UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

 

Commission File Number 001-15019

 

PEPSIAMERICAS, INC.

 

(Exact name of registrant as specified in its charter)

 

 

(612) 661-4000

 

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of June 30, 2007, the aggregate market value of the registrant’s common stock held by non-affiliates (assuming for the sole purpose of this calculation, that all directors and officers of the registrant are “affiliates”) was $1,415.0 million (based on the closing sale price of the registrant’s common stock as reported on the New York Stock Exchange). The number of shares of common stock outstanding at that date was 128,231,175 shares.

 

The number of shares of common stock outstanding as of February 22, 2008 was 128,647,121.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain information required by Part III of this document is incorporated by reference to specified portions of the registrant’s definitive proxy statement for the annual meeting of shareholders to be held April 24, 2008.

 

 

PEPSIAMERICAS, INC.

FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED DECEMBER 29, 2007

TABLE OF CONTENTS

 

 

 

General

 

On November 30, 2000, Whitman Corporation merged with PepsiAmericas, Inc. (the “former PepsiAmericas”), and in January 2001, the combined entity changed its name to PepsiAmericas, Inc. (referred to as “PepsiAmericas,” “we,” “our” and “us”). We manufacture, distribute and market a broad portfolio of beverage products in the United States (“U.S.”), Central and Eastern Europe (“CEE”) and the Caribbean, and have expanded our distribution to include snack foods and beer in certain markets.

 

We sell a variety of brands that we bottle under licenses from PepsiCo, Inc. (“PepsiCo”) or PepsiCo joint ventures, which accounted for approximately 90 percent of our total net sales in fiscal year 2007. We account for approximately 19 percent of all PepsiCo beverage products sold in the U.S. In some territories, we manufacture, package, sell and distribute products under brands licensed by companies other than PepsiCo, and in some territories we distribute our own brands, such as Toma brands in CEE and the Caribbean and Sandora brands in Ukraine.

 

Our distribution channels for the retail sale of our products include supermarkets, supercenters, club stores, mass merchandisers, convenience stores, gas stations, small grocery stores, dollar stores and drug stores. We also distribute our products through various other channels, including restaurants and cafeterias, vending machines and other formats that provide for immediate consumption of our products. In fiscal year 2007, our largest distribution channels were supermarkets and supercenters, and our fastest growing channels were club stores, drug stores, and dollar stores.

 

We deliver our products through these channels primarily using a direct store delivery system. In our territories, we are responsible for selling products, providing timely service to our existing customers, and identifying and obtaining new customers. We are also responsible for local advertising and marketing, as well as executing national and regional selling programs created by brand owners in our territories. The bottling business is capital intensive. Manufacturing operations require specialized high-speed equipment, and distribution requires investment in trucks and warehouse facilities as well as extensive placement of fountain equipment, cold drink vending machines and coolers.

 

In the third quarter of 2007, a PepsiAmericas and PepsiCo joint venture acquired an 80 percent interest in Sandora LLC (“Sandora”). In the fourth quarter of 2007, the joint venture acquired the remaining 20 percent. Sandora manufactures and distributes a variety of juice brands and is the market leader in the high growth juice category in Ukraine. Under the terms of the joint venture agreement, we hold a 60 percent interest and PepsiCo holds a 40 percent interest in the joint venture. In the third quarter of 2007, we purchased a 20 percent interest in a joint venture that owns Agrima JSC (“Agrima”). Agrima produces, sells and distributes PepsiCo products and other beverages throughout Bulgaria.

 

In June 2005, we acquired 49 percent of the outstanding stock of Quadrant-Amroq Bottling Company Limited (“QABCL” or “Romania”). In July 2006, we completed the acquisition of the remaining 51 percent of QABCL. QABCL, through its subsidiaries, produces, sells, and distributes Pepsi and other beverages throughout Romania. In January 2005, we completed the acquisition of Central Investment Corporation (“CIC”), the seventh largest Pepsi bottler in the U.S. CIC had bottling operations in southeast Florida and central Ohio.

 

Our annual, quarterly and current reports, and all amendments to those reports, are included on our website at www.pepsiamericas.com, and are made available, free of charge, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. Our corporate governance guidelines, code of conduct, code of ethics and key committee charters are available on our website and in print upon written request to PepsiAmericas, Inc., 4000 Dain Rauscher Plaza, 60 South Sixth Street, Minneapolis, Minnesota 55402, Attention: Investor Relations.

Business Segments

 

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and Note 21 to the Consolidated Financial Statements for additional information regarding business and operating results of our geographic segments. See “Risk Factors” in Item 1A for additional information regarding specific risks in our international operations.

 

Relationship with PepsiCo

 

PepsiCo beneficially owned approximately 44 percent of PepsiAmericas’ outstanding common stock as of the end of fiscal year 2007.

 

While we manage all phases of our operations, including pricing of our products, PepsiAmericas and PepsiCo exchange production, marketing and distribution information, which benefits both companies’ respective efforts to lower costs, improve quality and productivity and increase product sales. We have a significant ongoing relationship with PepsiCo and have entered into a number of significant transactions and agreements with PepsiCo. We expect to enter into additional transactions and agreements with PepsiCo in the future.

 

We purchase concentrates from PepsiCo, pay royalties related to Aquafina products, and manufacture, package, sell, and distribute cola and non-cola beverages under various bottling agreements with PepsiCo. These agreements give us the right to manufacture, package, sell and distribute beverage products of PepsiCo in both bottles and cans, as well as fountain syrup in specified territories. These agreements provide PepsiCo with the ability to set prices of concentrates, as well as the terms of payment and other terms and conditions under which we purchase such concentrates. See “Franchise Agreements” for discussion of significant agreements. We also purchase finished beverage and snack food products from PepsiCo, as well as products from certain affiliates of PepsiCo.

 

Other significant transactions and agreements with PepsiCo include arrangements for marketing, promotional and advertising support; manufacturing services related to PepsiCo’s national account customers; procurement of raw materials; and the acquisition of Sandora (see “Related Party Transactions” in Item 7 and Note 22 to the Consolidated Financial Statements for further discussion).

 

Products and Packaging

 

Our portfolio of beverage products includes some of the best-recognized trademarks in the world. Our three largest brands in terms of volume are Pepsi, Diet Pepsi and Mountain Dew. While the majority of our volume is derived from brands licensed from PepsiCo and PepsiCo joint ventures, we also sell and distribute brands licensed from others, as well as some of our own brands. Our top five beverage brands in fiscal year 2007 by geographic segment are listed below:

 

 

In addition to the beverage products described above, we distribute snack food products in Trinidad and Tobago, the Czech Republic, and Hungary pursuant to a distribution agreement with Frito-Lay, Inc., a subsidiary of PepsiCo.

 

Our beverages are available in different package types, including but not limited to, aluminum cans, glass and polyethylene terephthalate (“PET”) bottles, paperboard cartons and bag-in-box packages for fountain use. The can and bottle packages are available in both single-serve and multi-pack offerings.

Territories

 

In the U.S., we serve a significant portion of a 19-state region, primarily in the Midwest. Internationally, we serve Central and Eastern European and Caribbean markets, including Poland, Hungary, the Czech Republic, Republic of Slovakia, Romania, Ukraine, Puerto Rico, Jamaica, the Bahamas, and Trinidad and Tobago. We have distribution rights and distribute in Moldova, Estonia, Latvia, Lithuania and Barbados. We serve areas with a total population of approximately 200 million people in these markets. In addition, through our Sandora investment, we sell Sandora-branded products to third-party distributors in Belarus, Azerbaijan, Russia and other countries in Eastern Europe and Central Asia. Although we distribute Frito-Lay products in Ukraine, we currently do not distribute any Pepsi branded beverage products in the Ukraine. We also have a 20 percent equity investment in Agrima which gives us a market presence in Bulgaria. In fiscal year 2007, we derived approximately 76 percent of our net sales from U.S. operations and approximately 24 percent of our net sales from international operations (see Note 21 to the Consolidated Financial Statements for further discussion).

 

Sales, Marketing and Distribution

 

Our sales and marketing approach varies by region and channel to respond to unique local competitive environments. In the U.S., channels with larger stores can accommodate a number of beverage suppliers and, therefore, marketing efforts tend to focus on increasing the amount of shelf space and the number of displays in any given outlet. In locations where our products are purchased for immediate consumption, marketing efforts are aimed not only at securing the account but also on providing equipment that facilitates the sale of cold beverages, such as vending machines, coolers and fountain equipment.

 

Package mix is an important consideration in the development of our marketing plans. Although some packages are more expensive to produce and distribute, in certain channels those packages may have higher average selling prices. For example, a packaged product that is sold cold for immediate consumption generally has better margins than a product that is sold to take home. This cold drink channel includes vending machines and coolers. We own a majority of the vending machines used to dispense our products. We refurbish a majority of our cold drink equipment in our refurbishment centers in the U.S. and Puerto Rico.

 

In the U.S., we distribute directly to a majority of customers in our licensed territories through a direct store distribution system. Our sales force is key to our selling efforts as it continually interacts with our customers to promote and sell our products. We utilize Next Generation, a pre-sell system, that allows sales managers to call accounts in advance to determine how much product and promotional material to deliver. We have continued to address internal capabilities and efficiencies throughout our organization. In fiscal year 2007, we realigned our organization in the U.S. from a sales organization based on geography to one built around customer channels. This new structure enables us to dedicate more resources and sales support to channels and customers that are growing and helps us to align more directly with the way our customers do business. We also operate a call center, Pepsi Connect, in Fargo, North Dakota, which enables us to provide the level of service our customers require in a manner that is cost effective.

 

In the U.S., the direct store distribution system is used for all packaged goods and certain fountain accounts. We have the exclusive right to sell and deliver fountain syrup to local customers in our territories. We have a number of sales people who are responsible for calling on prospective fountain accounts, developing relationships, selling products and interacting with customers on an ongoing basis. We also manufacture and distribute fountain products and provide fountain equipment service to PepsiCo customers in certain of our territories in accordance with various agreements with PepsiCo.

 

In our international markets, we use both direct store distribution systems and third-party distributors. In these less developed markets, small retail outlets represent a large percentage of the market. However, with the emergence of larger, more sophisticated retailers in CEE, the percentage of total soft drinks sold to supermarkets and other larger accounts is increasing. In order to optimize the infrastructure in CEE and the Caribbean, we use an alternative sales and distribution strategy in which third-party distributors are utilized in certain locations in an effort to reduce delivery costs and expand our points of distribution.

Franchise Agreements

 

We conduct our business primarily under franchise agreements with PepsiCo. These agreements give us the exclusive right in specified territories to manufacture, package, sell and distribute PepsiCo beverages, and to use the related PepsiCo tradenames and trademarks. These agreements require us, among other things, to purchase concentrates for the beverages solely from PepsiCo, at prices established by PepsiCo, to use only PepsiCo authorized containers, packages and labeling, and to diligently promote the sale and distribution of PepsiCo beverages. We also have similar agreements with other brand owners such as Cadbury Schweppes plc.

 

Set forth below is a summary of our Master Bottling Agreement with PepsiCo, pursuant to which we manufacture, package, sell and distribute cola and non-cola beverages in the U.S and in certain countries outside the U.S. In addition, we have similar arrangements with other companies whose brands we produce and distribute. Generally, the franchise agreements exist in perpetuity and contain operating and marketing commitments and conditions for termination. Also set forth below is a summary of our Master Fountain Syrup Agreement with PepsiCo, pursuant to which we manufacture, sell and distribute fountain syrup for PepsiCo beverages.

