-single-digit growth in revenue growth. The balance of the reflecting the net revenue growth. This Oatmeal, high-single-digit growth in portfolio experienced a low-single-digit growth was partially offset by higher Life cereal and low-single-digit growth decline. The absence of the prior year’s advertising and marketing costs behind in Cap’n Crunch cereal. These increases additional week negatively impacted programs for core brands and innova- were partially offset by a low-single- these results. tion, as well as an unfavorable cost of digit decline in Aunt Jemima syrup and sales comparison primarily due to 2005 mix and a mid-single-digit decline in Net revenue Rice-A-Roni. Net revenue growth was increased 13% and also driven by favorable effective net In 2006 and 2005, Smart Spot eligible products volume increased pricing, which contributed almost 2 per- represented over half of QFNA’s total net revenue. 9%. The volume centage points to net revenue growth, increase reflects and favorable Canadian foreign double-digit exchange rates which contributed higher energy and raw material costs in growth in Oatmeal, Aunt Jemima syrup almost 1 percentage point. The absence the latter part of 2005. The additional and mix, Rice-A-Roni and Pasta Roni, as of the prior year’s additional week week in 2005 contributed approximately well as high-single-digit growth in reduced both net revenue and 2 percentage points to operating Cap’n Crunch cereal and mid-single- volume growth by approximately profit growth. digit growth in Life cereal. Higher 2 percentage points. Smart Spot eligible products effective net pricing contributed nearly Operating profit increased 3% reprsented approximately half of net 3 percentage points of growth reflect- primarily reflecting the net revenue revenue and had double-digit revenue ing favorable product mix, the growth. Increased cost of sales, primar- growth. The balance of the portfolio settlement of prior year trade spending ily driven by higher raw material and also experienced double-digit accruals and price increases on ready-to- energy costs, were largely offset by revenue growth. eat cereals taken in the third quarter of lower advertising and marketing 2004. Favorable Canadian exchange expenses. The absence of the prior year’s rates contributed nearly 1 percentage additional week reduced operating point to net revenue growth. The addi- profit growth by approximately 2 points. tional week in 2005 contributed

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Our Liquidity and Capital Resources

Our strong cash–generating capability and financial 2006 Cash Utilization condition give us ready access to capital markets Long-term debt Other, net $106 $223 throughout the world. Our principal source of liquidity Acquisitions Short-term investments $522 $2,017 is our operating cash flow. This cash–generating Dividends Cash proceeds $1,854 capability is one of our fundamental strengths and from sale of PBG stock provides us with substantial financial flexibility in $318 Stock option exercises Capital spending meeting operating, investing and financing needs. In $1,194 $2,068 addition, we have revolving credit facilities that are further discussed in Note 9. Our cash provided from operating activities is somewhat impacted by Share repurchases Operating activities $3,010 seasonality. Working capital needs are impacted by $6,084 weekly sales, which are generally highest in the third Short-term borrowings quarter due to seasonal and holiday–related sales $2,341 patterns, and generally lowest in the first quarter.

Source of Cash Use of Cash

Operating Activities short-term investments of $1.0 billion. shareholders through common share In 2006, our operations provided These amounts were partially offset by repurchases of $3.0 billion and dividend $6.1 billion of cash compared to the proceeds from our sale of PBG stock payments of $1.9 billion. Net repay- $5.9 billion in the prior year. The of $214 million. ments of short-term borrowings of increase primarily reflects our solid busi- In the first quarter of 2007, we com- $2.3 billion were partially offset by stock ness results. Our operating cash flow in pleted our acquisition of Naked Juice option proceeds of $1.2 billion. In 2005, 2006 also reflects increased net tax Company which was funded with exist- we used $1.9 billion for our financing payments over the prior year of ing domestic cash. This acquisition will activities, primarily reflecting share $897 million, which included $420 mil- be included in the first quarter of 2007 repurchases of $3.0 billion and dividend lion related to our repatriation of as an investing activity in our payments of $1.6 billion, partially offset international cash in 2005 in connection Condensed Consolidated Statement of by net proceeds from short-term bor- with the AJCA, substantially offset by Cash Flows. rowings of $1.8 billion and stock option reductions in pension plan We anticipate net capital spending of proceeds of $1.1 billion. contributions over the prior year of approximately $2.6 billion in 2007, which On May 3, 2006, our Board of $744 million. is expected to be within our net capital Directors authorized and publicly spending target of approximately 5% announced our new $8.5 billion repur- Investing Activities to 7% of net revenue in each of the chase program, which expires on June In 2006, we used $194 million for our next few years. Planned capital spend- 30, 2009. Since inception of the new investing activities. Capital spending of ing in 2007 includes increased program, we have repurchased $1.1 bil- $2.1 billion and acquisitions of $522 mil- investments at PI, particularly in the lion of shares, leaving $7.4 billion of lion were mostly offset by net sales of developing and emerging markets, and remaining authorization. We have his- short-term investments of $2.0 billion additional investments in manufactur- torically repurchased significantly more and proceeds from our sale of PBG ing capacity to support our North shares each year than we have issued stock of $318 million. The increase in American Gatorade business as well as under our stock-based compensation capital spending over the prior year pri- other non-carbonated beverage busi- plans, with average net annual repur- marily reflects increased investments at nesses. New capital projects are chases of 1.4% of outstanding shares PI and in our North American Gatorade evaluated on a case-by-case basis and for the last five years. We target an business, as well as increased support must meet certain payback and internal annual dividend payout of approxi- behind our ongoing BPT initiative. In rate of return targets. mately 45% of prior year’s net income 2005, we used $3.5 billion, primarily from continuing operations. Annually, reflecting capital spending of $1.7 bil- Financing Activities we review our capital structure with our lion, acquisitions of $1.1 billion, In 2006, we used $6.0 billion for our Board, including our dividend policy primarily the $750 million acquisition of financing activities, primarily reflecting and share repurchase activity. General Mills’ minority interest in Snack the return of operating cash flow to our Ventures Europe, and net purchases of

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2005 Cash Utilization 2004 Cash Utilization

Other, net Other, net $70 Long-term debt $69 $152 Short-term borrowings Stock option exercises Short-term $1,848 Acquisitions $965 investments Cash proceeds $1,095 $969 from sale of PBG stock Short-term borrowings $214 Dividends $1,112 Dividends Stock option exercises $1,642 $1,329 $1,099 Short-term investments $991 Capital spending $1,387 Capital spending Operating activities Operating activities $1,736 $5,054 $5,852

Share repurchases Share repurchases $3,055 $3,031

Source of Cash Use of Cash Source of Cash Use of Cash

2006 2005 2004 Net cash provided by operating activities $ 6,084 $ 5,852 $ 5,054 Capital spending (2,068) (1,736) (1,387) Sales of property, plant and equipment 49 88 38 Management operating cash flow $ 4,065 $ 4,204 $ 3,705

Management Operating Cash Flow through dividends and share Off-Balance-Sheet Arrangements We focus on management operating repurchases. However, see “Our It is not our business practice to enter cash flow as a key element in achieving Business Risks” for certain factors that into off-balance-sheet arrangements, maximum shareholder value, and it is may impact our operating cash flows. other than in the normal course of the primary measure we use to monitor business, nor is it our policy to issue Credit Ratings cash flow performance. However, it is guarantees to our bottlers, non- Our debt ratings of Aa3 from Moody’s not a measure provided by accounting controlled affiliates or third parties. and A+ from Standard & Poor’s principles generally accepted in the U.S. However, certain guarantees were nec- contribute to our ability to access global Since net capital spending is essential to essary to facilitate the separation of our capital markets. We have maintained our product innovation initiatives and bottling and restaurant operations strong investment grade ratings for maintaining our operational capabili- from us. At year-end 2006, we believe it over a decade. Each rating is considered ties, we believe that it is a recurring and is remote that these guarantees would strong investment grade and is in the necessary use of cash. As such, we require any cash payment. We do not first quartile of their respective ranking believe investors should also consider enter into off-balance-sheet trans- systems. These ratings also reflect the net capital spending when evaluating actions specifically structured to provide impact of our anchor bottlers’ cash our cash from operating activities. The income or tax benefits or to avoid flows and debt. table above reconciles the net cash pro- recognizing or disclosing assets or vided by operating activities as Credit Facilities and Long-Term liabilities. See Note 9 for a description reflected in our Consolidated Statement Contractual Commitments of our off-balance-sheet arrangements. of Cash Flows to our management oper- See Note 9 for a description of our ating cash flow. Management credit facilities and long-term contrac- operating cash flow was used primarily tual commitments. to repurchase shares and pay dividends. We expect to continue to return approximately all of our management operating cash flow to our shareholders

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Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2006, December 31, 2005 and December 25, 2004 (in millions except per share amounts) 2006 2005 2004 Net Revenue...... $35,137 $32,562 $29,261 Cost of sales...... 15,762 14,176 12,674 Selling, general and administrative expenses...... 12,774 12,314 11,031 Amortization of intangible assets...... 162 150 147 Restructuring and impairment charges...... – – 150 Operating Profit...... 6,439 5,922 5,259 Bottling equity income...... 616 557 380 Interest expense...... (239) (256) (167) Interest income ...... 173 159 74 Income from Continuing Operations before Income Taxes...... 6,989 6,382 5,546 Provision for Income Taxes ...... 1,347 2,304 1,372 Income from Continuing Operations ...... 5,642 4,078 4,174 Tax Benefit from Discontinued Operations ...... – –38 Net Income ...... $ 5,642 $ 4,078 $ 4,212

Net Income per Common Share — Basic Continuing operations...... $3.42 $2.43 $2.45 Discontinued operations...... – – 0.02 Total ...... $3.42 $2.43 $2.47 Net Income per Common Share — Diluted Continuing operations...... $3.34 $2.39 $2.41 Discontinued operations...... – – 0.02 Total ...... $3.34 $2.39 $2.44*

* Based on unrounded amounts. See accompanying notes to consolidated financial statements.

Net Revenue Operating Profit

$35,137 $32,562 $6,439 $29,261 $5,922 $5,259

2004 2005 2006 2004 2005 2006

Income from Continuing Operations Net Income per Common Share — Continuing Operations

$3.34 $5,642

$2.41 $4,174 $4,078 $2.39

2004 2005 2006 2004 2005 2006

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Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2006, December 31, 2005 and December 25, 2004 (in millions) 2006 2005 2004 Operating Activities Net income ...... $ 5,642 $ 4,078 $ 4,212 Depreciation and amortization...... 1,406 1,308 1,264 Stock-based compensation expense ...... 270 311 368 Excess tax benefits from share-based payment arrangements...... (134) –– Restructuring and impairment charges...... – – 150 Cash payments for merger-related costs and restructuring charges ...... – (22) (92) Tax benefit from discontinued operations...... – – (38) Pension and retiree medical plan contributions...... (131) (877) (534) Pension and retiree medical plan expenses ...... 544 464 395 Bottling equity income, net of dividends...... (479) (411) (297) Deferred income taxes and other tax charges and credits...... (510) 440 (203) Other non-cash charges and credits, net...... 32 145 166 Change in accounts and notes receivable ...... (330) (272) (130) Change in inventories...... (186) (132) (100) Change in prepaid expenses and other current assets...... (37) (56) (31) Change in accounts payable and other current liabilities...... 223 188 216 Change in income taxes payable ...... (295) 609 (268) Other, net ...... 69 79 (24) Net Cash Provided by Operating Activities ...... 6,084 5,852 5,054 Investing Activities Snack Ventures Europe (SVE) minority interest acquisition ...... – (750) – Capital spending ...... (2,068) (1,736) (1,387) Sales of property, plant and equipment...... 49 88 38 Investment in finance assets...... (25) –– Other acquisitions and investments in noncontrolled affiliates ...... (522) (345) (64) Cash proceeds from sale of PBG stock...... 318 214 – Divestitures...... 37 352 Short-term investments, by original maturity More than three months — purchases ...... (29) (83) (44) More than three months — maturities...... 25 84 38 Three months or less, net...... 2,021 (992) (963) Net Cash Used for Investing Activities...... (194) (3,517) (2,330) Financing Activities Proceeds from issuances of long-term debt...... 51 25 504 Payments of long-term debt ...... (157) (177) (512) Short-term borrowings, by original maturity More than three months — proceeds...... 185 332 153 More than three months — payments...... (358) (85) (160) Three months or less, net...... (2,168) 1,601 1,119 Cash dividends paid ...... (1,854) (1,642) (1,329) Share repurchases — common...... (3,000) (3,012) (3,028) Share repurchases — preferred...... (10) (19) (27) Proceeds from exercises of stock options...... 1,194 1,099 965 Excess tax benefits from share-based payment arrangements...... 134 –– Net Cash Used for Financing Activities ...... (5,983) (1,878) (2,315) Effect of exchange rate changes on cash and cash equivalents ...... 28 (21) 51 Net (Decrease)/Increase in Cash and Cash Equivalents...... (65) 436 460 Cash and Cash Equivalents, Beginning of Year ...... 1,716 1,280 820 Cash and Cash Equivalents, End of Year...... $ 1,651 $ 1,716 $ 1,280 See accompanying notes to consolidated financial statements. 55 267419_L01_P27_81.v2.qxd 2/28/07 4:09 PM Page 56

Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 30, 2006 and December 31, 2005 (in millions except per share amounts) 2006 2005 ASSETS Current Assets Cash and cash equivalents ...... $ 1,651 $ 1,716 Short-term investments...... 1,171 3,166 Accounts and notes receivable, net...... 3,725 3,261 Inventories ...... 1,926 1,693 Prepaid expenses and other current assets...... 657 618 Total Current Assets...... 9,130 10,454 Property, Plant and Equipment, net...... 9,687 8,681 Amortizable Intangible Assets, net...... 637 530 Goodwill...... 4,594 4,088 Other nonamortizable intangible assets...... 1,212 1,086 Nonamortizable Intangible Assets ...... 5,806 5,174 Investments in Noncontrolled Affiliates...... 3,690 3,485 Other Assets ...... 980 3,403 Total Assets...... $29,930 $31,727

LIABILITIES AND SHAREHOLDERS’ EQUITY Current Liabilities Short-term obligations ...... $ 274 $ 2,889 Accounts payable and other current liabilities...... 6,496 5,971 Income taxes payable ...... 90 546 Total Current Liabilities ...... 6,860 9,406 Long-Term Debt Obligations ...... 2,550 2,313 Other Liabilities ...... 4,624 4,323 Deferred Income Taxes...... 528 1,434 Total Liabilities ...... 14,562 17,476

Commitments and Contingencies

Preferred Stock, no par value ...... 41 41 Repurchased Preferred Stock...... (120) (110)

Common Shareholders’ Equity Common stock, par value 1 2/3¢ per share (issued 1,782 shares) ...... 30 30 Capital in excess of par value...... 584 614 Retained earnings...... 24,837 21,116 Accumulated other comprehensive loss...... (2,246) (1,053) 23,205 20,707 Less: repurchased common stock, at cost (144 and 126 shares, respectively)...... (7,758) (6,387) Total Common Shareholders’ Equity ...... 15,447 14,320 Total Liabilities and Shareholders’ Equity ...... $29,930 $31,727

See accompanying notes to consolidated financial statements.

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Consolidated Statement of Common Shareholders’ Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 30, 2006, December 31, 2005 and December 25, 2004 2006 2005 2004 (in millions) Shares Amount Shares Amount Shares Amount Common Stock ...... 1,782 $ 30 1,782 $ 30 1,782 $ 30 Capital in Excess of Par Value Balance, beginning of year ...... 614 618 548 Stock-based compensation expense...... 270 311 368 Stock option exercises(a) ...... (300) (315) (298) Balance, end of year...... 584 614 618 Retained Earnings Balance, beginning of year ...... 21,116 18,730 15,961 Net income...... 5,642 4,078 4,212 Cash dividends declared — common...... (1,912) (1,684) (1,438) Cash dividends declared — preferred ...... (1) (3) (3) Cash dividends declared — RSUs ...... (8) (5) (2) Balance, end of year...... 24,837 21,116 18,730 Accumulated Other Comprehensive Loss Balance, beginning of year ...... (1,053) (886) (1,267) Currency translation adjustment ...... 465 (251) 401 Cash flow hedges, net of tax: Net derivative (losses)/gains ...... (18) 54 (16) Reclassification of (gains)/losses to net income .... (5) (8) 9 Unamortized pension and retiree medical, net of tax.. (1,782) –– Minimum pension liability adjustment, net of tax.... 138 16 (19) Unrealized gain on securities, net of tax ...... 9 24 6 Other ...... – (2) – Balance, end of year...... (2,246) (1,053) (886) Repurchased Common Stock Balance, beginning of year ...... (126) (6,387) (103) (4,920) (77) (3,376) Share repurchases...... (49) (3,000) (54) (2,995) (58) (2,994) Stock option exercises ...... 31 1,619 31 1,523 32 1,434 Other ...... –10 –5 –16 Balance, end of year...... (144) (7,758) (126) (6,387) (103) (4,920) Total Common Shareholders’ Equity ...... $15,447 $14,320 $13,572

2006 2005 2004 Comprehensive Income Net income...... $5,642 $4,078 $4,212 Currency translation adjustment ...... 465 (251) 401 Cash flow hedges, net of tax ...... (23) 46 (7) Minimum pension liability adjustment, net of tax...... 5 16 (19) Unrealized gain on securities, net of tax ...... 9 24 6 Other ...... – (2) – Total Comprehensive Income ...... $6,098 $3,911 $4,593

(a) Includes total tax benefits of $130 million in 2006, $125 million in 2005 and $183 million in 2004. See accompanying notes to consolidated financial statements.

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Notes to Consolidated Financial Statements

Note 1 — Basis of Presentation and Our Divisions

Basis of Presentation Our financial statements include the In connection with our ongoing BPT amounts of assets, liabilities, revenues, consolidated accounts of PepsiCo, Inc. initiative, we aligned certain account- expenses and disclosure of contingent and the affiliates that we control. In ing policies across our divisions in 2005. assets and liabilities. Estimates are used addition, we include our share of the We conformed our methodology for in determining, among other items, sales results of certain other affiliates based calculating our bad debt reserves and incentives accruals, tax reserves, stock- on our economic ownership interest. We modified our policy for recognizing rev- based compensation, pension and do not control these other affiliates, as enue for products shipped to customers retiree medical accruals, useful lives for our ownership in these other affiliates is by third-party carriers. Additionally, we intangible assets, and future cash flows generally less than 50%. Our share of conformed our method of accounting associated with impairment testing for the net income of noncontrolled bot- for certain costs, primarily warehouse perpetual brands, goodwill and other tling affiliates is reported in our income and freight. These changes reduced our long-lived assets. Actual results could statement as bottling equity income. net revenue by $36 million and our differ from these estimates. Bottling equity income also includes any operating profit by $60 million in 2005. See “Our Divisions” below and for changes in our ownership interests of Raw materials, direct labor and plant additional unaudited information on these affiliates. Bottling equity income overhead, as well as purchasing and items affecting the comparability of our includes $186 million and $126 million receiving costs, costs directly related to consolidated results, see “Items of pre-tax gains on our sales of PBG production planning, inspection costs Affecting Comparability” in stock in 2006 and 2005, respectively. See and raw material handling facilities, are Management’s Discussion and Analysis. Note 8 for additional information on included in cost of sales. The costs of Tabular dollars are in millions, except our significant noncontrolled bottling moving, storing and delivering finished per share amounts. All per share affiliates. Intercompany balances and product are included in selling, general amounts reflect common per share transactions are eliminated. In 2005, we and administrative expenses. amounts, assume dilution unless noted, had an additional week of results (53rd The preparation of our consolidated and are based on unrounded amounts. week). Our fiscal year ends on the last financial statements in conformity with Certain reclassifications were made to Saturday of each December, resulting in generally accepted accounting princi- prior years’ amounts to conform to the an additional week of results every five ples requires us to make estimates and 2006 presentation. or six years. assumptions that affect reported

Our Divisions We manufacture or use contract manu- fourth quarter of 2005, we began cen- reflect the contract purchase price of facturers, market and sell a variety of trally managing commodity derivatives the energy or other commodities. salty, sweet and grain-based snacks, car- on behalf of our divisions. Certain of Division results are based on how our bonated and non-carbonated the commodity derivatives, primarily President and Chief Executive Officer beverages, and foods through our those related to the purchase of energy assesses the performance of and reallo- North American and international busi- for use by our divisions, do not qualify cates resources to our divisions. Division ness divisions. Our North American for hedge accounting treatment. These results exclude certain Corporate-initi- divisions include the United States and derivatives hedge underlying commod- ated restructuring and impairment Canada. The accounting policies for the ity price risk and were not entered into charges. For additional unaudited infor- divisions are the same as those for speculative purposes. Such deriva- mation on our divisions, see “Our described in Note 2, except for certain tives are marked to market with the Operations” in Management’s allocation methodologies for stock- resulting gains and losses recognized in Discussion and Analysis. based compensation expense and corporate unallocated expenses. These pension and retiree medical expenses, gains and losses are subsequently as described in the unaudited informa- reflected in division results when the tion in “Our Critical Accounting divisions take delivery of the underlying Policies.” Additionally, beginning in the commodity. Therefore, division results

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PepsiCo Frito-Lay PepsiCo Quaker Foods Beverages North America International North America North America (FLNA) (PI) (QFNA) (PBNA)

Net Revenue Operating Profit

2006 2005 2004 2006 2005 2004 FLNA $10,844 $10,322 $ 9,560 $2,615 $2,529 $2,389 PBNA 9,565 9,146 8,313 2,055 2,037 1,911 PI 12,959 11,376 9,862 1,948 1,607 1,323 QFNA 1,769 1,718 1,526 554 537 475 Total division 35,137 32,562 29,261 7,172 6,710 6,098 Corporate – ––(733) (788) (689) 35,137 32,562 29,261 6,439 5,922 5,409 Restructuring and impairment charges – –– – – (150) Total $35,137 $32,562 $29,261 $6,439 $5,922 $5,259

Net Revenue Division Operating Profit Corporate QFNA 5% Corporate includes costs of our corpo- rate headquarters, centrally-managed QFNA initiatives, such as our BPT initiative in 8% North America, unallocated insurance FLNA and benefit programs, foreign FLNA 31% exchange transaction gains and losses, PI 36% PI 27% and certain commodity derivative gains 37% and losses, as well as profit-in-inventory elimination adjustments for our non- PBNA PBNA 27% 29% controlled bottling affiliates and certain other items. Restructuring and Impairment Charges — See Note 3.

Other Division Information

Total Assets Capital Spending

2006 2005 2004 2006 2005 2004

FLNA $ 5,969 $ 5,948 $ 5,476 $ 499 $ 512 $ 469 PBNA 6,567 6,316 6,048 492 320 265 PI 11,274 9,983 8,921 835 667 537 QFNA 1,003 989 978 31 31 33 Total division 24,813 23,236 21,423 1,857 1,530 1,304 Corporate (a) 1,739 5,331 3,569 211 206 83 Investments in bottling affiliates 3,378 3,160 2,995 – –– $29,930 $31,727 $27,987 $2,068 $1,736 $1,387 (a) Corporate assets consist principally of cash and cash equivalents, short-term investments, and property, plant and equipment.

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Total Assets Capital Spending Net Revenue

QFNA 2% Corporate 10% Other FLNA FLNA 17% 24% Other QFNA 20% 22% 3%

Canada United States 5% 59% PBNA PI PI 22% 40% PBNA United 38% 24% Kingdom Mexico 5% 9%

Amortization of Depreciation and Intangible Assets Other Amortization Long-Lived Assets 2006 2005 2004 2006 2005 2004

FLNA $9 $3 $3 $ 432 $ 419 $ 420 PBNA 77 76 75 282 264 258 Other Canada 24% PI 76 71 68 478 420 382 3% QFNA – –1 33 34 36 United Total division 162 150 147 1,225 1,137 1,096 Kingdom 10% Corporate – –– 19 21 21 Mexico United States $162 $150 $147 $1,244 $1,158 $1,117 5% 58%

Net Revenue(a) Long-Lived Assets(b) 2006 2005 2004 2006 2005 2004 U.S. $20,788 $19,937 $18,329 $11,515 $10,723 $10,212 Mexico 3,228 3,095 2,724 996 902 878 United Kingdom 1,839 1,821 1,692 1,995 1,715 1,896 Canada 1,702 1,509 1,309 589 582 548 All other countries 7,580 6,200 5,207 4,725 3,948 3,339 $35,137 $32,562 $29,261 $19,820 $17,870 $16,873 (a) Represents net revenue from businesses operating in these countries. (b) Long-lived assets represent property, plant and equipment, nonamortizable intangible assets, amortizable intangible assets, and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used.