 

Master Bottling Agreement.  The Master Bottling Agreement (the “Bottling Agreement”) under which we manufacture, package, sell and distribute cola and non-cola beverages bearing the Pepsi-Cola and Pepsi trademarks was entered into in November 2000. The Bottling Agreement gives us the exclusive and perpetual right to distribute cola beverages for sale in specified territories in authorized containers, with the exception of Romania. In Romania, our agreement has certain performance measures that, if exceeded, enable the agreement to automatically renew. The Bottling Agreement provides that we will purchase our entire requirements of concentrates for cola beverages from PepsiCo at prices, and on terms and conditions, determined from time to time by PepsiCo. PepsiCo has no rights under the Bottling Agreement with respect to the prices at which we sell our products. PepsiCo may determine from time to time what types of containers we are authorized to use.

 

Under the Bottling Agreement, we are obligated to:

 

 

The Bottling Agreement requires that we meet with PepsiCo on an annual basis to discuss the business plan for the following three years. At these meetings, we are obligated to present the plans necessary to perform the duties required under the Bottling Agreement. These include marketing, management, advertising and financial plans.

 

The Bottling Agreement provides that PepsiCo may, in its sole discretion, reformulate any of the cola beverages or discontinue them, with some limitations, so long as all cola beverages are not discontinued. PepsiCo may also introduce new beverages under the Pepsi-Cola trademarks or any modification thereof. If that occurs, we will be obligated to manufacture, package, sell and distribute such new beverages with the

same obligations as then exist with respect to other cola beverages. We are prohibited from producing or handling cola products, other than those of PepsiCo, or products or packages that imitate, infringe or cause confusion with the products, containers or trademarks of PepsiCo. The Bottling Agreement also imposes requirements with respect to the use of PepsiCo’s trademarks, authorized containers, packaging and labeling.

 

PepsiCo can terminate the Bottling Agreement if any of the following occur:

 

 

We are prohibited from assigning, transferring or pledging the Bottling Agreement without PepsiCo’s prior consent.

 

Master Fountain Syrup Agreement.  The Master Fountain Syrup Agreement (the “Syrup Agreement”) grants us the exclusive right to manufacture, sell and distribute fountain syrup to local customers in our territories. The Syrup Agreement also grants us the right to act as a manufacturing and delivery agent for national accounts within our territories that specifically request direct delivery without using a middleman. In addition, PepsiCo may appoint us to manufacture and deliver fountain syrup to national accounts that elect delivery through independent distributors. Under the Syrup Agreement, we have the exclusive right to service fountain equipment for all of the national account customers within our territories. The Syrup Agreement provides that the determination of whether an account is local or national is at the sole discretion of PepsiCo.

 

The Syrup Agreement contains provisions that are similar to those contained in the Bottling Agreement with respect to pricing, territorial restrictions with respect to local customers and national customers electing direct-to-store delivery only, planning, quality control, transfer restrictions and related matters. The Syrup Agreement, which we entered into in November 2000, had an initial term of five years and was automatically renewed for an additional five-year period in November 2005 on the same terms and conditions. The Syrup Agreement is automatically renewable for additional five-year periods unless PepsiCo terminates it for cause. PepsiCo has the right to terminate the Syrup Agreement without cause at any time upon 24 months’ notice. If PepsiCo terminates the Syrup Agreement without cause, PepsiCo is required to pay us the fair market value of our rights thereunder. The Syrup Agreement will terminate if PepsiCo terminates the Bottling Agreement.

 

Advertising

 

We obtain the benefits of national advertising campaigns conducted by PepsiCo and the other beverage companies whose products we sell. We supplement PepsiCo’s national ad campaigns by purchasing advertising in our local markets, including the use of television, radio, print and billboards. We also make extensive use of in-store, point-of-sale displays to reinforce national and local advertising and to stimulate demand.

 

Raw Materials and Manufacturing

 

Expenditures for concentrates constitute our largest individual raw material cost. We buy various soft drink concentrates from PepsiCo and other soft drink companies, and mix them with other ingredients in our plants, including water, carbon dioxide and sweeteners. Artificial sweeteners are included in the concentrates we purchase for diet soft drinks. In addition to soft drink concentrates, we buy juice concentrates for our Toma and Sandora juice brands.

In addition to concentrates, we purchase sweeteners, glass and PET bottles, aluminum cans, closures, paperboard cartons, bag-in-box packages, syrup containers, other packaging materials and carbon dioxide. We purchase raw materials and supplies, other than concentrates, from multiple suppliers. PepsiCo acts as our agent for the purchase of several such raw materials (see “Related Party Transactions” in Item 7 and Note 22 to the Consolidated Financial Statements for further discussion of PepsiCo’s procurement services).

 

A portion of our contractual cost of cans, PET bottles and sweeteners is subject to price fluctuations based on commodity price changes in aluminum, PET resin, corn and sugar. We periodically use derivative financial instruments to hedge the price risk associated with anticipated purchases of commodities.

 

The inability of suppliers to deliver concentrates or other products to us could adversely affect operating results. None of the raw materials or supplies in use is currently in short supply, although factors outside of our control could adversely impact the future availability of these supplies.

 

Seasonality

 

Sales of our products are seasonal, with the second and third quarters generating higher net sales than the first and fourth quarters. Approximately 53 percent of our net sales in fiscal year 2007 was generated during the second and third quarters. Net sales in our CEE operations tend to be more seasonal and sensitive to weather conditions than our U.S. and Caribbean operations.

 

Competition

 

The carbonated soft drink and the non-carbonated beverage markets are highly competitive. Our principal competitors are bottlers who produce, package, sell and distribute Coca-Cola products. Additionally, in both the carbonated soft drink and non-carbonated beverage markets, we also compete with bottlers and distributors of nationally advertised and marketed products, bottlers and distributors of regionally advertised and marketed products, and bottlers of private label products sold in chain stores. The industry competes primarily on the basis of advertising to create brand awareness, price and price promotions, retail space management, customer service, consumer points of access, new products, packaging innovations and distribution methods. We believe that brand recognition is a primary factor affecting our competitive position.

 

Employees

 

We employed approximately 20,700 people worldwide as of the end of fiscal year 2007. This included approximately 12,200 employees in our U.S. operations and approximately 8,500 employees in our international operations. Employment levels are subject to seasonal variations. We are a party to collective bargaining agreements covering approximately 5,700 employees in the U.S. and Puerto Rico. Fourteen agreements covering approximately 1,570 employees will be renegotiated in 2008. We regard our employee relations as generally satisfactory.

 

Government Regulation

 

Our operations and properties are subject to regulation by various federal, state and local governmental entities and agencies in the U.S., as well as foreign governmental entities. As a producer of beverage products, we are subject to production, packaging, quality, labeling and distribution standards in each of the countries where we have operations including, in the U.S., those of the Federal Food, Drug and Cosmetic Act. In the U.S., we are also subject to the Soft Drink Interbrand Competition Act, which permits us to retain an exclusive right to manufacture, distribute and sell a soft drink product in a geographic territory if the soft drink product is in substantial and effective competition with other products of the same class in the same market or markets. We believe that there is such substantial and effective competition in each of the exclusive territories in which we operate. The operations of our production and distribution facilities are subject to various federal, state and local environmental laws and workplace regulations both in the U.S. and abroad. These laws and regulations include, in the U.S., the Occupational Safety and Health Act, the Unfair Labor Standards Act, the Clean Air Act, the Clean Water Act and laws relating to the maintenance of fuel storage tanks. We believe

that our current legal and environmental compliance programs adequately address these areas and that we are in substantial compliance with applicable laws and regulations.

 

Environmental Matters

 

Current Operations.  We maintain compliance with federal, state and local laws and regulations relating to materials used in production and to the discharge of wastes, and other laws and regulations relating to the protection of the environment. The capital costs of such management and compliance, including the modification of existing plants and the installation of new manufacturing processes, are not material to our continuing operations.

 

We are defendants in lawsuits that arise in the ordinary course of business, none of which is expected to have a material adverse effect on our financial condition, although amounts recorded in any given period could be material to the results of operations or cash flows for that period.

 

Discontinued Operations — Remediation.  Under the agreement pursuant to which we sold our subsidiaries, Abex Corporation and Pneumo Abex Corporation (collectively, “Pneumo Abex”), in 1988 and a subsequent settlement agreement entered into in September 1991, we have assumed indemnification obligations for certain environmental liabilities of Pneumo Abex, after any insurance recoveries. Pneumo Abex has been and is subject to a number of environmental cleanup proceedings, including responsibilities under the Comprehensive Environmental Response, Compensation and Liability Act and other related federal and state laws regarding release or disposal of wastes at on-site and off-site locations. In some proceedings, federal, state and local government agencies are involved and other major corporations have been named as potentially responsible parties. Pneumo Abex is also subject to private claims and lawsuits for remediation of properties previously owned by Pneumo Abex and its subsidiaries.

 

There is an inherent uncertainty in assessing the total cost to investigate and remediate a given site. This is because of the evolving and varying nature of the remediation and allocation process. Any assessment of expenses is more speculative in an early stage of remediation and is dependent upon a number of variables beyond the control of any party. Furthermore, there are often timing considerations, in that a portion of the expense incurred by Pneumo Abex, and any resulting obligation of ours to indemnify Pneumo Abex, may not occur for a number of years.

 

In fiscal year 2001, we investigated the use of insurance products to mitigate risks related to our indemnification obligations under the 1988 agreement, as amended. We oversaw a comprehensive review of the former facilities operated or impacted by Pneumo Abex. Advances in the techniques of retrospective risk evaluation and increased experience (and therefore available data) at our former facilities made this comprehensive review possible. The review was completed in fiscal year 2001 and was updated in fiscal year 2005.

 

During fiscal year 2007, we recorded a charge of $2.1 million, net of taxes, related to revised estimates for environmental remediation, legal and related administrative costs. As of the end of fiscal year 2007, we had $40.2 million accrued to cover potential indemnification obligations, compared to $60.3 million recorded as of the end of fiscal year 2006. The decrease was primarily due to payments made during the year for remediation activities, legal and administrative fees and settlement costs or negotiations. This indemnification obligation includes costs associated with approximately 15 sites in various stages of remediation or negotiations. At the present time, the most significant remaining indemnification obligation is associated with the Willits site, as discussed below, while no other single site has significant estimated remaining costs associated with it. Of the total amount accrued, $19.5 million and $26.2 million were classified as a current liability as of the end of fiscal year 2007 and 2006, respectively. The amounts exclude possible insurance recoveries and are determined on an undiscounted cash flow basis. The estimated indemnification liabilities include expenses for the investigation and remediation of identified sites, payments to third parties for claims and expenses (including product liability and toxic tort claims), administrative expenses, and the expenses of on-going evaluations and litigation. We expect a significant portion of the accrued liabilities will be spent during the next five years.

Included in our indemnification obligations is financial exposure related to certain remedial actions required at a facility that manufactured hydraulic and related equipment in Willits, California. Various chemicals and metals contaminate this site. A final consent decree was issued in August 1997 and amended in December 2000 in the case of the People of the State of California and the City of Willits, California v. Remco Hydraulics, Inc. The final consent decree established a trust (the “Willits Trust”) which is obligated to investigate and clean up this site. We are currently funding the Willits Trust and the investigation and interim remediation costs on a year-to-year basis as required in the final amended consent decree. We have accrued $15.4 million for future remediation and trust administration costs, with the majority of this amount to be spent over the next several years.

 

Although we have certain indemnification obligations for environmental liabilities at a number of sites other than the site discussed above, including Superfund sites, it is not anticipated that additional expense at any specific site will have a material effect on us. At some sites, the volumetric contribution for which we have an obligation has been estimated and other large, financially viable parties are responsible for substantial portions of the remainder. In our opinion, based upon information currently available, the ultimate resolution of these claims and litigation, including potential environmental exposures, and considering amounts already accrued, should not have a material effect on our financial condition, although amounts recorded in a given period could be material to our results of operations or cash flows for that period.