Note 2 — Our Significant Accounting Policies

Revenue Recognition house-distributed products is to replace to concentration of credit risk by our We recognize revenue upon shipment damaged and out-of-date products. customers, Wal-Mart and PBG. In 2006, or delivery to our customers based on Based on our historical experience with Wal-Mart represented approximately written sales terms that do not allow this practice, we have reserved for 9% of our total net revenue, including for a right of return. However, our pol- anticipated damaged and out-of-date concentrate sales to our bottlers which icy for DSD and chilled products is to products. For additional unaudited are used in finished goods sold by them remove and replace damaged and out- information on our revenue recognition to Wal-Mart; and PBG represented of-date products from store shelves to and related policies, including our pol- approximately 10%. We have ensure that our consumers receive the icy on bad debts, see “Our Critical not experienced credit issues with product quality and freshness that they Accounting Policies” in Management’s these customers. expect. Similarly, our policy for ware- Discussion and Analysis. We are exposed

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Sales Incentives and Other Software Costs • Stock-Based Compensation Expense — Marketplace Spending We capitalize certain computer Note 6 and, for additional unaudited We offer sales incentives and discounts software and software development information, see “Our Critical through various programs to our cus- costs incurred in connection with devel- Accounting Policies” in Management’s tomers and consumers. Sales incentives oping or obtaining computer software Discussion and Analysis. and discounts are accounted for as a for internal use. Capitalized software • Pension, Retiree Medical and Savings reduction of revenue and totaled costs are included in property, plant Plans — Note 7 and, for additional $10.1 billion in 2006, $8.9 billion in 2005 and equipment on our balance sheet unaudited information, see “Our and $7.8 billion in 2004. While most of and amortized on a straight-line Critical Accounting Policies” in these incentive arrangements have basis when placed into service over the Management’s Discussion and Analysis. terms of no more than one year, certain estimated useful lives of the software, • Risk Management — Note 10 and, for arrangements, such as fountain pouring which approximate five to seven additional unaudited information, see rights, extend beyond one year. Costs years. Net capitalized software and “Our Business Risks” in Management’s incurred to obtain these arrangements development costs were $537 million Discussion and Analysis. are recognized over no longer than the at December 30, 2006 and $327 million Recent Accounting Pronouncements contract period and the remaining bal- at December 31, 2005. As further discussed in Note 6, we ances of $297 million at December 30, Commitments and Contingencies adopted SFAS 123R on January 1, 2006. 2006 and $321 million at December 31, We are subject to various claims and As further discussed in Note 7, we 2005 are included in current assets and contingencies related to lawsuits, taxes adopted SFAS 158 on December 30, 2006. other assets on our balance sheet. For and environmental matters, as well as In September 2006, the SEC issued additional unaudited information on commitments under contractual and SAB 108 to address diversity in practice our sales incentives, see “Our Critical other commercial obligations. We rec- in quantifying financial statement mis- Accounting Policies” in Management’s ognize liabilities for contingencies and statements. SAB 108 requires that we Discussion and Analysis. commitments when a loss is probable quantify misstatements based on their Other marketplace spending includes and estimable. For additional informa- impact on each of our financial state- the costs of advertising and other mar- tion on our commitments, see Note 9. ments and related disclosures. On keting activities and is reported as December 30, 2006, we adopted SAB selling, general and administrative Research and Development 108. Our adoption of SAB 108 did not expenses. Advertising expenses were We engage in a variety of research and impact our financial statements. $1.7 billion in 2006, $1.8 billion in 2005 development activities. These activities In July 2006, the FASB issued FIN 48 and $1.7 billion in 2004. Deferred principally involve the development of which clarifies the accounting for uncer- advertising costs are not expensed until new products, improvement in the tainty in tax positions. FIN 48 requires the year first used and consist of: quality of existing products, improve- that we recognize in our financial state- • media and personal service ment and modernization of production ments, the impact of a tax position, if prepayments, processes, and the development and that position is more likely than not of • promotional materials in inventory, and implementation of new technologies to being sustained on audit, based on the • production costs of future media enhance the quality and value of both technical merits of the position. The advertising. current and proposed product lines. provisions of FIN 48 are effective as of Deferred advertising costs of Research and development costs were the beginning of our 2007 fiscal year, $171 million and $202 million at year- $344 million in 2006 and $340 million in with the cumulative effect of the end 2006 and 2005, respectively, are 2005 and are reported as selling, gen- change in accounting principle classified as prepaid expenses on our eral and administrative expenses. recorded as an adjustment to opening balance sheet. Other Significant Accounting Policies retained earnings. We do not expect Distribution Costs Our other significant accounting poli- our adoption of FIN 48 to materially Distribution costs, including the costs of cies are disclosed as follows: impact our financial statements. shipping and handling activities, are • Property, Plant and Equipment and In September 2006, the FASB issued reported as selling, general and adminis- Intangible Assets — Note 4 and, for SFAS 157 which defines fair value, trative expenses. Shipping and handling additional unaudited information on establishes a framework for measuring expenses were $4.6 billion in 2006, brands and goodwill, see “Our Critical fair value, and expands disclosures $4.1 billion in 2005 and $3.9 billion Accounting Policies” in Management’s about fair value measurements. The in 2004. Discussion and Analysis. provisions of SFAS 157 are effective • Income Taxes — Note 5 and, for addi- as of the beginning of our 2008 fiscal Cash Equivalents tional unaudited information, see year. We are currently evaluating the Cash equivalents are investments with “Our Critical Accounting Policies” in impact of adopting SFAS 157 on our original maturities of three months or Management’s Discussion and Analysis. financial statements. less which we do not intend to rollover beyond three months.

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Note 3 — Restructuring and Impairment Charges

2006 Restructuring and 2005 Restructuring Charges share) in conjunction with the consolida- Impairment Charges In 2005, we incurred a charge of $83 mil- tion of FLNA’s manufacturing network as In 2006, we incurred a charge of $67 mil- lion ($55 million after-tax or $0.03 per part of its ongoing productivity lion ($43 million after-tax or $0.03 per share) in conjunction with actions taken program. Of this charge, $93 million share) in conjunction with consolidating to reduce costs in our operations, princi- related to asset impairments, primarily the manufacturing network at FLNA by pally through headcount reductions. Of reflecting the closure of four U.S. plants. closing two plants in the U.S., and ratio- this charge, $34 million related to FLNA, Production from these plants was rede- nalizing other assets, to increase $21 million to PBNA, $16 million to PI ployed to other FLNA facilities in the U.S. manufacturing productivity and supply and $12 million to Corporate. Most of The remaining $57 million included chain efficiencies. The charge was com- this charge related to the termination employee-related costs of $29 million, prised of $43 million of asset of approximately 700 employees. As of contract termination costs of $8 million impairments, $14 million of severance December 30, 2006, all terminations and other exit costs of $20 million. and other employee costs and $10 million had occurred and substantially no Employee-related costs primarily reflect of other costs. Employee-related costs accrual remains. the termination costs for approximately primarily reflect the termination costs for 700 employees. As of December 30, 2004 Restructuring and approximately 380 employees. We expect 2006, all terminations had occurred and Impairment Charges all of the cash payments related to this substantially no accrual remains. In 2004, we incurred a charge of $150 charge to be paid by the end of 2007. million ($96 million after-tax or $0.06 per

Note 4 — Property, Plant and Equipment and Intangible Assets

Average Useful Life 2006 2005 2004 Property, plant and equipment, net Land and improvements 10 – 30 yrs. $ 756 $ 685 Buildings and improvements 20 – 44 4,095 3,736 Machinery and equipment, including fleet and software 5 – 15 12,768 11,658 Construction in progress 1,439 1,066 19,058 17,145 Accumulated depreciation (9,371) (8,464) $ 9,687 $ 8,681 Depreciation expense $1,182 $1,103 $1,062 Amortizable intangible assets, net Brands 5 – 40 $1,288 $1,054 Other identifiable intangibles 3 – 15 290 257 1,578 1,311 Accumulated amortization (941) (781) $ 637 $ 530 Amortization expense $162 $150 $147

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Depreciation and amortization are Useful lives are periodically evaluated reporting unit, including goodwill, with recognized on a straight-line basis over to determine whether events or circum- its fair value, as determined by its dis- an asset’s estimated useful life. Land is stances have occurred which indicate counted cash flows. If the book value of not depreciated and construction in the need for revision. For additional a reporting unit exceeds its fair value, progress is not depreciated until ready unaudited information on our amortiz- we complete the second step to deter- for service. Amortization of intangible able brand policies, see “Our Critical mine the amount of goodwill assets for each of the next five years, Accounting Policies” in Management’s impairment loss that we should record. based on average 2006 foreign Discussion and Analysis. In the second step, we determine an exchange rates, is expected to be implied fair value of the reporting unit’s Nonamortizable Intangible Assets $49 million in 2007, $49 million in 2008, goodwill by allocating the fair value of Perpetual brands and goodwill are $47 million in 2009, $46 million in 2010 the reporting unit to all of the assets assessed for impairment at least annu- and $44 million in 2011. and liabilities other than goodwill ally. If the carrying amount of a Depreciable and amortizable assets (including any unrecognized intangible perpetual brand exceeds its fair value, are only evaluated for impairment assets). The amount of impairment loss as determined by its discounted cash upon a significant change in the operat- is equal to the excess of the book value flows, an impairment loss is recognized ing or macroeconomic environment. In of the goodwill over the implied fair in an amount equal to that excess. these circumstances, if an evaluation of value of that goodwill. No impairment Goodwill is evaluated using a two-step the undiscounted cash flows indicates charges resulted from the required impairment test at the reporting unit impairment, the asset is written down impairment evaluations. The change in level. A reporting unit can be a division to its estimated fair value, which is the book value of nonamortizable or business within a division. The first based on discounted future cash flows. intangible assets is as follows: step compares the book value of a

Balance, Translation Balance, Translation Balance, Beginning 2005 Acquisitions and Other End of 2005 Acquisitions and Other End of 2006 Frito-Lay North America Goodwill $ 138 $ – $ 7 $ 145 $139 $ – $ 284 PepsiCo Beverages North America Goodwill 2,161 – 3 2,164 39 – 2,203 Brands 59 – – 59 – – 59 2,220 – 3 2,223 39 – 2,262 PepsiCo International Goodwill 1,435 278 (109) 1,604 183 145 1,932 Brands 869 263 (106) 1,026 – 127 1,153 2,304 541 (215) 2,630 183 272 3,085 Quaker Foods North America Goodwill 175 – – 175 – – 175 Corporate Pension intangible 5 – (4) 1 – (1) – Total goodwill 3,909 278 (99) 4,088 361 145 4,594 Total brands 928 263 (106) 1,085 – 127 1,212 Total pension intangible 5 – (4) 1 – (1) – $4,842 $541 $(209) $5,174 $361 $271 $5,806

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Note 5 — Income Taxes

2006 2005 2004 Income before income taxes — continuing operations U.S...... $3,844 $3,175 $2,946 Foreign ...... 3,145 3,207 2,600 $6,989 $6,382 $5,546 Provision for income taxes — continuing operations Current: U.S. Federal...... $ 776 $1,638 $1,030 Foreign...... 569 426 256 State ...... 56 118 69 1,401 2,182 1,355 Deferred: U.S. Federal...... (31) 137 11 Foreign...... (16) (26) 5 State ...... (7) 11 1 (54) 122 17 $1,347 $2,304 $1,372 Tax rate reconciliation — continuing operations U.S. Federal statutory tax rate ...... 35.0% 35.0% 35.0% State income tax, net of U.S. Federal tax benefit...... 0.5 1.4 0.8 Taxes on AJCA repatriation...... – 7.0 – Lower taxes on foreign results...... (6.5) (6.5) (5.4) Settlement of prior years’ audit...... – – (4.8) 2006 Tax Adjustments...... (8.6) –– Other, net ...... (1.1) (0.8) (0.9) Annual tax rate ...... 19.3% 36.1% 24.7% Deferred tax liabilities Investments in noncontrolled affiliates...... $1,103 $ 993 Property, plant and equipment...... 784 772 Pension benefits...... – 863 Intangible assets other than nondeductible goodwill ...... 169 135 Zero coupon notes...... 27 35 Other ...... 221 169 Gross deferred tax liabilities ...... 2,304 2,967 Deferred tax assets Net carryforwards ...... 667 608 Stock-based compensation...... 443 426 Retiree medical benefits...... 541 400 Other employee-related benefits ...... 342 342 Pension benefits...... 38 – Other ...... 592 520 Gross deferred tax assets...... 2,623 2,296 Valuation allowances...... (624) (532) Deferred tax assets, net...... 1,999 1,764 Net deferred tax liabilities ...... $ 305 $1,203 Deferred taxes included within: Assets: Prepaid expenses and other current assets...... $223 $231 Liabilities: Deferred income taxes ...... $528 $1,434 Analysis of valuation allowances Balance, beginning of year ...... $532 $564 $438 Provision/(benefit) ...... 71 (28) 118 Other additions/(deductions)...... 21 (4) 8 Balance, end of year ...... $624 $532 $564

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For additional unaudited information vested outside the U.S. and recorded favorable resolution of certain previ- on our income tax policies, including income tax expense of $460 million ously open tax issues. In addition, in our reserves for income taxes, see “Our related to this repatriation. Other than 2004, we recognized a tax benefit of Critical Accounting Policies” in the earnings repatriated, we intend to $38 million upon agreement with the Management’s Discussion and Analysis. continue to reinvest earnings outside IRS on a previously open issue related to the U.S. for the foreseeable future and, our discontinued restaurant operations. Carryforwards, Credits and therefore, have not recognized any U.S. The IRS has initiated their audits of Allowances tax expense on these earnings. At our tax returns for the years 2003 Operating loss carryforwards totaling December 30, 2006, we had approxi- through 2005. While it is often difficult $6.1 billion at year-end 2006 are being mately $10.8 billion of undistributed to predict the final outcome or the tim- carried forward in a number of foreign international earnings. ing of resolution of any particular tax and state jurisdictions where we are matter, we believe that our reserves permitted to use tax operating losses Reserves reflect the probable outcome of known from prior periods to reduce future tax- A number of years may elapse before a tax contingencies. We adjust these able income. These operating losses will particular matter, for which we have reserves, as well as the related interest, expire as follows: $0.2 billion in 2007, established a reserve, is audited and in light of changing facts and circum- $5.0 billion between 2008 and 2026 and finally resolved. The number of years stances. Settlement of any particular $0.9 billion may be carried forward with open tax audits varies depending issue would usually require the use of indefinitely. In addition, certain tax on the tax jurisdiction. In 2006, we rec- cash. Favorable resolution would be rec- credits generated in prior periods of ognized non-cash tax benefits of ognized as a reduction to our annual approximately $33.9 million are avail- $602 million, substantially all of which tax rate in the year of resolution. Our able to reduce certain foreign tax related to the IRS’s examination of our tax reserves, covering all federal, state liabilities through 2011. We establish consolidated income tax returns for the and foreign jurisdictions, are presented valuation allowances for our deferred years 1998 through 2002. The IRS issued on our balance sheet within other liabil- tax assets when the amount of a Revenue Agent’s Report (RAR), and ities (see Note 14), except for any expected future taxable income is not we are in agreement with their conclu- amounts relating to items we expect to likely to support the use of the deduc- sion, except for one matter which we pay in the coming year which are tion or credit. continue to dispute. The agreed adjust- included in current income taxes ments relate to transfer pricing and Undistributed International Earnings payable. For further unaudited infor- various other transactions, including The AJCA created a one-time incentive mation on the impact of the resolution certain acquisitions, the public offering for U.S. corporations to repatriate of open tax issues, see “Other of PBG, as well as the restructuring of undistributed international earnings by Consolidated Results.” our international snack foods providing an 85% dividends received As further discussed in Note 2, we operations during that audit period. deduction. In 2005, we repatriated will adopt FIN 48 as of the beginning of During 2004, we recognized $266 mil- approximately $7.5 billion in earnings our 2007 fiscal year. lion of tax benefits related to the previously considered indefinitely rein-