 

Discontinued Operations — Insurance.  During fiscal year 2002, as part of a comprehensive program concerning environmental liabilities related to the former Whitman Corporation subsidiaries, we purchased new insurance coverage related to the sites previously owned and operated or impacted by Pneumo Abex and its subsidiaries. In addition, a trust, which was established in 2000 with the proceeds from an insurance settlement (the “Trust”), purchased insurance coverage and funded coverage for remedial and other costs (“Finite Funding”) related to the sites previously owned and operated or impacted by Pneumo Abex and its subsidiaries.

 

Essentially all of the assets of the Trust were expended by the Trust in connection with the purchase of the insurance coverage, the Finite Funding and related expenses. These actions were taken to fund remediation and related costs associated with the sites previously owned and operated or impacted by Pneumo Abex and its subsidiaries and to protect against additional future costs in excess of our self-insured retention. The original amount of self-insured retention (the amount we must pay before the insurance carrier is obligated to begin payments) was $114.0 million of which $50.2 million has been eroded, leaving a remaining self-insured retention of $63.8 million as of the end of fiscal year 2007. The estimated range of aggregate exposure related only to the remediation costs of such environmental liabilities is approximately $20 million to $45 million. We had accrued $23.7 million at the end of fiscal year 2007 for remediation costs, which is our best estimate of the contingent liabilities related to these environmental matters. The Finite Funding may be used to pay a portion of the $23.7 million and thus reduces our future cash obligations. Amounts recorded in our Consolidated Balance Sheets related to Finite Funding were $11.5 million and $13.7 million as of the end of fiscal years 2007 and 2006, respectively, and were recorded in “Other assets,” net of $4.7 million and $4.2 million recorded in “Other current assets” as of the end of fiscal years 2007 and 2006, respectively.

 

In addition, we had recorded other receivables of $2.6 million and $7.8 million as of the end of fiscal years 2007 and 2006, respectively, for future probable amounts to be received from insurance companies and other responsible parties. These amounts were recorded in “Other current assets” as of the end of fiscal year 2007 and in “Other assets” as of the end of fiscal year 2006 in the Consolidated Balance Sheets. Of this total, no portion of the receivable was reflected as current as of the end of fiscal year 2006.

 

On May 31, 2005, Cooper Industries, LLC (“Cooper”) filed and later served a lawsuit against us, Pneumo Abex, LLC, and the Trustee of the Trust (the “Trustee”), captioned Cooper Industries, LLC v. PepsiAmericas, Inc., et al., Case No. 05 CH 09214 (Cook Cty. Cir. Ct.). The claims involve the Trust and insurance policy described above. Cooper asserts that it was entitled to access $34 million that previously was in the Trust and that was used to purchase the insurance policy. Cooper claims that Trust funds should have been distributed for underlying Pneumo Abex asbestos claims indemnified by Cooper. Cooper complains that it was deprived of access to money in the Trust because of the Trustee’s decision to use the Trust funds to purchase the

insurance policy described above. Pneumo Abex, LLC, the corporate successor to our prior subsidiary, has been dismissed from the suit.

 

During the second quarter of 2006, the Trustee’s motion to dismiss, in which we had joined, was granted and three counts against us based on the use of Trust funds were dismissed with prejudice, as were all counts against the Trustee, on the grounds that Cooper lacks standing to pursue these counts because it is not a beneficiary under the Trust. We then filed a separate motion to dismiss the remaining counts against us. Our motion was granted during the second quarter of 2006 and all remaining counts against us were dismissed with prejudice. Cooper subsequently filed a notice of appeal with regard to all rulings by the court dismissing the counts against us and the Trustee. Prior to any oral argument, the appellate court on September 7, 2007 issued an opinion affirming the trial court’s opinion. Cooper subsequently filed motion papers asking the Illinois Supreme Court to accept a discretionary appeal of the rulings. The Trustee then filed an opposition brief explaining why the Illinois Supreme Court should not allow another appeal, and we joined in that brief. On November 29, 2007, the Supreme Court of Illinois denied Cooper’s petition for leave to appeal the appellate court’s September 7, 2007 ruling. Cooper has until February 27, 2008 to file a petition for certiorari seeking discretionary review by the United States Supreme Court.

 

Discontinued Operations — Product Liability and Toxic Tort Claims.  We also have certain indemnification obligations related to product liability and toxic tort claims that might emanate out of the 1988 agreement with Pneumo Abex. Other companies not owned by or associated with us also are responsible to Pneumo Abex for the financial burden of all asbestos product liability claims filed against Pneumo Abex after a certain date in 1998, except for certain claims indemnified by us.

 

In fiscal year 2004, we noted that three mass-filed lawsuits accounted for thousands of claims for which Pneumo Abex claimed indemnification. During the fourth quarter of fiscal year 2005, these and other related claims were resolved for an amount we viewed as reasonable given all of the circumstances and consistent with our prior judgments as to valuation. We have received year-end 2007 claim statistics from law firms and Pneumo Abex which reflect the resolution of those claims and the remaining cases for which Pneumo Abex claims indemnification from PepsiAmericas. After giving effect to the noted resolution of prior mass-filed claims, there are less than 7,500 claims for which indemnification is claimed at the end of fiscal year 2007. Of these claims, approximately 5,500 are filed in federal court and are subject to orders issued by the Multi-District Litigation panel, which effectively stay all federal claims, subject to specific requests to activate a particular claim or a discrete group of claims. The remaining cases are in state court and some are in “pleural registries” or other similar classifications that cause a case not to be allowed to go to trial unless there is a specific showing as to a particular plaintiff. Over 50 percent of the state court claims were filed prior to or in 1998. Prior to 1980, sales ceased for the asbestos-containing product claimed to have generated the largest subset of the open cases, and, therefore, we expect a decreasing rate of individual claims for that subset of cases. We oversee monitoring of the defense of the underlying claims that are or may be indemnifiable by us.

 

At the end of fiscal years 2007 and 2006, we had accrued $4.0 million and $5.5 million, respectively, related to product liability. These accruals primarily relate to probable asbestos claim settlements and legal defense costs. We also have additional amounts accrued for legal and other costs associated with obtaining insurance recoveries for previously resolved and currently open claims and their related costs. These amounts are included in the total liabilities of $40.2 million accrued as of the end of fiscal year 2007. In addition to the known and probable asbestos claims, we may be subject to additional asbestos claims that are possible for which no reserve had been established as of the end of fiscal year 2007. These additional reasonably possible claims are primarily asbestos related and the aggregate exposure related to these possible claims is estimated to be in the range of $4 million to $17 million. These amounts are undiscounted and do not reflect any insurance recoveries that we will pursue from insurers for these claims.

 

In addition, three lawsuits have been filed in California, which name several defendants including certain of our prior subsidiaries. The lawsuits allege that we and our former subsidiaries are liable for personal injury and/or property damage resulting from environmental contamination at the Willits facility. There are approximately 125 personal injury plaintiffs in the lawsuits seeking an unspecified amount of damages, punitive

damages, injunctive relief and medical monitoring damages. We are actively defending the lawsuits. At this time, we do not believe these lawsuits are material to our business or financial condition.

 

We have other indemnification obligations related to product liability matters. In our opinion, based on the information currently available and the amounts already accrued, these claims should not have a material effect on our financial condition.

 

We also participate in and monitor insurance-recovery efforts for the claims against Pneumo Abex. Recoveries from insurers vary year by year because certain insurance policies exhaust and other insurance policies become responsive. Recoveries also vary due to delays in litigation, limits on payments in particular periods, and because insurers sometimes seek to avoid their obligations based on positions that we believe are improper. We, assisted by our consultants, monitor the financial ratings of insurers that issued responsive coverage and the claims submitted by Pneumo Abex.

 

Executive Officers of the Registrant

 

Our executive officers and their ages as of February 22, 2008 were as follows:

 

 

Each executive officer has been appointed to serve until his or her successor is duly appointed or his or her earlier removal or resignation from office. There are no familial relationships between any director or executive officer. The following is a brief description of the business background of each of our executive officers.

 

Mr. Pohlad became Chief Executive Officer of PepsiAmericas in November 2000, was named Vice Chairman in January 2001 and became Chairman of the Board in January 2002. From 1987 to present, Mr. Pohlad has also served as President of Pohlad Companies. Mr. Pohlad is also a director of MAIR Holdings, Inc. and has served as its Chairman since March 2006.

 

Mr. Keiser was named President and Chief Operating Officer in January 2002 with responsibilities for the global operations of PepsiAmericas. Mr. Keiser is also a director of C.H. Robinson Worldwide, Inc.

 

Mr. Ware was named Executive Vice President, Chief Financial Officer in March 2005. From January 2003 to March 2005, Mr. Ware had served as Senior Vice President, Planning and Corporate Development.

 

Mr. Durkin was named Executive Vice President, U.S. in March 2005. Prior to this role, Mr. Durkin served as Chief Financial Officer of PepsiAmericas since 2000. Mr. Durkin also serves on the Board of Directors of The Schwan Food Company, Inc.

 

Mr. Rogers was named Executive Vice President, International in September 2004. Prior to this appointment, he served as Executive Vice President/General Manager of Central Europe since August 2000.

 

Mr. Hulbert was named Executive Vice President, Worldwide Supply Chain in January 2008. Prior to this appointment, he served as Senior Vice President, Supply Chain since December 2002.

 

Ms. Sample was named Executive Vice President, Human Resources in January 2008. Prior to this appointment, she served as Senior Vice President, Human Resources since May 2001.

 

Mr. Johnsen was named Senior Vice President, Chief Information Officer in July 2001. From November 1997 to June 2001, he served as Chief of Information Technology.

 

Mr. Gorman was named Senior Vice President, Controller in January 2008. Prior to this appointment, he served as Vice President and Controller since May 2003, and Vice President, Planning and Reporting from August 1999 to May 2003.

 

Mr. Stark was named Vice President, Treasurer in July 2002. Prior to his appointment, Mr. Stark served as Assistant Treasurer since August 1998.

 

 

The following are certain risk factors that could affect our business, financial condition, operating results and cash flows. These risk factors should be considered in connection with evaluating the forward-looking statements contained in this Annual Report on Form 10-K because these risk factors could cause our actual results to differ materially from those expressed in any forward-looking statement. The risks we have highlighted below are not the only ones we face. If any of these events actually occur, our business, financial condition, operating results or cash flows could be negatively affected. We caution you to keep in mind these risk factors and to refrain from attributing undue certainty to any forward-looking statements, which speak only as of the date of this report.

 

Our operating results may fluctuate based on changes in marketplace conditions, especially customer and competitor consolidation; changes in consumer preferences, including our consumers’ shift from carbonated soft drinks to non-carbonated beverages; and unfavorable weather conditions in the territories in which we operate.

 

We face intense competition in the carbonated soft drink market and the non-carbonated beverage market and are impacted by both customer and competitor consolidation. Our response to marketplace competition and retailer consolidations may result in lower than expected net pricing of our products. Retail consolidation has increased the importance of our major customers and further consolidation is expected. In addition, competitive pressures may cause channel and product mix to shift from more profitable channels and packages and adversely affect our overall pricing. Our efforts to improve pricing may result in lower than expected volumes. Changes in net pricing and volume could have an adverse effect on our business, results of operations and financial condition.