Note 6 — Stock–Based Compensation

Our stock-based compensation program expense was $270 million in 2006, Method of Accounting and is a broad-based program designed to $311 million in 2005 and $368 million in Our Assumptions attract and retain employees while also 2004. Related income tax benefits rec- We account for our employee stock aligning employees’ interests with the ognized in earnings were $80 million in options, which include grants under our interests of our shareholders. A majority 2006, $87 million in 2005 and $103 mil- executive program and broad-based of our employees participate in our lion in 2004. Stock-based compensation SharePower program, under the fair stock-based compensation programs. In cost capitalized in connection with our value method of accounting using a addition, members of our Board of BPT initiative was $3 million in 2006, Black-Scholes valuation model to mea- Directors participate in our stock-based $4 million in 2005 and none in 2004. At sure stock option expense at the date of compensation program in connection year-end 2006, 36 million shares were grant. All stock option grants have an with their service on our Board. Stock available for future stock-based com- exercise price equal to the fair market options and RSUs are granted to pensation grants. For additional value of our common stock on the date employees under the shareholder- unaudited information on our stock- of grant and generally have a 10-year approved 2003 Long-Term Incentive based compensation program, see “Our term. The fair value of stock option Plan (LTIP), our only active stock-based Critical Accounting Policies” in grants is amortized to expense over the plan. Stock-based compensation Management’s Discussion and Analysis. vesting period, generally three years.

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Executives who are awarded long-term settled in a share of our stock after the accounted for our stock-based compensa- incentives based on their performance vesting period. Vesting of RSU awards for tion plans under the fair value provisions are offered the choice of stock options or senior officers is contingent upon the of SFAS 123, our adoption did not signifi- RSUs. Executives who elect RSUs receive achievement of pre-established perfor- cantly impact our financial position or one RSU for every four stock options that mance targets. There have been no our results of operations. Under SFAS would have otherwise been granted. reductions to the exercise price of previ- 123R, actual tax benefits recognized in Senior officers do not have a choice and ously issued awards, and any repricing of excess of tax benefits previously estab- are granted 50% stock options and 50% awards would require approval of our lished upon grant are reported as a RSUs. RSU expense is based on the fair shareholders. financing cash inflow. Prior to adoption, value of PepsiCo stock on the date of On January 1, 2006, we adopted SFAS such excess tax benefits were reported as grant and is amortized over the vesting 123R under the modified prospective an operating cash inflow. period, generally three years. Each RSU is method. Since we had previously

Our weighted-average Black-Scholes fair value assumptions are as follows: 2006 2005 2004 Expected life 6 yrs. 6 yrs. 6 yrs. Risk free interest rate 4.5% 3.8% 3.3% Expected volatility 18% 23% 26% Expected dividend yield 1.9% 1.8% 1.8%

A summary of our stock-based compensation activity for the year ended December 30, 2006 is presented below:

Average Aggregate Average Life Intrinsic Our Stock Option Activity Options (a) Price (b) (years) (c) Value (d) Outstanding at January 1, 2006 150,149 $42.03 Granted 12,519 57.72 Exercised (31,056) 38.61 Forfeited/expired (3,863) 49.06 Outstanding at December 30, 2006 127,749 $44.24 5.46 $2,339,562 Exercisable at December 30, 2006 91,381 $41.02 4.42 $1,967,843 (a) Options are in thousands and include options previously granted under Quaker plans. No additional options or shares may be granted under the Quaker plans. (b) Weighted-average exercise price. (c) Weighted-average contractual life remaining. (d) In thousands.

Average Average Aggregate Intrinsic Life Intrinsic Our RSU Activity RSUs (a) Value (b) (years) (c) Value (d) Outstanding at January 1, 2006 5,669 $50.70 Granted 2,992 58.22 Converted (183) 50.00 Forfeited/expired (593) 53.17 Outstanding at December 30, 2006 7,885 $53.38 1.38 $493,201 (a) RSUs are in thousands. (b) Weighted-average intrinsic value at grant date. (c) Weighted-average contractual life remaining. (d) In thousands.

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Other Stock-Based Compensation Data 2006 2005 2004 Stock Options Weighted-average fair value of options granted $12.81 $13.45 $12.04 Total intrinsic value of options exercised(a) $686,242 $632,603 $667,001 RSUs Total number of RSUs granted(a) 2,992 3,097 3,077 Weighted-average intrinsic value of RSUs granted $58.22 $53.83 $47.28 Total intrinsic value of RSUs converted(a) $10,934 $4,974 $914 (a) In thousands. At December 30, 2006, there was $301 million of total unrecognized compensation cost related to nonvested share-based com- pensation grants. This unrecognized compensation is expected to be recognized over a weighted-average period of 1.5 years.

Note 7 — Pension, Retiree Medical and Savings Plans

Our pension plans cover full-time assumptions and from changes in our nize the overfunded or underfunded employees in the U.S. and certain inter- assumptions are also determined at status of our Plans as an asset or liability national employees. Benefits are each measurement date. If this net on our December 30, 2006 balance determined based on either years of accumulated gain or loss exceeds 10% sheet. Subsequent changes in the service or a combination of years of ser- of the greater of plan assets or liabili- funded status will be recognized vice and earnings. U.S. and Canada ties, a portion of the net gain or loss is through comprehensive income in the retirees are also eligible for medical and included in expense for the following year in which they occur. SFAS 158 also life insurance benefits (retiree medical) year. The cost or benefit of plan requires that, beginning in 2008, our if they meet age and service changes that increase or decrease assumptions used to measure our requirements. Generally, our share of benefits for prior employee service annual pension and retiree medical retiree medical costs is capped at speci- (prior service cost/(credit)) is included in expenses be determined as of the bal- fied dollar amounts, which vary based earnings on a straight-line basis over ance sheet date, and all plan assets and upon years of service, with retirees con- the average remaining service period of liabilities be reported as of that date. In tributing the remainder of the costs. those expected to benefit, which is accordance with SFAS 158, prior year We use a September 30 measurement approximately 11 years for pension amounts have not been adjusted. date and all plan assets and liabilities expense and approximately 13 years for The following illustrates the incre- are generally reported as of that date. retiree medical. mental effect of applying SFAS 158 on Other gains and losses resulting from On December 30, 2006, we adopted individual line items on our balance actual experience differing from our SFAS 158 which requires that we recog- sheet as of December 30, 2006:

Before After Application Application of SFAS 158 Adjustments of SFAS 158 Other nonamortizable intangible assets $1,229 $(17) $1,212 Other assets $2,979 $(1,999) $980 Total assets $31,946 $(2,016) $29,930 Accounts payable and other current liabilities $6,475 $21 $6,496 Other liabilities $4,127 $497 $4,624 Deferred income taxes $1,419 $(891) $528 Total liabilities $14,935 $(373) $14,562 Accumulated other comprehensive loss $603 $1,643 $2,246 Total common shareholders’ equity $17,090 $(1,643) $15,447

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Pension Retiree Medical 2006 2005 2006 2005 2006 2005 U.S. International Change in projected benefit liability Liability at beginning of year $5,771 $4,968 $1,263 $ 952 $1,312 $1,319 Service cost 245 213 52 32 46 40 Interest cost 319 296 68 55 72 78 Plan amendments 11 – 8 3 – (8) Participant contributions – – 12 10 – – Experience (gain)/loss (163) 517 20 203 (34) (45) Benefit payments (233) (241) (38) (28) (75) (74) Settlement/curtailment loss (7) – (6) – – – Special termination benefits 4 21 – – 1 2 Foreign currency adjustment – – 126 (68) – – Other – (3) 6 104 48 – Liability at end of year $5,947 $5,771 $1,511 $1,263 $1,370 $1,312 Change in fair value of plan assets Fair value at beginning of year $5,086 $4,152 $1,099 $ 838 $– $– Actual return on plan assets 513 477 112 142 – – Employer contributions/funding 19 699 30 104 75 74 Participant contributions – – 12 10 – – Benefit payments (233) (241) (38) (28) (75) (74) Settlement/curtailment loss (7) – – – – – Foreign currency adjustment – – 116 (61) – – Other – (1) (1) 94 – – Fair value at end of year $5,378 $5,086 $1,330 $1,099 $– $– Reconciliation of funded status Funded status $(569) $ (685) $(181) $(164) $(1,370) $(1,312) Adjustment for fourth quarter contributions 6 5 13 4 16 19 Unrecognized prior service cost/(credit) – 5 – 17 – (113) Unrecognized experience loss – 2,288 – 474 – 402 Net amount recognized $(563) $1,613 $(168) $ 331 $(1,354) $(1,004) Amounts recognized Other assets $ 185 $2,068 $6 $367 $– $– Intangible assets – – – 1 – – Other current liabilities (19) – (2) – (84) – Other liabilities (729) (479) (172) (41) (1,270) (1,004) Minimum pension liability – 24 – 4 – – Net amount recognized $(563) $1,613 $(168) $331 $(1,354) $(1,004) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss $1,836 $– $475 $– $ 364 $– Prior service cost/(credit) 13 – 24 – (101) – Minimum pension liability – 24 – 4 – – Total $1,849 $24 $499 $4 $ 263 $– Components of the (decrease)/increase in net loss Change in discount rate $(123) $ 365 $2 $194 $ (30) $61 Employee-related assumption changes (45) 57 6 2 – – Liability-related experience different from assumptions 5 95 6 7 (4) (54) Actual asset return different from expected return (122) (133) (30) (73) – – Amortization of losses (164) (106) (29) (15) (21) (26) Other, including foreign currency adjustments and 2003 Medicare Act (3) (3) 46 (22) 17 (52) Total $(452) $(275) $1 $93 $ (38) $ (71) Liability at end of year for service to date $4,998 $4,783 $1,239 $1,047

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Components of benefit expense are as follows: Pension Retiree Medical 2006 2005 2004 2006 2005 2004 2006 2005 2004 U.S. International Components of benefit expense Service cost $ 245 $ 213 $ 193 $52 $32 $27 $46 $40 $38 Interest cost 319 296 271 68 55 47 72 78 72 Expected return on plan assets (391) (344) (325) (81) (69) (65) – –– Amortization of prior service cost/(credit) 3 36 2 11 (13) (11) (8) Amortization of net loss 164 106 81 29 15 9 21 26 19 340 274 226 70 34 19 126 133 121 Settlement/curtailment loss 3 –4 – –1 – –– Special termination benefits 4 21 19 – –1 1 24 Total $ 347 $ 295 $ 249 $70 $34 $21 $127 $135 $125

The estimated amounts to be amortized from accumulated other comprehensive loss into benefit expense in 2007 for our pension and retiree medical plans are as follows: Pension Retiree Medical

U.S. International Net loss $136 $29 $ 18 Prior service cost/(credit) 5 3 (13) Total $141 $32 $ 5

The following table provides the weighted-average assumptions used to determine projected benefit liability and benefit expense for our pension and retiree medical plans: Pension Retiree Medical 2006 2005 2004 2006 2005 2004 2006 2005 2004 U.S. International Weighted average assumptions Liability discount rate 5.8% 5.7% 6.1% 5.2% 5.1% 6.1% 5.8% 5.7% 6.1% Expense discount rate 5.7% 6.1% 6.1% 5.1% 6.1% 6.1% 5.7% 6.1% 6.1% Expected return on plan assets 7.8% 7.8% 7.8% 7.3% 8.0% 8.0% – –– Rate of salary increases 4.5% 4.4% 4.5% 3.9% 4.1% 3.9% – ––

The following table provides selected information about plans with liability for service to date and total benefit liability in excess of plan assets: Pension Retiree Medical 2006 2005 2006 2005 2006 2005 U.S. International Selected information for plans with liability for service to date in excess of plan assets Liability for service to date $(387) $(374) $(286) $(65) Fair value of plan assets $1 $8 $237 $33 Selected information for plans with benefit liability in excess of plan assets Benefit liability $(754) $(2,690) $(1,387) $(1,158) $(1,370) $(1,312) Fair value of plan assets $1 $1,758 $1,200 $985 – –

Of the total projected pension benefit liability at year-end 2006, $701 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment.

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Future Benefit Payments and Funding Our estimated future benefit payments are as follows: 2007 2008 2009 2010 2011 2012-16 Pension $265 $285 $310 $345 $375 $2,490 Retiree medical* $90 $95 $100 $100 $105 $595 *Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the Medicare Act. Subsidies are expected to be approximately $5 million for each of the years from 2007 through 2011 and approximately $40 million for 2012 through 2016.

These future benefits to beneficiaries recognizes each year’s asset gain or loss equity and debt securities to achieve include payments from both funded over a five-year period. Therefore, it our long-term return expectation. Our and unfunded pension plans. takes five years for the gain or loss from investment policy also permits the use In 2007, we expect to make pension any one year to be fully included in the of derivative instruments to enhance contributions of up to $150 million with value of pension plan assets that is used the overall return of the portfolio. We up to $75 million expected to be discre- to calculate the expected return. Our use a third-party advisor to assist us in tionary. Our cash payments for retiree pension plan investment strategy is determining our investment allocation medical are estimated to be approxi- reviewed annually and is established and modeling our long-term rate of mately $85 million in 2007. based upon plan liabilities, an evalua- return assumptions. Our expected long- tion of market conditions, tolerance for term rate of return on U.S. plan assets is Pension Assets risk, and cash requirements for benefit 7.8%, reflecting estimated long-term The expected return on pension plan payments. Our investment objective is rates of return of 9.3% from equity assets is based on our historical experi- to ensure that funds are available to securities and 5.8% from fixed income ence, our pension plan investment meet the plans’ benefit obligations securities. Our target allocation and strategy and our expectations for long- when they are due. Our investment actual pension plan asset allocations for term rates of return. We use a strategy is to prudently invest plan the plan years 2006 and 2005 are market-related value method that assets in high-quality and diversified as follows:

Actual Allocation Asset Category Target Allocation 2006 2005 Equity securities 60% 61% 60% Debt securities 40% 39% 39% Other, primarily cash – – 1% Total 100% 100% 100%

Pension assets include 5.5 million Retiree Medical Cost Trend Rates plan expense and liability. However, shares of PepsiCo common stock with a An average increase of 9% in the cost the cap on our share of retiree medical market value of $358 million in 2006, of covered retiree medical benefits is costs limits the impact. A 1-percentage- and 5.5 million shares with a market assumed for 2007. This average increase point change in the assumed health value of $311 million in 2005. Our invest- is then projected to decline gradually to care trend rate would have the ment policy limits the investment in 5% in 2011 and thereafter. These following effects: PepsiCo stock at the time of investment assumed health care cost trend rates to 10% of the fair value of plan assets. have an impact on the retiree medical

1% Increase 1% Decrease 2006 service and interest cost components $4 $(3) 2006 benefit liability $42 $(36)

Savings Plan retirement. We make matching contribu- For additional unaudited information Our U.S. employees are eligible to partic- tions on a portion of eligible pay based on our pension and retiree medical plans ipate in 401(k) savings plans, which are on years of service. In 2006 and 2005, our and related accounting policies and voluntary defined contribution plans. matching contributions were $56 million assumptions, see “Our Critical The plans are designed to help employ- and $52 million, respectively. Accounting Policies” in Management’s ees accumulate additional savings for Discussion and Analysis.

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Note 8 — Noncontrolled Bottling Affiliates

Our most significant noncontrolled bot- stock that we own at year-end 2006 and end 2006 and 2005, respectively. tling affiliates are PBG and PAS. 2005, respectively, we own 100% of Bottling equity income includes Approximately 10% of our total net PBG’s class B common stock and approx- $186 million and $126 million of pre- revenue in 2006, 2005 and 2004 reflects imately 7% of the equity of Bottling tax gains on our sales of PBG stock in sales to PBG. Group, LLC, PBG’s principal operating 2006 and 2005, respectively. subsidiary. This gives us economic own- The Pepsi Bottling Group ership of approximately 43% and 45% In addition to approximately 38% and of PBG’s combined operations at year- 41% of PBG’s outstanding common

PBG’s summarized financial information is as follows: Our investment in PBG, which includes the related goodwill, was 2006 2005 2004 $500 million and $400 million higher Current assets $ 2,749 $ 2,412 than our ownership interest in their Noncurrent assets 9,178 9,112 net assets at year-end 2006 and 2005, Total assets $11,927 $11,524 respectively. Based upon the quoted Current liabilities $2,051 $2,598 closing price of PBG shares at year-end Noncurrent liabilities 7,252 6,387 2006 and 2005, the calculated market Minority interest 540 496 value of our shares in PBG, excluding our investment in Bottling Group, LLC, Total liabilities $9,843 $9,481 exceeded our investment balance by Our investment $1,842 $1,738 approximately $1.4 billion and Net revenue $12,730 $11,885 $10,906 $1.5 billion, respectively. Gross profit $5,920 $5,632 $5,250 Operating profit $1,017 $1,023 $976 Net income $522 $466 $457

PepsiAmericas Our investment in PAS, which At year-end 2006 and 2005, we owned approximately 44% and 43% of includes the related goodwill, was PepsiAmericas, respectively, and their summarized financial information is as follows: $316 million and $292 million higher 2006 2005 2004 than our ownership interest in their net assets at year-end 2006 and 2005, Current assets $ 675 $ 598 respectively. Based upon the quoted Noncurrent assets 3,532 3,456 closing price of PAS shares at year-end Total assets $4,207 $4,054 2006 and 2005, the calculated market Current liabilities $ 694 $ 722 value of our shares in PepsiAmericas Noncurrent liabilities 1,909 1,763 exceeded our investment balance by Total liabilities $2,603 $2,485 approximately $173 million and Our investment $1,028 $968 $364 million, respectively. Net revenue $3,972 $3,726 $3,345 In January 2005, PAS acquired a Gross profit $1,608 $1,562 $1,423 regional bottler, Central Investment Operating profit $356 $393 $340 Corporation. The table includes the results of Central Investment Net income $158 $195 $182 Corporation from the transaction date forward.

Related Party Transactions tion of CSDs and non-carbonated bever- and finished goods are reported net of Our significant related party transactions ages. We also sell certain finished goods bottler funding. For further unaudited involve our noncontrolled bottling affil- to these affiliates and we receive royal- information on these bottlers, see “Our iates. We sell concentrate to these ties for the use of our trademarks for Customers” in Management’s Discussion affiliates, which they use in the produc- certain products. Sales of concentrate and Analysis.

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These transactions with our bottling affiliates are reflected in our consolidated financial statements as follows: 2006 2005 2004 our bottlers with suppliers. Once we Net revenue $4,837 $4,633 $4,170 have negotiated the contracts, the bot- Selling, general and administrative expenses $87 $143 $114 tlers order and take delivery directly Accounts and notes receivable $175 $178 from the supplier and pay the suppliers directly. Consequently, these Accounts payable and other current liabilities $62 $117 transactions are not reflected in our consolidated financial statements. As Such amounts are settled on terms In addition, we coordinate, on an the contracting party, we could be liable consistent with other trade receivables aggregate basis, the negotiation and to these suppliers in the event of any and payables. See Note 9 regarding our purchase of sweeteners and other raw nonpayment by our bottlers, but we guarantee of certain PBG debt. materials requirements for certain of consider this exposure to be remote.

Note 9 — Debt Obligations and Commitments

2006 2005 amount of the interest rate swaps out- standing at December 30, 2006 and Short-term debt obligations December 31, 2005 was $500 million. Current maturities of long-term debt $ 605 $ 143 The terms of the interest rate swaps Commercial paper (5.3% and 3.3%) 792 3,140 match the terms of the debt they mod- Other borrowings (7.3% and 7.4%) 377 356 ify. The swaps mature in May 2007. Amounts reclassified to long-term debt (1,500) (750) At December 30, 2006, approxi- $ 274 $2,889 mately 63% of total debt, after the Long-term debt obligations impact of the related interest rate Short-term borrowings, reclassified $1,500 $ 750 swaps, was exposed to variable interest Notes due 2007-2026 (6.0% and 5.4%) 1,148 1,161 rates, compared to 78% at December 31, 2005. In addition to variable rate Zero coupon notes, $425 million due 2007-2012 (13.4%) 299 312 long-term debt, all debt with maturities Other, due 2007-2016 (6.1% and 6.3%) 208 233 of less than one year is categorized as $3,155 2,456 variable for purposes of this measure. Less: current maturities of long-term debt obligations (605) (143) $2,550 $2,313 Cross Currency Interest Rate Swaps The interest rates in the above table reflect weighted-average rates at year-end. In 2004, we entered into a cross currency interest rate swap to hedge the currency exposure on U.S. dollar In the second quarter of 2006, we and are fully committed to the extent denominated debt of $50 million held entered into a new unsecured revolving of our borrowings. by a foreign affiliate. The terms of this credit agreement which enables us to In the third quarter of 2006, we swap match the terms of the debt it borrow up to $1.5 billion subject to cus- entered into a U.S. $2.5 billion euro modifies. The swap matures in 2008. tomary terms and conditions. Funds medium term note program. Under the The unrealized gain related to this swap borrowed under this agreement may be program, we may issue unsecured notes was less than $1 million at December used for general corporate purposes, under mutually agreed upon terms with 30, 2006 and December 31, 2005, including supporting our outstanding the purchasers of the notes. Proceeds resulting in a U.S. dollar liability of commercial paper issuances. The agree- from any issuance of notes may be used $50 million. We have also entered into ment terminates in May 2011 and for general corporate purposes, except cross currency interest rate swaps to replaces our previous $2.1 billion of as otherwise specified in the related hedge the currency exposure on U.S. credit facilities. As of December 30, prospectus. As of December 30, 2006, dollar denominated intercompany debt 2006, we have reclassified $1.5 billion of we have no outstanding notes under of $95 million at December 30, 2006 short-term debt to long-term based on the program. and $125 million at December 31, 2005. our intent and ability to refinance on a The terms of the swaps match the terms Interest Rate Swaps long-term basis. of the debt they modify. The swaps We entered into interest rate swaps in In addition, $394 million of our debt mature in 2007. The net unrealized loss 2004 to effectively convert the interest related to borrowings from various lines related to these swaps was less than rate of a specific debt issuance from a of credit maintained for our international $1 million at December 30, 2006 and fixed rate of 3.2% to a variable rate. divisions. These lines of credit are subject the net unrealized gain related to The variable weighted-average interest to normal banking terms and conditions these swaps was $5 million at rate that we pay is linked to LIBOR and December 31, 2005. is subject to change. The notional

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Long-Term Contractual Commitments Payments Due by Period Total 2007 2008-2009 2010-2011 2012 and beyond Long-term debt obligations(a) $1,050 $ – $ 583 $ 125 $ 342 Interest on debt obligations(b) 295 50 57 43 145 Operating leases 922 231 302 176 213 Purchasing commitments 5,205 1,357 2,216 871 761 Marketing commitments 1,199 287 453 332 127 Other commitments 279 229 43 5 2 $8,950 $2,154 $3,654 $1,552 $1,590 (a) Excludes current maturities of long-term debt of $605 million which are classified within current liabilities, as well as short-term borrowings reclassified as long-term debt of $1,500 million. (b) Interest payments on floating-rate debt are estimated using interest rates effective as of December 30, 2006. The above table reflects non-cancelable commitments as of December 30, 2006 based on year-end foreign exchange rates.