 

Health and wellness trends have decreased demand for sugared carbonated soft drinks and shifted interest to diet soft drinks and non-carbonated beverages. In the U.S., carbonated soft drink volume, which represented approximately 80 percent of our volume mix, declined 4 percent in both fiscal years 2007 and 2006. In response to changes in consumers’ preferences, we have increased our emphasis on diet carbonated soft drinks and non-carbonated beverages, including Aquafina, Sobe, Tropicana juice drinks, Lipton Iced Tea and energy drinks. Our business could be adversely impacted by a significant decline in sales of sugared carbonated soft drinks and our inability to offset that decline with sales of diet soft drinks and non-carbonated beverages. Because we rely mainly on PepsiCo to provide us with the products that we sell, if PepsiCo fails to develop innovative products that respond to these and other consumer trends, this could put us at a competitive disadvantage in the marketplace and adversely affect our business and financial results.

 

Our business could also be adversely affected by other consumer trends, such as consumer health concerns about obesity, product attributes and ingredients. Consumer preferences may change due to a variety of factors, including the aging of the general population, changes in social trends, changes in travel, vacation or leisure activity patterns or a downturn in economic conditions.

 

Additionally, our business is highly seasonal and unfavorable weather conditions in our markets may impact sales volume. Sales volumes in our CEE operations tend to be more sensitive to weather conditions than our U.S. and Caribbean operations.

 

Our business may be adversely impacted by unfavorable global and local economic, political and regulatory developments or other risks in the countries in which we operate.

 

Our operations are affected by local and global economic environments, including inflation, recession and currency volatility. Political and regulatory changes, some of which may be disruptive, can interfere with our supply chain, our customers and all of our activities in a particular location.

 

An increase in the price of raw materials, natural gas and fuel or a decrease in the availability of raw materials, natural gas and fuel could adversely affect our financial condition. Disruption of our supply chain also could have an adverse effect on our business, financial condition and operating results.

 

Increases in the price of ingredients, packaging materials, other raw materials, natural gas and fuel could adversely impact our earnings and financial condition if we are unable to pass along these higher costs to our customers. The inability of suppliers to deliver concentrate, raw materials, other ingredients and products to us could also adversely affect operating results. The inability of our suppliers to meet our requirements could result in short-term shortages until alternative sources of supply could be located. In particular, we require significant amounts of aluminum cans and PET bottle containers to support our requirements. Failure of our suppliers to meet our purchase requirements could reduce our profitability. In addition, we also require access to significant amounts of water. Any sustained interruption in the supply of these materials or any significant increase in their prices could have a material adverse effect on our business and financial results.

 

Energy prices, including the price of natural gas, gasoline and diesel fuel, are cost drivers for our business. Sustained high energy or commodity prices could negatively impact our operating results and demand for our products. Events such as natural disasters could impact the supply of fuel and could impact the timely delivery of our products to our customers.

 

Our ability to make, move and sell products is critical to our success. Damage or disruption to our supply chain, including our manufacturing or distribution capabilities, due to weather, natural disaster, fire or explosion, terrorism, pandemic, strikes or other reasons could impair our ability to manufacture, package, sell and distribute our products. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial condition and results of operations, as well as require additional resources to restore our supply chain.

 

The successful operation of our business depends upon our relationship with PepsiCo, including its level of advertising, bottler incentives and brand innovation. We may also have conflicts of interest with PepsiCo.

 

We operate under various bottling agreements with PepsiCo that allow us to manufacture, package, sell and distribute carbonated and non-carbonated beverages. Our inability to comply with the terms and conditions established in these agreements could result in termination of bottling agreements which would have a material adverse impact on our short-term and long-term business. These agreements provide that we must purchase all of the concentrates for PepsiCo beverages at prices and on terms which are set by PepsiCo in its sole discretion. Any significant concentrate price increases could materially affect our business and financial results.

 

PepsiCo’s advertising campaigns and their effectiveness, bottler incentives provided by PepsiCo, and PepsiCo’s brand innovation directly impact our operations. Bottler incentives cover a variety of initiatives to support volume and market share growth. The level of support is negotiated regularly and can be increased or decreased at the discretion of PepsiCo. PepsiCo is under no obligation to continue past levels of support in the future. Material changes in expected levels of bottler incentive payments and other support arrangements could adversely affect future results of operations. Furthermore, if the sales volume of sugared carbonated soft drinks continues to decline, our sales volume growth will increasingly depend on product innovation by PepsiCo. Even if PepsiCo maintains a robust pipeline of new products, we may be unable to achieve volume growth through product and packaging initiatives.

 

PepsiCo also provides procurement services for certain raw materials which result in rebates from vendors as a result of procurement volume. Cost of goods sold may be negatively impacted if we are unable to

maintain targeted volume levels to secure such anticipated rebates or if PepsiCo no longer provides this service on our behalf.

 

Our past and ongoing relationship with PepsiCo could give rise to conflicts of interest. These potential conflicts include balancing the objectives of increasing sales volume of PepsiCo beverages and maintaining or increasing our profitability. Other possible conflicts could relate to the nature, quality and pricing of services or products provided to us from PepsiCo or by us to PepsiCo.

 

In addition, under our Master Bottling Agreement, we must obtain PepsiCo’s approval to acquire any independent PepsiCo bottler. PepsiCo has agreed not to withhold approval for any acquisition within agreed-upon U.S. territories if we have successfully negotiated the acquisition and, in PepsiCo’s reasonable judgment, satisfactorily performed our obligations under the Master Bottling Agreement.

 

As of the end of fiscal year 2007, PepsiCo beneficially owned approximately 44 percent of our common stock. As a result, PepsiCo is able to significantly affect the outcome of our shareholder votes, thereby affecting matters concerning us. PepsiCo has expressed its intent to reduce its ownership status to 37 percent over the next several years to return to the ownership levels at the time of the Whitman Corporation and PepsiAmericas merger, which may impact the market price of our common stock.

 

A negative change in our credit rating or the availability of capital could impact borrowing costs and financial results.

 

We depend, in part, upon the issuance of unsecured debt to fund our operations and contractual commitments. A number of factors could cause us to incur increased borrowing costs and to have greater difficulty accessing public and private markets for unsecured debt. These factors include the global capital market environment and outlook, our financial performance and outlook, and our credit ratings as determined primarily by rating agencies. It is possible that our other sources of funds, including available cash, bank facilities and cash flow from operations, may not provide adequate liquidity to fund our operations and contractual commitments.

 

Because our international operations are conducted under multiple local currencies, our operating results experience foreign currency fluctuations.

 

Our international operations are exposed to foreign exchange rate fluctuations resulting from foreign currency transactions and translation of the operations’ financial results from local currency into U.S. dollars upon consolidation. As exchange rates vary, revenue, capital spending and other operating results, when translated, may differ materially from expectations.

 

The cost to remediate environmental concerns associated with previously owned subsidiaries could be materially different than our estimates.

 

We are subject to federal and state requirements for protection of the environment, including those for the remediation of contaminated sites related to previously owned subsidiaries. We routinely assess our environmental exposure, including obligations and commitments for remediation of contaminated sites and assessments of ranges and probabilities of recoveries from other potentially responsible parties, including insurance providers. Due to the regulatory complexities and risk of unidentified contaminants on our former properties, the potential exists for remediation costs to be materially different from the costs we have estimated.

 

We cannot predict the outcome of legal proceedings and an adverse determination could negatively impact our financial results, nor can we predict the nature or outcome of future legal proceedings.

 

The nature of operations of previously owned subsidiaries exposes us to the potential for various claims and litigation related to, among other things, personal injury and asbestos product liability claims. The nature of assets we currently own and operate exposes us to the potential for various claims and litigation related to, among other things, personal injury and property damage. The resolution of outstanding claims and assessments may be materially different than what we have estimated.

 

In addition, litigation or other claims based on alleged unhealthful properties of soft drinks could be filed against us and would require our management to devote significant time and resources to dealing with such claims. While we would not believe such claims to be meritorious, any such claims would be accompanied by unfavorable publicity that could adversely affect the sales of certain of our products. Our failure to abide by laws, orders or other legal commitments could subject us to fines, penalties or other damages, including costs associated with recalling products. We could be required to recall products if they become contaminated or damaged.

 

Increases in the cost of compliance with applicable regulations, including those governing the production, packaging, quality, labeling and distribution of beverage products, could negatively impact our financial results.

 

Our operations and properties are subject to various federal, state and local laws and regulations, including those governing the production, packaging, quality, labeling and distribution of beverage products, environmental laws, competition laws, taxes and accounting standards. We are also subject to the jurisdiction of regulatory agencies of foreign countries. New laws or regulations or changes in existing laws or regulations could negatively impact our financial results by restricting our ability to distribute products in certain venues or through higher operating costs to achieve compliance.

 

Changes in tax laws or in the tax status of our international operations could increase our tax liability and negatively impact our financial results.

 

We are subject to taxes in the U.S. and various foreign jurisdictions. As a result, our effective tax rate could be adversely affected by changes in the mix of earnings in the U.S. and foreign countries with differing statutory tax rates, legislative changes impacting statutory tax rates, including the impact on recorded deferred tax assets and liabilities, changes in tax laws or material audit assessments. In addition, deferred tax balances reflect the benefit of net operating loss carryforwards, the realization of which will depend upon generating future taxable income in the corresponding tax jurisdiction.

 

A strike or work stoppage by our union employees, which represent approximately one-fourth of our workforce, could disrupt our business.

 

Approximately 28 percent of our employees are covered by collective bargaining agreements. These agreements expire at various dates, including some in fiscal year 2008. Our inability to successfully renegotiate these agreements could cause work stoppages and interruptions, which may adversely impact our operating results. The terms and conditions of existing or renegotiated agreements could also increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency.

 

Our acquisition strategy may be limited by our ability to successfully consummate proposed acquisitions or integrate acquired businesses.

 

We intend to continue to pursue acquiring businesses that would strategically fit within our operations. We may be unable to consummate, successfully integrate and manage acquired businesses without substantial costs, delay or difficulties.

 

Technology failures could disrupt our operations and negatively impact our business.

 

We rely on information technology systems to process, transmit and store electronic information. If we do not effectively manage our information technology infrastructure, we could be subject to transaction errors, processing inefficiencies, the loss of customers, and business disruptions.

 

 

None.

 

 

Our U.S. manufacturing facilities include ten owned and one leased combination bottling/canning plants, four owned bottling plants and two owned canning plants. International manufacturing facilities include four owned plants in Ukraine; two owned plants each in Poland, Hungary, the Czech Republic and Romania; and one owned plant each in Puerto Rico, the Bahamas, Jamaica and Trinidad. The total manufacturing area is approximately 2.9 million square feet. In addition, we operate 127 distribution facilities in the U.S., 51 distribution facilities in CEE and 9 distribution facilities in the Caribbean. Seventy-nine of the distribution facilities are leased and almost 6 percent of our U.S. production is from one leased domestic plant. We believe all facilities are adequately equipped and maintained and capacity is sufficient for our current needs. We currently operate a fleet of approximately 5,200 vehicles in the U.S. and approximately 2,000 vehicles internationally to service and support our distribution system. In addition, we own and lease various industrial and commercial real estate properties in the U.S.

 

In fiscal year 2007, we sold the operating assets of a leasing company, Whitman Leasing, which leased approximately 1,800 railcars comprised of locomotives, flatcars and hopper cars to the successor of the former Illinois Central Railroad Company. The lessee exercised a purchase option at the end of the lease agreement.

 

 

From approximately 1945 to 1995, various entities owned and operated a facility that manufactured hydraulic equipment in Willits, California. The plant site is contaminated by various chemicals and metals. On August 23, 1999, an action entitled Donna M. Avila, et al. v. Willits Environmental Remediation Trust, Remco Hydraulics, Inc., M-C Industries, Inc., Pneumo Abex Corporation and Whitman Corporation, Case No. C99-3941 CAL, was filed in U.S. District Court for the Northern District of California. On January 16, 2001, a second lawsuit, entitled Pamela Jo Alrich, et al. v. Willits Environmental Remediation Trust, et al., Case No. C 01 0266 SI, against essentially the same defendants was filed in the same court. In 2006, a third lawsuit, entitled Nickerman v. Remco Hydraulics, was filed against the same defendants. These three lawsuits are before the same judge in U.S. District Court for the Northern District of California. In these lawsuits, individual plaintiffs claim that PepsiAmericas is liable for personal injury and/or property damage resulting from environmental contamination at the facility. There were over 1,000 claims filed in the three lawsuits. The Court dismissed a large portion of the claims; and in 2006, we settled a significant number of the claims. Some of the remaining claims may be settled, go to trial or be appealed. As of the end of fiscal year 2007, there were approximately 125 personal injury plaintiffs in the lawsuits seeking an unspecified amount of damages, punitive damages, injunctive relief and medical monitoring damages from PepsiAmericas. We are actively defending the lawsuits. At this time, we do not believe these lawsuits are material to the business or financial condition of PepsiAmericas.

 

On May 31, 2005, Cooper Industries, LLC (“Cooper”) filed and later served a lawsuit against us, Pneumo Abex, LLC, and the Trustee of the Trust (the “Trustee”), captioned Cooper Industries, LLC v. PepsiAmericas, Inc., et al., Case No. 05 CH 09214 (Cook Cty. Cir. Ct.). The claims involve the Trust and insurance policy described in “Environmental Matters” in Item 1. Cooper asserts that it was entitled to access $34 million that previously was in the Trust and that was used to purchase the insurance policy. Cooper claims that Trust funds should have been distributed for underlying Pneumo Abex claims indemnified by Cooper. Cooper complains that we deprived it of access to money in the Trust because of the Trustee’s decision to use money in the Trust to purchase the insurance policy. Pneumo Abex, LLC, the corporate successor to our prior subsidiary, has been dismissed from the suit.

 

During the second quarter of 2006, the Trustee’s motion to dismiss, in which we had joined, was granted and three counts against us based on the use of Trust funds were dismissed with prejudice, as were all counts against the Trustee, on the grounds that Cooper lacks standing to pursue these counts because it is not a beneficiary under the Trust. We then filed a separate motion to dismiss the remaining counts against us. Our motion was granted during the second quarter of 2006 and all remaining counts against us were dismissed with prejudice. Cooper subsequently filed a notice of appeal with regard to all rulings by the court dismissing the counts against us and the Trustee. Prior to any oral argument, the appellate court on September 7, 2007

issued an opinion affirming the trial court’s opinion. Cooper subsequently filed motion papers asking the Illinois Supreme Court to accept a discretionary appeal of the rulings. The Trustee then filed an opposition brief explaining why the Illinois Supreme Court should not allow another appeal, and we joined in that brief. On November 29, 2007, the Supreme Court of Illinois denied Cooper’s petition for leave to appeal the appellate court’s September 7, 2007 ruling. Cooper has until February 27, 2008 to file a petition for certiorari seeking discretionary review by the United States Supreme Court.

 

We and our subsidiaries are defendants in numerous other lawsuits in the ordinary course of business, none of which, in the opinion of management, is expected to have a material adverse effect on our financial condition, although amounts recorded in any given period could be material to the results of operations or cash flows for that period.

 

See also “Environmental Matters” in Item 1 and Note 20 to the Consolidated Financial Statements for further discussion.

 

 

Not applicable.

 

 

The common stock of PepsiAmericas is listed and traded on the New York Stock Exchange under the stock trading symbol “PAS.” The table below sets forth the reported high and low sales prices as reported for New York Stock Exchange Composite Transactions for our common stock and indicates our dividends declared for each quarterly period for the fiscal years 2007 and 2006.

 

Performance Graph

 

The following performance graph compares the performance of PAS common stock to the Standard & Poor’s MidCap 400 Index (“MidCap 400”) and to an index of peer companies selected by us (the “Bottling Group Index”). In the past, we compared ourselves to PBG and CCE, individually; hence they are included in this graph for comparison purposes. The Bottling Group Index (“BGI”) consists of The Pepsi Bottling Group, Inc. (“PBG”), Coca-Cola Enterprises, Inc. (“CCE”), Coca-Cola Bottling Company Consolidated, Coca-Cola FEMSA S.A.B. de C.V. ADRs, and Coca-Cola Hellenic Bottling Company S.A. ADRs. As a result of our expanding international footprint and its increasingly significant contribution to profit growth, the peer companies were broadened to include bottlers with greater international presence in similar markets. The graph assumes the return on $100 invested on December 28, 2002 until December 29, 2007. The returns of each member of the Bottling Group Index are weighted according to the respective issuers’ stock market capitalization at the beginning of the return period and include the subsequent reinvestment of dividends into the respective stock.

 

 

 

The closing price of our stock on December 28, 2007 was $34.45.

 

Shareholders

 

There were 8,371 shareholders of record as of February 22, 2008.

Share Repurchase Program

 

See “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” in Item 12 for information regarding securities authorized for issuance under our equity compensation plans.

 

Our share repurchase program activity during the fourth quarter ended December 29, 2007 was as follows:

 

 

 

 

 

The following table presents summary operating results and other information of PepsiAmericas and should be read along with Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the Consolidated Financial Statements and accompanying notes included elsewhere in this Annual Report on Form 10-K (in millions, except per share and employee data).

 

The following were recorded during the periods presented:

 

In fiscal year 2007:

 

 

In fiscal year 2006:

 

 

In fiscal year 2005:

 

 

In fiscal year 2004:

 

 

In fiscal year 2003:

 

 

 

Forward-Looking Statements

 

This Annual Report on Form 10-K contains certain forward-looking statements of expected future developments, as defined in the Private Securities Litigation Reform Act of 1995. The forward-looking statements in this Annual Report on Form 10-K refer to our expectations regarding continuing operating improvement and other matters. These forward-looking statements reflect our expectations and are based on currently available data; however, actual results are subject to future risks and uncertainties, which could materially affect actual performance. Risks and uncertainties that could affect such performance include, but are not limited to, the following: competition, including product and pricing pressures; changing trends in consumer tastes; changes in our relationship and/or support programs with PepsiCo and other brand owners; market acceptance of new product and package offerings; weather conditions; cost and availability of raw materials; changing legislation, including tax laws; cost and outcome of environmental claims; availability and cost of capital including changes in our debt ratings; labor and employee benefit costs; unfavorable foreign currency rate fluctuations; costs and outcome of legal proceedings; integration of acquisitions; failure of information technology systems; and general economic, business, regulatory and political conditions in the countries and territories where we operate. See “Risk Factors” in Item 1A for additional information.

 

These events and uncertainties are difficult or impossible to predict accurately and many are beyond our control. We assume no obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

 

Executive Overview

 

What We Do

 

We manufacture, distribute, and market a broad portfolio of beverage products in the U.S., CEE and the Caribbean. We sell a variety of brands that we bottle under franchise agreements with various brand owners, the majority with PepsiCo or PepsiCo joint ventures. In some territories, we manufacture, package, sell and distribute our own brands, such as Toma brands in CEE and the Caribbean and Sandora brands in Ukraine. We operate in a significant portion of a 19 state region in the U.S. In CEE, we serve Poland, Hungary, the Czech Republic, Republic of Slovakia, Romania and Ukraine, with distribution rights in Moldova, Estonia, Latvia and Lithuania. In addition, we have an equity investment in Agrima, which gives us a market presence in Bulgaria. In the Caribbean, we serve Puerto Rico, Jamaica, the Bahamas, and Trinidad and Tobago, with distribution rights in Barbados.

 

Results of Operations

 

In the discussion of our results of operations below, the number of bottle and can cases sold is referred to as volume. Constant territory refers to the results of operations excluding the non-comparable territories year-over-year. For fiscal year 2007 comparisons, this excluded the operating results of Sandora and the first seven months of Romania, as we fully consolidated Romania operating results starting in August 2006. For fiscal year 2006, this excluded the operating results of Romania. Net pricing is net sales divided by the number of cases and gallons sold for our core businesses, which include bottles and cans (including bottle and can volume from vending equipment sales), as well as food service. Changes in net pricing include the impact of sales price (or rate) changes, as well as the impact of foreign currency translation and brand, package and

geographic mix. Net pricing and reported volume amounts exclude contract, commissary, and vending (other than bottles and cans) transactions. Contract sales represent sales of manufactured product to other franchise bottlers and typically decline as excess manufacturing capacity is utilized. Net pricing and volume also exclude activity associated with beer and snack food products. Cost of goods sold per unit is the cost of goods sold for our core businesses divided by the related number of cases and gallons sold.

 

Fiscal Year 2007 Key Financial Results

 

 

Our Focus in Fiscal Year 2007

 

Worldwide.  Our results for fiscal year 2007 were generated by both the consistent execution of our overall strategy and external factors, including the favorable impact of foreign currency translation. Our strategy was driven by three items. First, we rebuilt our U.S. sales organization from one based on geography to one built around customer channels. This new structure enables us to dedicate more resources and sales support to channels and customers, which resulted in our ability to manage a difficult cost environment, as we executed on innovation, pricing and single-serve distribution. Second, we have made significant progress in building scale and profitability organically and through acquisitions in CEE. During fiscal year 2007, we added Ukraine to our operations and entered into Bulgaria through an equity investment. Lastly, the diversity of our markets and continued capability investment drove our strong performance in fiscal year 2007.

 

On a worldwide basis, revenue was 12.8 percent higher than the prior year, due to volume growth of 7.8 percent and net selling price increases of 4.8 percent. These increases covered higher raw material costs and contributed to diluted earnings per share growth of 34.4 percent.

 

U.S. operations.  Price increases in raw materials continued to challenge our business in fiscal year 2007. We were able to successfully offset these higher costs through higher net pricing, product innovation and the execution of our single-serve initiative. We had a strong innovation calendar, which included the introduction of Diet Pepsi Max and Lipton White Tea. We also grew our higher margin single-serve package approximately 1 percent. Volume declined 1.4 percent during fiscal year 2007. We grew our non-carbonated portfolio 10 percent during the year, which partly offset a 4 percent decline in carbonated soft drink volume. Non-carbonated beverages are now 20 percent of our portfolio, a two percentage point increase from last year. This success was driven by volume growth in Trademark Lipton and the successful execution of our hydration and energy strategy, which will continue in fiscal year 2008.

 

International operations.  We continue to focus on our international markets as a key driver of growth. These markets now generate over $1 billion in net sales. Constant territory volume grew 7.9 percent. Operating income in CEE was $100.5 million, an increase of $79.6 million compared to the prior year. Organic growth contributed one quarter of the increase and the impact of foreign currency translation contributed approximately 30 percentage points of growth. The remainder of the increase was related to acquisitions.

In CEE, our expanded product portfolio performed well. Carbonated soft drinks grew in the high single digits due, in part, to strong growth in Trademark Pepsi. Non-carbonated beverages in our portfolio experienced double-digit growth led by Trademark Lipton. In each CEE market, we held either the number one or number two position in the fast-growing, ready-to-drink tea category. As a result of the successful execution of our strategies, volume grew in all CEE countries, with Poland and Romania each experiencing double-digit volume growth. We added selling resources to increase SKU distribution in existing accounts and increase business in the less-developed traditional trade. The flexibility in our distribution system allowed us to effectively utilize third parties for delivery in more rural areas.

 

In the Caribbean, volume declined 5.0 percent due to continued soft economic conditions and competitive pressures in Puerto Rico partly offset by volume growth in Jamaica. Operating income decreased $1.0 million to $4.0 million in fiscal year 2007. Net pricing increased during fiscal year 2007 to offset increases in raw material and utilities costs.