Most long-term contractual commit- Off-Balance-Sheet Arrangements structure of PBG’s separation from us ments, except for our long-term debt It is not our business practice to enter and our payment obligation would be obligations, are not recorded on our into off-balance-sheet arrangements, triggered if Bottling Group, LLC failed balance sheet. Non-cancelable operating other than in the normal course of to perform under these debt leases primarily represent building leases. business, nor is it our policy to issue obligations or the structure significantly Non-cancelable purchasing commit- guarantees to our bottlers, non- changed. Our guarantees of certain ments are primarily for oranges and controlled affiliates or third parties. obligations ensured YUM’s continued orange juice, cooking oil and packaging However, certain guarantees were nec- use of certain properties. These guaran- materials. Non-cancelable marketing essary to facilitate the separation of tees would require our cash payment if commitments primarily are for sports our bottling and restaurant operations YUM failed to perform under these marketing. Bottler funding is not from us. In connection with these lease obligations. reflected in our long-term contractual transactions, we have guaranteed See “Our Liquidity and Capital commitments as it is negotiated on an $2.3 billion of Bottling Group, LLC’s Resources” in Management’s Discussion annual basis. See Note 7 regarding long-term debt through 2012 and and Analysis for further unaudited our pension and retiree medical obliga- $23 million of YUM! Brands, Inc.’s information on our borrowings. tions and discussion below regarding (YUM) outstanding obligations, primar- our commitments to noncontrolled ily property leases, through 2020. The bottling affiliates and former restaurant terms of our Bottling Group, LLC debt operations. guarantee are intended to preserve the

Note 10 — Risk Management

We are exposed to the risk of loss earnings. See “Our Business Risks” in impact occur when the change in the arising from adverse changes in: Management’s Discussion and Analysis value of the hedge does not offset the • commodity prices, affecting the cost for further unaudited information on change in the value of the underlying of our raw materials and energy, our business risks. hedged item. If the derivative instru- • foreign exchange risks, For cash flow hedges, changes in fair ment is terminated, we continue to • interest rates, value are deferred in accumulated other defer the related gain or loss and include • stock prices, and comprehensive loss within shareholders’ it as a component of the cost of the • discount rates affecting the measure- equity until the underlying hedged underlying hedged item. Upon determi- ment of our pension and retiree item is recognized in net income. For nation that the underlying hedged item medical liabilities. fair value hedges, changes in fair value will not be part of an actual transaction, are recognized immediately in earnings, we recognize the related gain or loss in In the normal course of business, we consistent with the underlying hedged net income in that period. manage these risks through a variety of item. Hedging transactions are limited We also use derivatives that do not strategies, including the use of deriva- to an underlying exposure. As a result, qualify for hedge accounting treatment. tives. Certain derivatives are designated any change in the value of our derivative We account for such derivatives at mar- as either cash flow or fair value hedges instruments would be substantially off- ket value with the resulting gains and and qualify for hedge accounting treat- set by an opposite change in the value of losses reflected in our income statement. ment, while others do not qualify and the underlying hedged items. Hedging We do not use derivative instruments for are marked to market through ineffectiveness and a net earnings trading or speculative purposes, and we

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limit our exposure to individual counter- used to hedge commodity price risks that swaps are entered into concurrently with parties to manage credit risk. do not qualify for hedge accounting are the issuance of the debt that they are marked to market each period and intended to modify. The notional Commodity Prices reflected in our income statement. amount, interest payment and maturity We are subject to commodity price risk date of the swaps match the principal, because our ability to recover increased Foreign Exchange interest payment and maturity date of costs through higher pricing may be lim- Our operations outside of the U.S. gener- the related debt. These swaps are ited in the competitive environment in ate approximately 40% of our net entered into only with strong creditwor- which we operate. This risk is managed revenue, with Mexico, the United thy counterparties, are settled on a net through the use of fixed-price purchase Kingdom and Canada comprising basis and are of relatively short duration. orders, pricing agreements, geographic approximately 20% of our net revenue. diversity and derivatives. We use deriva- As a result, we are exposed to foreign Stock Prices tives, with terms of no more than two currency risks from unforeseen economic The portion of our deferred compensa- years, to economically hedge price fluctu- changes and political unrest. On tion liability that is based on certain ations related to a portion of our occasion, we enter into hedges, primarily market indices and on our stock price is anticipated commodity purchases, pri- forward contracts with terms of no more subject to market risk. We hold mutual marily for natural gas and diesel fuel. For than two years, to reduce the effect of fund investments and prepaid forward those derivatives that qualify for hedge foreign exchange rates. Ineffectiveness of contracts to manage this risk. Changes in accounting, any ineffectiveness is these hedges has not been material. the fair value of these investments and recorded immediately. However, such contracts are recognized immediately in commodity cash flow hedges have not Interest Rates earnings and are offset by changes in had any significant ineffectiveness for all We centrally manage our debt and the related compensation liability. periods presented. We classify both the investment portfolios considering invest- earnings and cash flow impact from ment opportunities and risks, tax Fair Value these derivatives consistent with the consequences and overall financing All derivative instruments are underlying hedged item. During the next strategies. We may use interest rate and recognized on our balance sheet at fair 12 months, we expect to reclassify net cross currency interest rate swaps to man- value. The fair value of our derivative gains of $1 million related to cash flow age our overall interest expense and instruments is generally based on hedges from accumulated other compre- foreign exchange risk. These instruments quoted market prices. Book and fair hensive loss into net income. Derivatives effectively change the interest rate and values of our derivative and financial currency of specific debt issuances. These instruments are as follows:

2006 2005 Book Value Fair Value Book Value Fair Value Assets Cash and cash equivalents(a) $1,651 $1,651 $1,716 $1,716 Short-term investments(b) $1,171 $1,171 $3,166 $3,166 Forward exchange contracts(c) $8 $8 $19 $19 Commodity contracts(d) $2 $2 $41 $41 Prepaid forward contracts(e) $73 $73 $107 $107 Cross currency interest rate swaps(f) $1 $1 $6 $6 Liabilities Forward exchange contracts(c) $24 $24 $15 $15 Commodity contracts(d) $29 $29 $3 $3 Debt obligations $2,824 $2,955 $5,202 $5,378 Interest rate swaps(g) $4 $4 $9 $9 The above items are included on our balance sheet under the captions noted or as indicated below. In addition, derivatives qualify for hedge accounting unless otherwise noted below. (a) Book value approximates fair value due to the short maturity. (b) Principally short-term time deposits and includes $145 million at December 30, 2006 and $124 million at December 31, 2005 of mutual fund investments used to manage a portion of market risk arising from our deferred compensation liability. (c) The 2006 liability includes $10 million related to derivatives that do not qualify for hedge accounting and the 2005 asset includes $14 million related to derivatives that do not qualify for hedge accounting. Assets are reported within current assets and other assets and liabilities are reported within current liabilities and other liabilities. (d) The 2006 liability includes $28 million related to derivatives that do not qualify for hedge accounting. The 2005 asset includes $2 million related to derivatives that do not qualify for hedge accounting and the liability relates entirely to derivatives that do not qualify for hedge accounting. Assets are reported within current assets and other assets and liabilities are reported within current liabilities and other liabilities. (e) Included in current assets and other assets. (f) Asset included within other assets. (g) Reported in other liabilities. This table excludes guarantees, including our guarantee of $2.3 billion of Bottling Group, LLC’s long-term debt. The guarantee had a fair value of $35 million at December 30, 2006 and $47 million at December 31, 2005 based on a third-party estimate of the cost to us of transferring the liability to an independent financial institution. See Note 9 for additional information on our guarantees.

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Note 11 — Net Income per Common Share from Continuing Operations

Basic net income per common share is the effect that would occur if in-the- diluted earnings per common share net income available to common share- money employee stock options were because these options were out-of-the- holders divided by the weighted exercised and RSUs and preferred money. Out-of-the-money options had average of common shares outstanding shares were converted into common average exercise prices of $65.24 in during the period. Diluted net income shares. Options to purchase 0.1 million 2006, $53.77 in 2005 and $52.88 in 2004. per common share is calculated using shares in 2006, 3.0 million shares in the weighted average of common 2005 and 7.0 million shares in 2004 shares outstanding adjusted to include were not included in the calculation of

The computations of basic and diluted net income per common share from continuing operations are as follows: 2006 2005 2004 Income Shares(a) Income Shares(a) Income Shares(a) Net income $5,642 $4,078 $4,174 Preferred shares: Dividends (2) (2) (3) Redemption premium (9) (16) (22) Net income available for common shareholders $5,631 1,649 $4,060 1,669 $4,149 1,696 Basic net income per common share $3.42 $2.43 $2.45 Net income available for common shareholders $5,631 1,649 $4,060 1,669 $4,149 1,696 Dilutive securities: Stock options and RSUs –36 –35–31 ESOP convertible preferred stock 11 2 18 2 24 2 Diluted $5,642 1,687 $4,078 1,706 $4,173 1,729 Diluted net income per common share $3.34 $2.39 $2.41 (a) Weighted-average common shares outstanding.

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Note 12 — Preferred and Common Stock

As of December 30, 2006 and December 803,953 preferred shares issued and unpaid dividends. There were 17 million 31, 2005, there were 3.6 billion shares 320,853 and 354,853 shares outstand- shares of common stock held in the of common stock and 3 million shares ing, respectively. The outstanding accounts of ESOP participants as of of convertible preferred stock autho- preferred shares had a fair value of December 30, 2006 and December 31, rized. The preferred stock was issued $100 million as of December 30, 2006 2005. Quaker made the final award to only for an ESOP established by Quaker and $104 million as of December 31, its ESOP plan in June 2001. and these shares are redeemable for 2005. Each share is convertible at the common stock by the ESOP participants. option of the holder into 4.9625 shares The preferred stock accrues dividends at of common stock. The preferred shares an annual rate of $5.46 per share. At may be called by us upon written notice year-end 2006 and 2005, there were at $78 per share plus accrued and

2006 2005 2004 Shares Amount Shares Amount Shares Amount Preferred stock 0.8 $41 0.8 $41 0.8 $41 Repurchased preferred stock Balance, beginning of year 0.5 $110 0.4 $ 90 0.3 $63 Redemptions –100.1 19 0.1 27 Balance, end of year 0.5 $120 0.5 $110* 0.4 $90 *Does not sum due to rounding.

Note 13 — Accumulated Other Comprehensive Loss

Comprehensive income is a measure of recognition into our income statement. income/(loss) was $456 million in 2006, income which includes both net income Accumulated other comprehensive loss $(167) million in 2005 and $381 million and other comprehensive income or is separately presented on our balance in 2004. The accumulated balances for loss. Other comprehensive income or sheet as part of common shareholders’ each component of other comprehen- loss results from items deferred from equity. Other comprehensive sive loss were as follows:

2006 2005 2004 Currency translation adjustment $ (506) $ (971) $(720) Cash flow hedges, net of tax(a) 4 27 (19) Unamortized pension and retiree medical, net of tax(b) (1,782) –– Minimum pension liability adjustment(c) – (138) (154) Unrealized gain on securities, net of tax 40 31 7 Other (2) (2) – Accumulated other comprehensive loss $(2,246) $(1,053) $(886) (a) Includes $3 million gain in 2006, no impact in 2005 and $6 million gain in 2004 for our share of our equity investees’ accumulated derivative activity. (b) Net of taxes of $964 million in 2006. (c) Net of taxes of $72 million in 2005 and $77 million in 2004. Also includes $120 million in 2005 and $121 million in 2004 for our share of our equity investees’ minimum pension liability adjustments.

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Note 14 — Supplemental Financial Information

2006 2005 2004 Accounts receivable Trade receivables $3,147 $2,718 Other receivables 642 618 3,789 3,336 Allowance, beginning of year 75 97 $105 Net amounts charged/(credited) to expense 10 (1) 18 Deductions(a) (27) (22) (25) Other(b) 6 1 (1) Allowance, end of year 64 75 $ 97 Net receivables $3,725 $3,261 Inventories(c) Raw materials $ 860 $ 738 Work-in-process 140 112 Finished goods 926 843 $1,926 $1,693 (a) Includes accounts written off. (b) Includes currency translation effects and other adjustments. (c) Inventories are valued at the lower of cost or market. Cost is determined using the average, first-in, first-out (FIFO) or last-in, first-out (LIFO) methods. Approximately 19% in 2006 and 17% in 2005 of the inventory cost was computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. 2006 2005 2004 Other assets Non-current notes and accounts receivable $149 $ 186 Deferred marketplace spending 232 281 Unallocated purchase price for recent acquisitions 196 256 Pension plans 197 2,440 Other 206 240 $980 $3,403 Accounts payable and other current liabilities Accounts payable $2,102 $1,799 Accrued marketplace spending 1,444 1,383 Accrued compensation and benefits 1,143 1,062 Dividends payable 492 431 Other current liabilities 1,315 1,296 $6,496 $5,971 Other liabilities Reserves for income taxes $1,435 $1,884 Other 3,189 2,439 $4,624 $4,323 Other supplemental information Rent expense $291 $228 $245 Interest paid $215 $213 $137 Income taxes paid, net of refunds $2,155 $1,258 $1,833 Acquisitions(a) Fair value of assets acquired $ 678 $ 1,089 $ 78 Cash paid and debt issued (522) (1,096) (64) SVE minority interest eliminated – 216 – Liabilities assumed $ 156 $ 209 $ 14 (a) In 2005, these amounts include the impact of our acquisition of General Mills, Inc.’s 40.5% ownership interest in SVE for $750 million. The excess of our purchase price over the fair value of net assets acquired is $250 million and is included in goodwill. We also reacquired rights to distribute global brands for $263 million which is included in other nonamortizable intangible assets.