 

Focusing on Fiscal Year 2008

 

In fiscal year 2008, we will continue to execute the strategies already in place. We expect to capture market share and cash flow opportunities in the U.S., while continuing to focus on growing net sales and operating income in CEE.

 

In the U.S., we will focus on non-carbonated beverage growth through our tea, energy and hydration initiatives. We expect our non-carbonated beverage mix to increase 2 to 3 percentage points to represent approximately 22 to 23 percent of our portfolio. We plan to strengthen our share position in ready-to-drink teas with programs and innovation for our three-tea strategy: Lipton Pureleaf, Lipton Iced Tea and Lipton Brisk. In the energy category, we will focus on Mountain Dew AMP with innovation and marketing. To support our hydration initiative, we have implemented a multi-brand strategy with the relaunches of SoBe LifeWater and Aquafina Alive in the enhanced water category and the recently introduced Propel along with the distribution of G2 by Gatorade in the convenience and gas channel. While we anticipate carbonated soft drink volume declines will be consistent with fiscal year 2007, we expect that the product innovation from fiscal year 2007, specifically Diet Pepsi Max, will benefit fiscal year 2008. We will also support carbonated soft drinks through the new Trademark Mountain Dew program, DEWmocracy. Lastly, we will drive local marketing efforts to support single-serve growth.

 

We expect to increase pricing in fiscal year 2008 to cover anticipated higher cost of goods sold. We will leverage our new revenue management structure for even more targeted pricing opportunities.

 

We also will continue progress in our supply chain productivity initiative, Customer Optimization to the Third Power or CO3, with the goal of improving forecasting accuracy and reducing out-of-stocks at our customers. During fiscal year 2007, we completed the rollout of our demand planning and forecasting tools. During fiscal year 2008, we will complete our rollout of our new power pre-sell hand-held technology and will implement warehouse processes including voice-pick and ASN technology, which we expect will drive pallet accuracy to 99.9 percent. We have also expanded our supply chain initiatives to include formalized SKU rationalization, route optimization and warehouse standardization. We believe that these efforts will result in greater productivity in fiscal year 2008.

 

Internationally, we anticipate opportunities for growth in net sales and operating income in CEE. Like fiscal year 2007, growth in fiscal year 2008 should be across all categories. We expect relatively strong macroeconomic factors to continue and favorably impact consumer spending. We anticipate additional opportunities to add categories in key markets like Ukraine, Romania and Poland. We will continue to invest in advertising and marketing to build brand equity, which is important as the markets in CEE are fragmented. Our growth in CEE requires us to add manufacturing capacity with a new aseptic line in Poland, an improved logistics center in Hungary and a new production facility in Romania. The addition of Sandora adds diversity to our products and provides opportunities to further expand our portfolio.

 

In fiscal year 2008, we expect diluted earnings per share to be in the range of $1.77 to $1.83, including an estimated impact of $0.01 for special charges in the U.S. and Hungary, offset by an estimated $0.01 benefit

from the impact of the 53rd week in fiscal year 2008. This compares to fiscal year 2007 diluted earnings per share of $1.64 which included a $0.02 reduction related to discontinued operations. We expect worldwide volume to increase in the range of 13 to 14 percent, and to improve average net selling price by 2.5 to 3.5 percent. We expect cost of goods sold per unit to increase approximately 6 to 7 percent, and selling, delivery and administrative (“SD&A”) expenses to be higher by 9 to 10 percent compared to fiscal year 2007. Overall, we expect to generate operating income growth of 10 to 12 percent. The outlook described above includes the impact of the 53rd week, which is expected to contribute 1 percent growth in volume, SD&A expenses and operating income, as well as the impact of the Sandora acquisition, which is expected to contribute 10 percent growth in volume, reduce pricing by 2 percent, raise SD&A expenses by 4 percent and raise operating income by 5 percent to 6 percent.

 

Our ability to generate significant operating cash flow makes several options available to us, including reinvesting in our existing business, pursuing acquisitions with an appropriate expected economic return, repurchasing our stock and paying dividends to our shareholders. We will continue to examine the optimal uses of cash to maximize shareholder value.

 

The above overview should not be considered by itself in determining full disclosure and should be read in conjunction with the other sections of this Annual Report on Form 10-K.

 

Items Impacting Comparability

 

Acquisitions

 

In the second quarter of 2007, we completed the formation of a joint venture with PepsiCo to acquire an interest in Sandora, the leading juice company in Ukraine. Under the terms of the joint venture agreement, we hold a 60 percent interest and PepsiCo holds a 40 percent interest. In August 2007, the joint venture acquired 80 percent of Sandora. In November 2007, the joint venture completed the acquisition of the remaining 20 percent interest. We fully consolidated the results of operations of the joint venture and report minority interest in our Consolidated Financial Statements. Due to the timing of the receipt of available financial information, we record results on a one-month lag basis.

 

QABCL is a holding company that, through its subsidiaries produces, sells and distributes Pepsi and other beverages throughout Romania and also has distribution rights in Moldova. In June 2005, we acquired a 49 percent interest in QABCL. This initial investment was recorded under the equity method in accordance with Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock”. We recorded our share of QABCL earnings in “Equity in net earnings of nonconsolidated companies” in the Consolidated Statements of Income. Equity in net earnings of nonconsolidated companies was $5.6 million in fiscal year 2006. In July 2006, we acquired the remaining 51 percent interest in QABCL. QABCL is now a wholly-owned subsidiary which was consolidated in the third quarter of 2006. Due to the timing of the receipt of available financial information from QABCL, we record results on a one-month lag basis.

 

Special Charges

 

In fiscal year 2007, we recorded special charges of $6.3 million. In the U.S., we recorded $4.8 million of special charges primarily related to severance and relocation costs associated with our strategic realignment announced in the fourth quarter of 2006. In CEE, we recorded special charges of $1.5 million related to lease termination costs in Hungary and associated severance costs.

 

In fiscal year 2006, we recorded special charges of $11.5 million in the U.S. related to our strategic realignment to further strengthen our customer focused go-to-market strategy. These special charges were primarily for severance and other employee related costs, including the acceleration of vesting of certain restricted stock awards. We also incurred costs for consulting services associated with the strategic realignment which were included in the special charges. In addition, we recorded special charges of $2.2 million in CEE, primarily for a reduction in the workforce. These special charges were primarily for severance costs and related benefits.

In fiscal year 2005, we recorded special charges of $2.5 million in CEE, primarily for a reduction in the workforce in CEE and the consolidation of certain production facilities as we rationalized our cost structure. These special charges were primarily for severance costs, related benefits and asset write-downs.

 

Marketable Securities Impairment

 

In fiscal years 2007 and 2006, we recorded other-than-temporary impairment losses of $4.0 million and $7.3 million, respectively, related to a common stock investment that is classified as available-for-sale on our Consolidated Balance Sheets. The loss was recorded in “Other expense, net.”

 

Gain on Sale of Non-Core Property

 

In fiscal year 2007, we recorded a gain of $10.2 million related to the sale of non-core property, which consisted of railcars and locomotives. The gain was recorded in “Other expense, net.”

 

Fructose Settlement

 

In fiscal year 2005, we recorded income of $16.6 million related to proceeds we received from the settlement of a class action lawsuit. The lawsuit alleged price fixing related to high fructose corn syrup purchased from July 1, 1991 through June 30, 1995.

 

Lease Exit Costs

 

In fiscal year 2005, we recorded $1.4 million of expense for the early termination of a real estate lease for our corporate offices in the Chicago area and $6.1 million of expense related to the remaining obligations under this lease.

 

Operating Results — 2007 compared with 2006

 

Volume.  Sales volume growth (decline) for fiscal years 2007 and 2006 were as follows:

 

 

 

In fiscal year 2007, worldwide volume increased 7.8 percent compared to the prior year. The increase in worldwide volume was attributable to volume growth of 49.5 percent in CEE, due to the incremental impact of acquisitions and constant territory growth, which was partly offset by volume declines in the U.S. and the Caribbean.

 

Volume in the U.S. declined 1.4 percent compared to fiscal year 2006 due to a decline in carbonated soft drink volume of approximately 4 percent, which was consistent with fiscal year 2006. The non-carbonated beverage category, excluding water, grew approximately 17 percent driven primarily by Trademark Lipton. Aquafina volume grew 1.5 percent in fiscal year 2007. Non-carbonated beverages represented 20 percent of our volume mix during fiscal year 2007 compared to 18 percent in the prior year. Single-serve volume grew 1 percent due mainly to innovation, including Diet Pepsi Max and Mountain Dew Game Fuel, and strong marketing programs.

Volume in CEE increased 49.5 percent in fiscal year 2007 compared to fiscal year 2006. The increase was primarily due to acquisitions, which contributed 41.6 percentage points of the increase. The remaining growth in CEE was due to growth in the non-carbonated beverage category, driven by double-digit growth in Trademark Lipton and juices and single-digit growth in the water category. Carbonated soft drink volume grew in the mid-single digits due to growth in Trademark Pepsi.

 

Volume in the Caribbean declined 5.0 percent in fiscal year 2007 compared to fiscal year 2006. The volume decline was driven primarily by soft economic conditions and competitive pressures in Puerto Rico, partly offset by volume growth in Jamaica. Carbonated soft drink volume declined 11 percent and was partly offset by double-digit growth in non-carbonated beverages.

 

Net Sales.  Net sales and net pricing statistics for fiscal years 2007 and 2006 were as follows (dollar amounts in millions):

 

 

 

 

 

 

 

 

Net sales increased $507.1 million, or 12.8 percent, to $4,479.5 million in fiscal year 2007 compared to $3,972.4 million in fiscal year 2006. The increase was primarily due to acquisitions, worldwide rate and mix increases, volume growth in CEE and the favorable impact of foreign currency translation, which added 1.9 percentage points of the increase.

 

Net sales in the U.S. in fiscal year 2007 increased $139.1 million, or 4.3 percent, to $3,384.9 million from $3,245.8 million in fiscal year 2006. The increase in net sales was due to a 5.1 percent increase in net pricing, driven primarily by rate increases necessary to cover the higher raw material costs, partly offset by a decline in volume. Package mix also positively contributed to net pricing by approximately 1 percent due to stronger single-serve package and non-carbonated beverage performance and lower take-home water volume.

 

Net sales in CEE in fiscal year 2007 increased $365.3 million, or 75.5 percent, to $849.4 million from $484.1 million in fiscal year 2006. The increase was primarily due to acquisitions, which contributed

45.3 percentage points of the increase. The remainder of the growth was contributed by our existing markets, led by Romania and Poland. Net pricing increased 19.2 percent, driven by the favorable impact of foreign currency translation and improvement in mix.

 

Net sales in the Caribbean increased $2.7 million, or 1.1 percent, in fiscal year 2007 to $245.2 million from $242.5 million in fiscal year 2006. The increase was a result of an increase in net pricing of 5.6 percent, partly offset by a volume decline of 5.0 percent. The increase in net pricing was driven by both rate and mix increases and from growth in the single-serve package.

 

Cost of Goods Sold.  Cost of goods sold and cost of goods sold per unit statistics for fiscal years 2007 and 2006 were as follows (dollar amounts in millions):

 

 

 

 

 

 

 

 

Cost of goods sold increased $291.9 million, or 12.3 percent, to $2,656.2 million in fiscal year 2007 from $2,364.3 million in fiscal year 2006. This increase was driven primarily by the impact of acquisitions, higher raw material costs and the unfavorable impact of foreign currency translation, which added 1.2 percentage points to the increase.

 

In the U.S., cost of goods sold increased $90.4 million, or 4.8 percent, to $1,982.0 million in fiscal year 2007 from $1,891.6 million in the prior year. Cost of goods sold per unit increased 5.2 percent in the U.S., due to price increases in ingredient costs and a 1 percentage point increase in mix due to a shift to more expensive non-carbonated beverages.

 

In CEE, cost of goods sold increased $198.7 million, or 67.9 percent, to $491.4 million in fiscal year 2007, compared to $292.7 million in the prior year. Acquisitions contributed 46.0 percentage points of the increase. Constant territory volume growth of 7.9 percent and higher ingredient costs also contributed to the increase of cost of goods sold. The remainder of the increase was mainly due to the unfavorable impact of foreign currency translation, which contributed a 10.4 percent increase in cost of goods sold.

In the Caribbean, cost of goods sold increased $2.8 million, or 1.6 percent, to $182.8 million in fiscal year 2007, compared to $180.0 million in fiscal year 2006. The increase was mainly driven by an increase in cost of goods sold per unit of 5.6 percent, attributable to increases in the price of raw materials, partly offset by a volume decline of 5.0 percent.

 

Selling, Delivery and Administrative Expenses.  SD&A expenses and SD&A expense statistics for fiscal years 2007 and 2006 were as follows (dollar amounts in millions):

 

 

 

 

In fiscal year 2007, SD&A expenses increased $142.5 million, or 11.5 percent, to $1,380.9 million from $1,238.4 million in the previous year. The unfavorable impact of foreign currency translation added 1.8 percentage points of the increase. As a percentage of net sales, SD&A expenses decreased to 30.8 percent in fiscal year 2007, compared to 31.2 percent in fiscal year 2006 due primarily to lower operating costs in Romania.

 

In the U.S., SD&A expenses increased $53.9 million, or 5.3 percent, to $1,066.5 million in fiscal year 2007, compared to $1,012.6 million in the prior year. As a percentage of net sales, SD&A expenses were 31.5 percent in fiscal year 2007 compared to 31.2 percent in the prior year. SD&A expenses increased in fiscal year 2007 primarily due to higher compensation and benefit costs. In fiscal year 2007, SD&A expenses also included $3.8 million in realized gains from the settlement of derivative financial instruments. These instruments were used to manage the risks associated with the variability in the market price for forecasted purchases of diesel fuel. Comparisons between periods were also impacted by various items in fiscal year 2006, including a $3.7 million benefit recorded as a result of a change in our estimate of healthcare costs and a $9.0 million benefit from lower medical costs, partly offset by a fixed asset charge of $6.5 million for marketing and merchandising equipment.

 

In CEE, SD&A expenses increased $87.7 million, or 52.1 percent, to $256.0 million from $168.3 million in the prior year. Acquisitions contributed 29.1 percentage points of this increase. The remainder of the increase was due to the unfavorable impact of foreign currency translation, volume growth and higher advertising and marketing expenses. As a percentage of net sales, SD&A expenses improved to 30.1 percent compared to 34.8 percent in the prior year, primarily due to lower overall operating costs in Romania as compared to the other markets in CEE.

In the Caribbean, SD&A expenses increased $0.9 million, or 1.6 percent, to $58.4 million in fiscal year 2007 from $57.5 million in the prior year. SD&A expenses as a percentage of net sales in fiscal year 2007 were essentially flat compared to the prior year.

 

Special Charges.  In fiscal year 2007, we recorded special charges of $6.3 million. In the U.S., we recorded $4.8 million of special charges associated with our strategic alignment to further strengthen our customer focused go-to-market strategy, primarily related to severance and relocation costs. In CEE, we recorded special charges of $1.5 million related to a lease termination in Hungary and associated severance costs.

 

Operating Income.  Operating income for fiscal years 2007 and 2006 was as follows (dollar amounts in millions):

 

 

Operating income increased $80.1 million, or 22.5 percent, to $436.1 million in fiscal year 2007, compared to $356.0 million in fiscal year 2006. The favorable impact of foreign currency translation added approximately 7 percentage points to the growth in worldwide operating income and acquisitions added approximately 10 percentage points of growth.

 

Operating income in the U.S. increased $1.5 million to $331.6 million in fiscal year 2007, compared to $330.1 million in fiscal year 2006. The increase was due to lower special charges and higher net pricing, partly offset by volume declines, higher cost of goods sold and higher SD&A expenses.

 

Operating income in CEE increased $79.6 million to $100.5 million in fiscal year 2007, compared to operating income of $20.9 million in fiscal year 2006. This increase was primarily due to acquisitions, which contributed approximately 45 percentage points of this growth. The remainder of the growth was primarily due to volume growth, increases in net pricing and the beneficial impact of foreign currency translation, which contributed approximately 30 percentage points of operating income growth.

 

Operating income in the Caribbean decreased $1.0 million to $4.0 million in fiscal year 2007, compared to $5.0 million in fiscal year 2006. The decline in operating income was caused by the soft economic environment in Puerto Rico, which was partly offset by operating income growth in Jamaica.

 

Interest Expense and Other Expenses.  Net interest expense increased $7.9 million in fiscal year 2007 to $109.2 million, compared to $101.3 million in fiscal year 2006, due primarily to higher interest rates on floating rate debt and higher overall debt levels related to our acquisitions, partly offset by lower interest expense related to our securitization program.

 

We recorded other expense, net, of $0.6 million in fiscal year 2007 compared to other expense, net, of $11.7 million reported in fiscal year 2006. The decrease in other expense, net, was due primarily to a $10.2 million gain on the sale of non-core property in fiscal year 2007, offset partly by a $4.0 million other-than-temporary impairment related to an equity security investment in Northfield Laboratories, Inc.

 

Income Taxes.  The effective income tax rate, which is income tax expense expressed as a percentage of income from continuing operations before income taxes, minority interest and equity in net earnings of nonconsolidated companies, was 34.3 percent for fiscal year 2007, compared to 37.2 percent in fiscal year 2006. The effective tax rate decreased from the prior year due, in part, to the mix of country results and the associated lower in-country tax rates. The effective income tax rate was also favorably impacted by a reorganization of the legal entity structure in CEE in the second quarter of 2007.

 

Equity in Net Earnings of Nonconsolidated Companies.  In the second quarter of 2005, we acquired a 49 percent interest in QABCL. Equity in net earnings of nonconsolidated companies was $5.6 million in fiscal

year 2006. With the acquisition of the remaining 51 percent, we consolidated QABCL results beginning in the third quarter of fiscal year 2006.

 

Loss on Discontinued Operations.  In fiscal year 2007, we recorded a charge of $2.1 million, net of taxes, related to revised estimates for environmental remediation, legal and related administrative costs.

 

Net Income.  Net income increased $53.8 million to $212.1 million in fiscal year 2007, compared to $158.3 million in fiscal year 2006. The discussion of our operating results, included above, explains the increase in net income.

 

Operating Results — 2006 compared with 2005

 

Volume.  Sales volume growth for fiscal years 2006 and 2005 were as follows:

 

 

 

In fiscal year 2006, worldwide volume increased 5.6 percent compared to the prior year driven by growth in all three geographic segments, coupled with the impact of the QABCL acquisition.

 

Total volume in the U.S. grew 0.6 percent in fiscal year 2006. Non-carbonated beverages grew approximately 30 percent during fiscal year 2006, driven by the strong growth in both Trademark Aquafina and Lipton Iced Teas. Trademark Aquafina volume increased approximately 39 percent and Trademark Lipton volume increased approximately 42 percent during fiscal year 2006. This growth was partially offset by softness in our carbonated soft drink category, which declined 4 percent compared to fiscal year 2005. This softness was due in part to our consumers’ continued shift into the non-carbonated beverage category. Non-carbonated beverages constituted 18 percent of our sales volume during fiscal year 2006, an increase of 4 percentage points compared to fiscal year 2005.

 

Total volume in CEE increased 34.5 percent during fiscal year 2006. The acquisition of QABCL in fiscal year 2006 contributed 24.5 percentage points of volume growth during the period. The remaining growth was driven by strong performances across all brands and categories. Carbonated soft drink volume grew approximately 10 percent during fiscal year 2006, which reflected strong growth in Trademark Slice and Trademark Pepsi. Non-carbonated beverage growth of approximately 16 percent in fiscal year 2006 was driven by double-digit growth in Lipton products and the juice category, which includes Tropicana and Toma.

 

Volume in the Caribbean increased 1.6 percent during fiscal year 2006 compared to fiscal year 2005. Volume grew despite the challenging business environment in Puerto Rico and Jamaica during the second quarter of 2006. Volume growth was driven by 35 percent growth in the non-carbonated beverage category, partly offset by flat growth in Trademark Pepsi. The non-carbonated beverage category growth was driven primarily by contributions from Tropicana and energy drinks.

Net Sales.  Net sales and net pricing statistics for fiscal years 2006 and 2005 were as follows (dollar amounts in millions):

 

 

 

 

 

 

Net sales in fiscal year 2006 increased $246.4 million, or 6.6 percent, to $3,972.4 million. The acquisition of QABCL contributed 2.2 percentage points of growth, with the remaining increase driven by volume growth and an increase in net pricing.

 

Net sales in the U.S. in fiscal year 2006 increased $89.7 million, or 2.8 percent, to $3,245.8 million. The increase in net sales was due to the 1.1 percent increase in net pricing and 0.6 percent volume growth. The improvement in net pricing was driven by rate increases of 2.0 percent, partly offset by a negative package mix. During fiscal year 2006, a shift in package mix from single-serve to take-home packages caused a decrease in overall net pricing.

 

Net sales in CEE increased $140.6 million, or 40.9 percent, to $484.1 million in fiscal year 2006. The increase reflected the QABCL acquisition, which contributed 23.5 percentage points of growth in net sales. The remainder of the increase resulted from volume growth and higher net pricing, including a 3.1 percent contribution to net sales from foreign currency translation. The net pricing increase on a local currency basis was primarily driven by a higher mix of the single-serve package.

 

Caribbean net sales increased $16.1 million, or 7.1 percent, to $242.5 million in fiscal year 2006. Both a net selling price increase of 5.4 percent and volume growth of 1.6 percent drove the increase in net sales. This level of net selling price increase was necessitated by higher raw materials costs, including sugar.

Cost of Goods Sold.  Cost of goods sold and cost of goods sold per unit statistics for fiscal years 2006 and 2005 were as follows (dollar amounts in millions):

 

 

 

 

 

 

Cost of goods sold increased $200.8 million, or 9.3 percent, to $2,364.3 million. The growth in cost of goods sold during fiscal year 2006 was driven primarily by cost of goods sold per unit increases, volume growth and the impact of acquisitions. Worldwide cost of goods sold per unit increases were driven primarily by increases in raw material costs, including higher concentrate costs, and package mix shifts on a constant territory basis. Package mix changes were driven by shifts to higher cost products as a result of volume growth in our non-carbonated beverage portfolio. The worldwide cost of goods sold per unit was favorably impacted by the consolidation of QABCL during fiscal year 2006.

 

In the U.S., cost of goods sold increased $106.7 million, or 6.0 percent, to $1,891.6 million during fiscal year 2006. The increase was primarily driven by a higher cost of goods sold per unit. Cost of goods sold per unit increased 4.3 percent in the U.S., primarily due to higher raw material prices across all commodities, as well as the impact of mix shifts to higher cost non-carbonated beverages.

 

In CEE, cost of goods sold increased $81.4 million, or 38.5 percent, to $292.7 million during fiscal year 2006. Cost of goods sold increased due to the acquisition of QABCL, which contributed 22.4 percentage points of growth. The remainder of the increase was due to volume growth of 10.0 percent on a constant territory basis, higher cost of goods sold per unit, and the unfavorable impact of foreign currency translation, which increased cost of goods sold 2.6 percent. Cost of goods sold per unit increased 5.4 percent due to higher concentrate, resin and sugar costs.