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Management’s Responsibility for Financial Reporting

To Our Shareholders: Engaging strong and effective Corporate Governance from At PepsiCo, our actions — the actions of all our associates — our Board of Directors. We have an active, capable and dili- are governed by our Worldwide Code of Conduct. This code gent Board that meets the required standards for is clearly aligned with our stated values — a commitment to independence, and we welcome the Board’s oversight as a sustained growth, through empowered people, operating representative of our shareholders. Our Audit Committee is with responsibility and building trust. Both the code and our comprised of independent directors with the financial liter- core values enable us to operate with integrity — both within acy, knowledge and experience to provide appropriate the letter and the spirit of the law. Our code of conduct is oversight. We review our critical accounting policies, financial reinforced consistently at all levels and in all countries. We reporting and internal control matters with them and have maintained strong governance policies and practices for encourage their direct communication with KPMG LLP, with many years. our General Auditor, and with our General Counsel. We also The management of PepsiCo is responsible for the objec- have a senior compliance officer to lead and coordinate our tivity and integrity of our consolidated financial statements. compliance policies and practices. The Audit Committee of the Board of Directors has engaged independent registered public accounting firm, KPMG LLP, to Providing investors with financial results that are complete, audit our consolidated financial statements and they have expressed an unqualified opinion. transparent and understandable. The consolidated financial We are committed to providing timely, accurate and statements and financial information included in this report understandable information to investors. Our commitment are the responsibility of management. This includes prepar- encompasses the following: ing the financial statements in accordance with accounting principles generally accepted in the U.S., which require esti- Maintaining strong controls over financial reporting. Our mates based on management’s best judgment. system of internal control is based on the control criteria framework of the Committee of Sponsoring Organizations of PepsiCo has a strong history of doing what’s right. We real- the Treadway Commission published in their report titled, ize that great companies are built on trust, strong ethical Internal Control — Integrated Framework. The system is standards and principles. Our financial results are delivered designed to provide reasonable assurance that transactions from that culture of accountability, and we take responsibil- are executed as authorized and accurately recorded; that ity for the quality and accuracy of our financial reporting. assets are safeguarded; and that accounting records are suffi- ciently reliable to permit the preparation of financial statements that conform in all material respects with accounting principles generally accepted in the U.S. We main- tain disclosure controls and procedures designed to ensure Peter A. Bridgman that information required to be disclosed in reports under Senior Vice President and Controller the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the specified time periods. We monitor these internal controls through self-assessments and an ongoing program of internal audits. Our internal con- trols are reinforced through our Worldwide Code of Conduct, which sets forth our commitment to conduct business with integrity, and within both the letter and the spirit of the law. Richard Goodman Chief Financial Officer Exerting rigorous oversight of the business. We continuously review our business results and strategies. This encompasses financial discipline in our strategic and daily business decisions. Our Executive Committee is actively involved — from understanding strategies and alternatives to reviewing key initiatives and financial performance. The intent is to Indra K. Nooyi ensure we remain objective in our assessments, constructively President and Chief Executive Officer challenge our approach to potential business opportunities and issues, and monitor results and controls.

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Management’s Report on Internal Control over Financial Reporting

To Our Shareholders: Our management is responsible for establishing and main- taining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Peter A. Bridgman Chief Financial Officer, we conducted an evaluation of the Senior Vice President and Controller effectiveness of our internal control over financial reporting based upon the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that eval- uation, our management concluded that our internal control over financial reporting is effective as of December 30, 2006. KPMG LLP, an independent registered public accounting Richard Goodman firm, has audited the consolidated financial statements Chief Financial Officer included in this Annual Report and, as part of their audit, has issued their attestation report, included herein, (1) on our management’s assessment of the effectiveness of our internal controls over financial reporting and (2) on the effectiveness of our internal control over financial reporting. During our fourth fiscal quarter of 2006, we began migrat- ing certain of our financial processing systems to SAP Indra K. Nooyi software. This software implementation is part of our ongo- President and Chief Executive Officer ing Business Process Transformation initiative, and we plan to continue implementing such software throughout other parts of our businesses over the course of the next few years. In connection with the SAP implementation, we are modify- ing the design and documentation of our internal control processes and procedures relating to the new software. Except as described above, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during our fourth fiscal quarter of 2006.

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Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders PepsiCo, Inc.: statements in accordance with generally accepted accounting We have audited the accompanying Consolidated Balance principles, and that receipts and expenditures of the Sheet of PepsiCo, Inc. and Subsidiaries as of December 30, company are being made only in accordance with authoriza- 2006 and December 31, 2005 and the related Consolidated tions of management and directors of the company; and Statements of Income, Cash Flows and Common (3) provide reasonable assurance regarding prevention or Shareholders’ Equity for each of the years in the three-year timely detection of unauthorized acquisition, use, or disposi- period ended December 30, 2006. We have also audited man- tion of the company’s assets that could have a material effect agement’s assessment, included in Management’s Report on on the financial statements. Internal Control over Financial Reporting that PepsiCo, Inc. Because of its inherent limitations, internal control over and Subsidiaries maintained effective internal control over financial reporting may not prevent or detect misstatements. financial reporting as of December 30, 2006, based on criteria Also, projections of any evaluation of effectiveness to future established in Internal Control — Integrated Framework periods are subject to the risk that controls may become inade- issued by the Committee of Sponsoring Organizations of the quate because of changes in conditions, or that the degree of Treadway Commission (COSO). PepsiCo, Inc.’s management is compliance with the policies or procedures may deteriorate. responsible for these consolidated financial statements, for In our opinion, the consolidated financial statements maintaining effective internal control over financial report- referred to above present fairly, in all material respects, the ing, and for its assessment of the effectiveness of internal financial position of PepsiCo, Inc. and Subsidiaries as of control over financial reporting. Our responsibility is to December 30, 2006 and December 31, 2005, and the results of express an opinion on these consolidated financial their operations and their cash flows for each of the years in statements, an opinion on management’s assessment, and an the three-year period ended December 30, 2006, in confor- opinion on the effectiveness of PepsiCo, Inc.’s internal control mity with United States generally accepted accounting over financial reporting based on our audits. principles. Also, in our opinion, management’s assessment We conducted our audits in accordance with the standards that PepsiCo, Inc. maintained effective internal control over of the Public Company Accounting Oversight Board (United financial reporting as of December 30, 2006, is fairly stated, States). Those standards require that we plan and perform the in all material respects, based on criteria established in audits to obtain reasonable assurance about whether the con- Internal Control — Integrated Framework issued by COSO. solidated financial statements are free of material Furthermore, in our opinion, PepsiCo, Inc. maintained, in all misstatement and whether effective internal control over material respects, effective internal control over financial financial reporting was maintained in all material respects. reporting as of December 30, 2006, based on criteria estab- Our audit of the consolidated financial statements included lished in Internal Control — Integrated Framework issued examining, on a test basis, evidence supporting the amounts by COSO. and disclosures in the consolidated financial statements, As discussed in Note 7 to the consolidated financial state- assessing the accounting principles used and significant esti- ments, PepsiCo, Inc. and Subsidiaries adopted the provisions mates made by management, and evaluating the overall of FASB Statement No. 158, “Employers’ Accounting for financial statement presentation. Our audit of internal control Defined Benefit Pension and Other Postretirement Plans — over financial reporting included obtaining an understanding an amendment to FASB Statements No. 87, 88, 106 and of internal control over financial reporting, evaluating man- 132(R),” as of December 30, 2006. agement’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the cir- cumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding KPMG LLP the reliability of financial reporting and the preparation of New York, New York financial statements for external purposes in accordance with February 16, 2007 generally accepted accounting principles. A company’s inter- nal 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

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Selected Financial Data (in millions except per share amounts, unaudited)

First Second Third Fourth Five-Year Summary 2006 2005 2004 Quarterly Quarter Quarter Quarter Quarter Net revenue $35,137 $32,562 $29,261 Net revenue Income from continuing 2006 $7,205 $8,599 $8,950 $10,383 operations $5,642 $4,078 $4,174 2005 $6,585 $7,697 $8,184 $10,096 Net income $5,642 $4,078 $4,212 Gross profit Income per common share — 2006 $4,026 $4,790 $4,920 $5,639 basic, continuing operations $3.42 $2.43 $2.45 2005 $3,715 $4,383 $4,669 $5,619 Income per common share — diluted, continuing operations $3.34 $2.39 $2.41 2006 restructuring and impairment charges(a) Cash dividends declared 2006 – – – $67 per common share $1.16 $1.01 $0.85 (a) 2005 restructuring charges Total assets $29,930 $31,727 $27,987 2005 – – – $83 Long-term debt $2,550 $2,313 $2,397 (b) 2006 Tax Adjustments Return on invested capital(a) 30.4% 22.7% 27.4% 2006 – – – $(602) Five-Year Summary (Cont.) 2003 2002 AJCA tax charge(c) 2005 – – $468 $(8) Net revenue $26,971 $25,112 Net income Net income $3,568 $3,000 2006 $1,019 $1,358 $1,481 $1,784 Income per common share — basic $2.07 $1.69 2005 $912 $1,194 $864 $1,108 Income per common share — diluted $2.05 $1.68 Net income per common share — basic Cash dividends declared per 2006 $0.61 $0.82 $0.90 $1.09 common share $0.63 $0.595 2005 $0.54 $0.71 $0.52 $0.66 Total assets $25,327 $23,474 Net income per common share — diluted Long-term debt $1,702 $2,187 2006 $0.60 $0.80 $0.88 $1.06 Return on invested capital(a) 27.5% 25.7% 2005 $0.53 $0.70 $0.51 $0.65 (a) Return on invested capital is defined as adjusted net income divided by the sum of average shareholders’ equity and average total debt. Adjusted Cash dividends declared per common share net income is defined as net income plus net interest expense after-tax. 2006 $0.26 $0.30 $0.30 $0.30 Net interest expense after-tax was $72 million in 2006, $62 million in 2005, 2005 $0.23 $0.26 $0.26 $0.26 $60 million in 2004, $72 million in 2003 and $93 million in 2002. 2006 stock price per share(d) • Includes restructuring and impairment charges of: High $60.55 $61.19 $65.99 $65.99 2006 2005 2004 2003 Low $56.00 $56.51 $58.65 $61.15 Pre-tax $67 $83 $150 $147 Close $59.34 $59.70 $64.73 $62.55 After-tax $43 $55 $96 $100 2005 stock price per share(d) Per share $0.03 $0.03 $0.06 $0.06 High $55.71 $57.20 $56.73 $60.34 • Includes Quaker merger-related costs of: Low $51.34 $51.78 $52.07 $53.55 Close $52.62 $55.52 $54.65 $59.08 2003 2002 The first, second, and third quarters consist of 12 weeks and the fourth Pre-tax $59 $224 quarter consists of 16 weeks in 2006 and 17 weeks in 2005. After-tax $42 $190 Per share $0.02 $0.11 (a) The 2006 restructuring and impairment charges were $67 million ($43 million or $0.03 per share after-tax). The 2005 restructuring charges • In 2006, we recognized non-cash tax benefits of $602 million ($0.36 per were $83 million ($55 million or $0.03 per share after-tax). See Note 3. share) in connection with the 2006 Tax Adjustments. In 2005, we recorded (b) Represents non-cash tax benefits in connection with the 2006 Tax income tax expense of $460 million ($0.27 per share) related to our repatria- Adjustments. See Note 5. tion of earnings in connection with the AJCA. In 2004, we reached agree- (c) Represents income tax expense associated with our repatriation of earn- ment with the IRS for an open issue related to our discontinued restaurant ings in connection with the AJCA. See Note 5. operations which resulted in a tax benefit of $38 million ($0.02 per share). (d) Represents the composite high and low sales price and quarterly closing • On December 30, 2006, we adopted SFAS 158 which reduced total assets prices for one share of PepsiCo common stock. by $2,016 million, total common shareholders’ equity by $1,643 million and total liabilities by $373 million. • The 2005 fiscal year consisted of fifty-three weeks compared to fifty-two weeks in our normal fiscal year. The 53rd week increased 2005 net revenue by an estimated $418 million and net income by an estimated $57 million ($0.03 per share).

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Reconciliation of GAAP and Non–GAAP Information

The financial measures listed below are not measures defined Net Income Reconciliation 2006 2005 Growth by generally accepted accounting principles. However, we believe investors should consider these measures as they are Reported Net Income $5,642 $4,078 38% more indicative of our ongoing performance. Specifically, 2006 Tax Adjustments (602) – investors should consider the following: PepsiCo Share of PBG Tax Settlement (18) – • Our 2006 and 2005 division operating profit and our 2006 AJCA Tax Charge – 460 division operating profit growth; • Our 2006 net income without the impact of the 2006 Tax Extra Week – (57) Adjustments, our share of PBG’s tax settlement and restructur- Restructuring and Impairment Charges 43 55 ing and impairment charges; our 2005 net income without the Net Income Excluding above Items $5,065 $4,536 12% impact of the AJCA tax charge, restructuring charges and the extra week in 2005; and our 2006 net income growth without 2006 the impact of the aforementioned items; Diluted EPS Reconciliation 2006 2005 Growth 2004 • Our 2006 diluted EPS without the impact of the 2006 Tax Adjustments, our share of PBG’s tax settlement and restructur- Reported Diluted EPS $3.34 $2.39 40% $2.44 ing and impairment charges; our 2005 diluted EPS without the 2006 Tax Adjustments (0.36) –– impact of the AJCA tax charge, restructuring charges and the PepsiCo Share of PBG Tax extra week in 2005; our 2006 diluted EPS growth without the Settlement (0.01) –– impact of the aforementioned items; and our 2004 diluted AJCA Tax Charge – 0.27 – EPS without the impact of restructuring and impairment charges and certain tax benefits; and Extra Week – (0.03) – • Our 2006 return on invested capital (ROIC) without the impact Restructuring and Impairment of the 2006 Tax Adjustments, our adoption of SFAS 158, the Charges 0.03 0.03 0.06 AJCA tax charge, restructuring and impairment charges and 2004 Tax Benefits – – (0.18) the extra week in 2005. Diluted EPS Excluding above Items $3.00 $2.66 13% $2.32

Operating Profit Reconciliation 2006 2005 Growth ROIC Reconciliation 2006

Total PepsiCo Reported Reported ROIC 30% 2006 Tax Adjustments (3) Operating Profit $6,439 $5,922 9% SFAS 158 Adoption (1) 733 Corporate Unallocated 788 AJCA Tax Charge (1) PepsiCo Total Division ROIC Excluding above Items 26%* Operating Profit $7,172 $6,710 7% * Does not sum due to rounding. Additionally, the impact on ROIC of the 2006 and 2005 restructuring and impairment charges and the extra week in 2005 rounds to zero.

Glossary

Anchor bottlers: The Pepsi Bottling Group Concentrate Shipments and Equivalents (CSE): Management operating cash flow: net cash (PBG), PepsiAmericas (PAS) and Pepsi Bottling measure of our physical beverage volume sold to provided by operating activities less capital Ventures (PBV). our customers. This measure is reported on our spending plus sales of property, plant and fiscal year basis. equipment. It is our primary measure used to Bottler: customers to whom we have granted monitor cash flow performance. exclusive contracts to sell and manufacture cer- Consumers: people who eat and drink tain beverage products bearing our trademarks our products. Marketplace spending: sales incentives offered within a specific geographical area. through various programs to our customers and Customers: authorized bottlers and independent consumers (trade spending), as well as advertising Bottler Case Sales (BCS): measure of physical distributors and retailers. and other marketing activities. beverage volume sold from our bottlers to CSD: carbonated soft drinks. independent distributors and retailers. Servings: common metric reflecting our consoli- Derivatives: financial instruments that we use to dated physical unit volume. Our divisions’ physical Bottler funding: financial incentives we give to manage our risk arising from changes in com- unit measures are converted into servings based our bottlers to assist in the distribution and modity prices, interest rates, foreign exchange on U.S. Food and Drug Administration guidelines promotion of our beverage products. rates and stock prices. for single-serving sizes of our products. Business Process Transformation (BPT): our com- Direct-Store-Delivery (DSD): delivery system used Smart Spot: our initiative that helps consumers prehensive multi-year effort to drive efficiencies. by us and our bottlers to deliver snacks and bev- find our products that can contribute to It includes efforts to consolidate, or integrate, key erages directly to retail stores where our products healthier lifestyles. business functions to take advantage of our scale. are merchandised. It also includes moving to a common set of Transaction gains and losses: the impact on our processes that underlie our key activities, and Effective net pricing: reflects the year-over-year consolidated financial statements of exchange supporting them with a common technology impact of discrete pricing actions, sales incentive rate changes arising from specific transactions. application. And finally, it includes our SAP activities and mix resulting from selling varying Translation adjustments: the impact of the installation, the computer system that will link all products in different package sizes and in conversion of our foreign affiliates’ financial of our systems and processes. different countries. statements to U.S. dollars for the purpose of consolidating our financial statements.

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Common Stock Information Shareholder Information PepsiCo Stock Purchase Program – for Canadian employees: Fidelity Stock Plan Services Stock Trading Symbol — PEP Annual Meeting P.O. Box 5000 We believe Performance — achieving Contents Stock Exchange Listings The Annual Meeting of Shareholders will be held at Cincinnati, OH 45273-8398 Frito-Lay Corporate Headquarters, 7701 Legacy Drive, Telephone: 800-544-0275 PepsiCo at a Glance ...... 1 The New York Stock Exchange is the principal market for PepsiCo common stock, which is also listed on the Plano, Texas, on Wednesday, May 2, 2007, at 9 a.m. local Website: www.iStockPlan.com/ESPP financial results — matters most Letter to Shareholders ...... 2 Amsterdam, Chicago and Swiss Stock Exchanges. time. Proxies for the meeting will be solicited by an Please have a copy of your most recent statement Performance ...... 8 independent proxy solicitor. This Annual Report is not available when calling with inquiries. Shareholders part of the proxy solicitation. when it is combined with Purpose — Purpose ...... 16 At year-end 2006, there were approximately 190,000 If using overnight or certified mail send to: Corporate Officers and Principal Divisions . . . . 22 shareholders of record. Inquiries Regarding Your Stock Holdings Fidelity Investments PepsiCo Board of Directors ...... 23 Registered Shareholders (shares held by you in 100 Crosby Parkway improving people’s lives. Dividend Policy Mail Zone KC1F-L Advisory Boards your name) should address communications concerning We target an annual dividend payout of approximately transfers, statements, dividend payments, address changes, Covington, KY 41015 African American Advisory Board ...... 24 45% of prior year’s net income from continuing opera- lost certificates and other administrative matters to: Latino/Hispanic Advisory Board ...... 25 tions. Dividends are usually declared in January, May, July Shareholder Services and November and paid at the end of March, June and The Bank of New York Blue Ribbon Health and Wellness September and the beginning of January. The dividend Shareholder Services Department BuyDIRECT Plan Interested investors can make their initial purchase directly Advisory Board ...... 26 record dates for these payments are March 9, and, subject P.O. Box 11258 through The Bank of New York, transfer agent for PepsiCo, to approval of the Board of Directors, expected to be Church Street Station and Administrator for the Plan. A brochure detailing the Financial Highlights June 8, September 7 and December 7, 2007. We have New York, NY 10286-1258 Financial Review Plan is available on our website www.pepsico.com or from paid quarterly cash dividends since 1965. Telephone: 800-226-0083 Management’s Discussion and Analysis and our transfer agent: PepsiCo, Inc. and Subsidiaries 212-815-3700 (Outside the U.S.) ($ in millions except per share amounts; all per share amounts assume dilution) Consolidated Financial Statements ...... 27 E-mail: [email protected] The Bank of New York Our Business ...... 28 Cash Dividends Declared Website: www.stockbny.com PepsiCo Plan Per Share (In $) 1.16 or Our Critical Accounting Policies ...... 37 Church Street Station 1.01 Manager Shareholder Relations P.O. Box 1958 Net Revenue Division Operating Profit Our Financial Results ...... 44 PepsiCo, Inc. Newark, NJ 07101-9774 Total: $35,137 Total: $7,172 Consolidated Statement of Income ...... 54 .850 700 Anderson Hill Road Telephone: 800-226-0083 Purchase, NY 10577 Consolidated Statement of Cash Flows ...... 55 212-815-3700 (Outside the U.S.) Telephone: 914-253-3055 Website: www.stockbny.com Consolidated Balance Sheet ...... 56 .630 PepsiCo .595 E-mail: [email protected] Quaker Foods In all correspondence or telephone inquiries, please PepsiCo Quaker Foods International Consolidated Statement of Common International North America mention PepsiCo, your name as printed on your stock 5% North America 27% 8% Shareholders’ Equity ...... 57 Other services include dividend reinvestment, optional 37% certificate, your Social Security number, your address and cash investments by electronic funds transfer or check PepsiCo Notes to Consolidated Financial Statements . . 58 telephone number. drawn on a U.S. bank, sale of shares, online account Frito-Lay Beverages Management’s Responsibility for access, and electronic delivery of shareholder materials. PepsiCo Frito-Lay SharePower Participants (employees with North America North America Beverages North America Financial Reporting ...... 78 SharePower options) should address all questions regard- North America 31% 29% Financial and Other Information 36% Management’s Report on Internal Control 02 03 04 05 06 ing your account, outstanding options or shares received PepsiCo’s 2007 quarterly earnings releases are expected 27% through option exercises to: over Financial Reporting ...... 79 to be issued the weeks of April 23, July 23, October 8, Report of Independent Registered Merrill Lynch/SharePower 2007, and February 4, 2008. Stock Option Unit Copies of PepsiCo’s SEC reports, earnings and other Public Accounting Firm ...... 80 Stock Performance 1600 Merrill Lynch Drive financial releases, corporate news and additional company Selected Financial Data ...... 81 Mail Stop 06-02-SOP information are available on our website www.pepsico.com. PepsiCo was formed through the 1965 merger of Pepsi-Cola Our CEO and CFO Certifications required under Reconciliation of GAAP and Company and Frito-Lay, Inc. A $1,000 investment in our Pennington, NJ 08534 (a) Telephone: 800-637-6713 (U.S., Puerto Rico Sarbanes-Oxley Section 302 were filed as an exhibit to our 2006 2005 % Chg Non-GAAP Information ...... 82 stock made on December 31, 2001 was worth about Form 10-K filed on February 20, 2007. Our 2006 Domestic $1,393 on December 31, 2006, assuming the reinvestment and Canada) Glossary ...... 82 609-818-8800 (all other locations) Company Section 303A CEO Certification was filed with Summary of Operations of dividends into PepsiCo stock. This performance the New York Stock Exchange (NYSE). represents a compounded annual growth rate of 7%. Total net revenue $35,137 $32,562 8 In all correspondence, please provide your account number If you have questions regarding PepsiCo’s financial The closing price for a share of PepsiCo common stock (for U.S. citizens, this is your Social Security number), your performance contact: Division operating profit(b) $7,172 $6,710 7 on the New York Stock Exchange was the price as reported address, your telephone number and mention PepsiCo by Bloomberg for the years ending 2002-2006. Past Jamie Caulfield Total operating profit $6,439 $5,922 9 SharePower. For telephone inquiries, please have a copy of Primary Websites performance is not necessarily indicative of future returns your most recent statement available. Vice President, Investor Relations Net income(c) $5,065 $4,536 12 PepsiCo, Inc. — www.pepsico.com on investments in PepsiCo common stock. PepsiCo, Inc. Purchase, NY 10577 (c) Employee Benefit Plan Participants Earnings per share $3.00 $2.66 13 Frito-Lay North America — www.fritolay.com PepsiCo 401(k) Plan & PepsiCo Stock Purchase Program Telephone: 914-253-3035 Year-end Market Price of Stock Pepsi-Cola North America — www.pepsiworld.com Based on calendar year-end (In $) The PepsiCo Savings & Retirement Center at Fidelity Independent Auditors P.O. Box 770003 KPMG LLP Other Data Tropicana North America — www.tropicana.com Cincinnati, OH 45277-0065 345 Park Avenue Management operating cash flow(d) $4,065 $4,204 (3) Quaker Foods — www.quakeroats.com Telephone: 800-632-2014 New York, NY 10154-0102 Net cash provided by 60 (Overseas: Dial your country’s AT&T Access Number Telephone: 212-758-9700 Gatorade — www.gatorade.com +800-632-2014. In the U.S., access numbers are avail- operating activities $6,084 $5,852 4 able by calling 800-331-1140. From anywhere in the Corporate Headquarters Smart Spot — www.smartspot.com Capital spending $2,068 $1,736 19 40 world, access numbers are available online at PepsiCo, Inc. Walkers — www.walkers.co.uk www.att.com/traveler.) 700 Anderson Hill Road Common share repurchases $3,000 $3,012 – Website: www.netbenefits.fidelity.com Purchase, NY 10577 20 Dividends paid $1,854 $1,642 13 Sabritas — www.sabritas.com.mx Telephone: 914-253-2000 Long-term debt $2,550 $2,313 10 Gamesa — www.gamesa.com.mx PepsiCo Website: www.pepsico.com 0 Frito-Lay Canada — www.fritolay.ca 02 03 04 05 06 © 2007 PepsiCo, Inc. (a) Percentage changes above and in text are based on unrounded amounts. (b) Excludes corporate unallocated expenses. See page 82 for a reconciliation to the most directly When market or market share are referred to in this comparable financial measure in accordance with GAAP. report, the markets and share are defined by the PepsiCo’s Annual Report contains many of the valuable trademarks owned and/or used by PepsiCo and its subsidiaries and affiliates in the United States and internationally to distinguish products (c) In 2006, excludes restructuring and impairment charges and certain tax items. In 2005, excludes and services of outstanding quality. America On the Move™ is an initiative of the nonprofit organization, The Partnership to Promote Healthy Eating and Active Living (The Partnership: the impact of the American Jobs Creation Act (AJCA) tax charge, the 53rd week and restructuring sources of the information, primarily Information www.americaonthemove.org). Komen Race for the Cure is an initiative of the National Volunteer Recognition Program. charges. See page 82 for a reconciliation to the most directly comparable financial measure in Resources, Inc. and ACNielsen. The Measured accordance with GAAP. Channel Information excludes Wal*Mart, as Design: Eisenman Associates. Cover concept: Sondra Greenspan, Arcanna, Inc. Cover illustrations: 3DI Studio. Printing: L.P.Thebault. Photography: Stephen Wilkes, Ben Rosenthal, Grover Sterling, Steve Bonini, Kayte Deioma, PhotoBureau. Special thanks to Starbucks. (d) Includes the impact of net capital spending. Also, see “Our Liquidity and Capital Resources” in Wal*Mart does not report volume to these services. Management’s Discussion and Analysis. This report is entirely recyclable. The cover and editorial pages are printed on Sterling Ultra Recycled Cover and Sterling Ultra Recycled Dull Text. That paper was manufactured by NewPage with wood procurement certified by the Sustainable Forestry Initiative®. The financial pages are printed on Plainfield Smooth Opaque Text. That paper was manufactured by Domtar Inc., using sustainable energy sources and wood procurement practices certified by the Forest Stewardship Council©. 267419_L01_CRVS.v2 3/3/07 11:30 PM Page 1

2006 PERFORMANCE WITH PURPOSE