 

In the Caribbean, cost of goods sold increased $12.7 million, or 7.6 percent, to $180.0 million during fiscal year 2006. The increase was mainly driven by an increase in cost of goods sold per unit of 6.4 percent and volume growth of 1.6 percent. Cost of goods sold per unit increased due to higher raw material costs, including concentrate and sweeteners, and higher utility costs.

Selling, Delivery and Administrative Expenses.  SD&A expenses and SD&A statistics for fiscal years 2006 and 2005 were as follows (dollar amounts in millions):

 

 

 

 

In fiscal year 2006, SD&A expenses increased $55.2 million, or 4.7 percent, to $1,238.4 million from $1,183.2 million in the prior year. As a percentage of net sales, SD&A expenses decreased to 31.2 percent in fiscal year 2006, compared to 31.8 percent in fiscal year 2005 due primarily to the lower operating costs as a result of cost containment initiatives in both the U.S. and CEE. The QABCL acquisition did not have a material impact on worldwide SD&A expenses as a percent of net sales.

 

In the U.S., SD&A expenses increased $12.5 million to $1,012.6 million in fiscal year 2006. The increase in SD&A expenses was due, in part, to higher fuel costs, costs related to the airforce Nutrisoda brand investment and stock option expense related to the adoption of SFAS No. 123(R). In addition, we recorded fixed asset charges of $6.5 million in fiscal year 2006 for marketing and merchandising equipment. These higher costs were partly offset by lower workers’ compensation costs and lower costs for employee benefits, driven by a $3.7 million benefit recorded as a result of a change in our estimate of healthcare costs and a $9.0 million benefit from lower medical spending. In fiscal year 2005, we recorded a $1.4 million expense for the early termination of a real estate lease for our corporate offices in the Chicago area and $6.1 million of expense related to the remaining obligations under this lease. As a percentage of net sales, SD&A expenses decreased to 31.2 percent in fiscal year 2006, compared to 31.7 percent in the prior year.

 

In CEE, SD&A expenses increased $40.1 million, or 31.3 percent, to $168.3 million in fiscal year 2006. The QABCL acquisition contributed 16.2 percentage points of the increase. The remaining increase was driven by 10.0 percent constant territory volume growth and the unfavorable impact of foreign currency translation, which increased SD&A expenses 0.9 percent. In addition, spending on advertising and marketing was higher than in fiscal year 2005 to build brand awareness. Fiscal year 2006 was benefited by a $0.7 million gain on a sale of land in the Czech Republic, while fiscal year 2005 was benefited by a $1.1 million gain from the sale of a facility in Hungary. SD&A expenses as a percentage of net sales improved to 34.8 percent in fiscal year 2006, compared to 37.3 percent in the prior year primarily driven by the QABCL acquisition which benefited this measure by 1.8 percentage points.

 

SD&A expenses in the Caribbean increased $2.6 million to $57.5 million in fiscal year 2006. SD&A expenses as a percentage of net sales was 23.7 percent in fiscal year 2006, a decline from 24.2 percent in the prior year. SD&A expenses in fiscal year 2006 benefited $0.6 million from the sale of a warehouse in

Barbados, partly offset by severance costs incurred as a result of our entry into a new third-party distributor arrangement in Jamaica.

 

Special Charges.  In fiscal year 2006, we recorded special charges of $11.5 million in the U.S. related to our strategic realignment to further strengthen our customer focused go-to-market strategy. These special charges were primarily for severance and other employee related costs, including the acceleration of vesting of certain restricted stock awards. We also incurred costs associated with consulting services in connection with the realignment project, which were included in the special charges.

 

In addition, in fiscal year 2006, we recorded special charges of $2.2 million in CEE, primarily for a reduction in the workforce. These special charges were primarily for severance costs and related benefits.

 

Operating Income.  Operating income for fiscal years 2006 and 2005 was as follows (dollar amounts in millions):

 

 

 

 

Operating income decreased $37.4 million, or 9.5 percent, to $356.0 million in fiscal year 2006. This was driven by special charges, the operating performance in the U.S. during fiscal year 2006 and fructose settlement income in fiscal year 2005. The decrease was partly offset by the contribution of the QABCL acquisition and the strong operating performance in CEE.

 

Operating income in the U.S. decreased $57.6 million, or 14.9 percent, to $330.1 million in fiscal year 2006. Fiscal year 2005 included $16.6 million of fructose settlement income. The remaining decline in U.S. operating income was attributed to higher cost of goods sold, continued carbonated soft drink volume declines, a shift in our package mix to less profitable products and higher SD&A expenses.

 

Operating income in CEE increased $19.4 million to $20.9 million in fiscal year 2006, due to the contribution made by the QABCL acquisition and the operating performance of the constant territories. Fiscal year 2006 was favorably impacted by foreign currency translation of $3.9 million.

 

Operating income in the Caribbean increased $0.8 million to $5.0 million in fiscal year 2006 compared to $4.2 million in fiscal year 2005. Volume growth and the increase in net pricing contributed to this improvement.

 

Interest and Other Expenses.  Net interest expense increased $11.4 million to $101.3 million in fiscal year 2006 compared to $89.9 million in the prior year. This increase was due primarily to higher interest rates on floating rate debt and higher overall debt levels. The higher debt levels were primarily due to the acquisition of the remaining interest in QABCL in fiscal year 2006. Interest expense in fiscal year 2005 included a $5.6 million loss related to the early extinguishment of debt, partly offset by the receipt of $1.5 million of interest income related to a real estate tax appeals refund on a previously sold parcel of land.

 

We recorded other expense, net, of $11.7 million in fiscal year 2006 compared to other expense, net, of $5.0 million in fiscal year 2005. In fiscal year 2006, we recorded a $7.3 million other-than-temporary impairment related to an equity security investment in Northfield Laboratories, Inc. This was partially offset by foreign currency transaction gains of $1.3 million and a gain of $0.9 million on the sale of investments. Fiscal year 2005 included foreign currency transaction losses of $3.3 million.

 

Income Taxes.  The effective income tax rate, which is income tax expense expressed as a percentage of income from continuing operations before income taxes, minority interest and equity in net earnings of

nonconsolidated companies, was 37.2 percent for fiscal year 2006 compared to 36.4 percent for fiscal year 2005. The current year’s rate was unfavorably impacted by the mix of our international operations.

 

In fiscal year 2005, we recorded a $1.6 million benefit related to the reversal of valuation allowances for certain net operating loss carryforwards offset by tax contingency requirements. In addition, we recorded a $0.9 million benefit from a state income tax law change in the state of Ohio.

 

Equity in Net Earnings of Nonconsolidated Companies.  In June 2005, we acquired a 49 percent interest in QABCL. Equity in net earnings of nonconsolidated companies was $5.6 million in fiscal year 2006, which reflects our equity interest in QABCL until we acquired the remaining 51 percent of the outstanding common stock at the beginning of the third quarter of 2006.

 

Net Income.  Net income decreased $36.4 million to $158.3 million in fiscal year 2006, compared to $194.7 million in fiscal year 2005. The discussion of our operating results, included above, explains the decrease in net income.

 

Liquidity and Capital Resources

 

Operating Activities.  Net cash provided by operating activities of continuing operations increased by $89.7 million to $433.5 million in fiscal year 2007, compared to $343.8 million in fiscal year 2006. This increase can mainly be attributed to higher net income and the favorable year-over-year benefit from changes in primary working capital. The benefit from changes in primary working capital was due to improvements in cash flows from all components of primary working capital, namely accounts receivable, inventory and accounts payable, due to the timing of cash flows and management of working capital items.

 

Net cash provided by operating activities was favorably impacted by the year-over-year decrease in contributions made to our pension plans. We contributed $0.9 million to our pension plans in fiscal year 2007 compared to $10.0 million in fiscal year 2006. A minimum contribution of $0.4 million to our pension plans is required under the minimum funding standards in fiscal year 2008. At the current time, we do not anticipate making any additional contributions to our pension plans during 2008. We do not believe that any known trends or uncertainties related to our pension plans will result in a material change in our results of operations, financial condition, or our liquidity.

 

Investing Activities.  Investing activities during fiscal year 2007 included capital investments of $264.6 million, an increase of $95.3 million from capital investments of $169.3 million in fiscal year 2006. Capital spending in fiscal year 2007 increased primarily due to higher spending on machinery and equipment, marketing equipment and a progress payment on a corporate aircraft. Capital spending in fiscal year 2008 is expected to be in the range of $250 million to $260 million.

 

In the third quarter of 2007, a PepsiAmericas and PepsiCo joint venture acquired an 80 percent interest in Sandora. In the fourth quarter of 2007, the joint venture acquired the remaining 20 percent. Under the terms of the joint venture agreement, we hold a 60 percent interest and PepsiCo holds a 40 percent interest in the joint venture. The total purchase price of $679.4 million was net of cash received of $3.0 million. Of the total purchase price, our interest was $407.6 million. Reflected in financing activities was cash received from PepsiCo of $271.8 million. Additionally, we acquired $72.5 million of debt as part of the acquisition. As of the end of fiscal year 2007, $45.0 million of total long-term debt was classified in “Short-term debt, including current maturities of long-term debt” in the Consolidated Balance Sheet as we intend to refinance this debt with short-term financing in fiscal year 2008.

 

In the third quarter of 2007, we purchased a 20 percent interest in a joint venture that owns Agrima. Agrima produces, sells and distributes PepsiCo products and other beverages throughout Bulgaria.

 

Proceeds from the sale of property and equipment in fiscal year 2007 were $29.2 million compared to $9.7 million in fiscal year 2006. In fiscal year 2007, we received proceeds of $20.7 million related to the sale of non-core property, which consisted of railcars and locomotives.

 

In fiscal year 2005, we acquired 49 percent of the outstanding stock of QABCL for $51.0 million. During fiscal year 2006, we acquired the remaining 51 percent of the outstanding stock of QABCL for $81.9 million,

net of $17.0 million cash acquired. We acquired $55.4 million of debt as part of the acquisition. The increased purchase price for the remainder of QABCL was due to the improved operating performance subsequent to the initial acquisition of our 49 percent minority investment.

 

In fiscal year 2006, we also completed the acquisition of Ardea Beverage Co., the maker of the airforce Nutrisoda line of drinks for $6.6 million. The purchase agreement contained contingent consideration of $3.3 million that was finalized and paid in fiscal year 2007.

 

Financing Activities.  Our total debt increased $438.0 million to $2,141.1 million as of the end of fiscal year 2007, from $1,703.1 million as of the end of fiscal year 2006. During fiscal year 2007, we paid $11.6 million at maturity of the 8.25 percent notes due February 2007 and $27.4 million at maturity of the 3.875 notes due September 2007.

 

In fiscal year 2007, we issued $300 million of notes with a coupon rate of 5.75 percent due July 2012. The securities are unsecured, senior debt obligations and rank equally with all other unsecured and unsubordinated indebtedness. Net proceeds from this transaction were $297.2 million, which reflected the discount reduction of $0.8 million and the debt issuance costs of $2.0 million. The net proceeds from the issuance of the notes were used to fund the acquisition of Sandora, to repay commercial paper and for other general corporate purposes. In fiscal year 2007, we also borrowed $1.0 million in long-term debt in the Bahamas.

 

In fiscal year 2006, we issued $250 million of notes due May 2011 with a coupon rate of 5.625 percent. Net proceeds from this issuance were $247.4 million, which included a reduction for discount and issuance costs. The proceeds from the issuance were used primarily to repay our commercial paper obligations and for other general corporate purposes.

 

In January 2005, we issued $300 million of notes due January 2015 with a coupon rate of 4.875 percent. Net proceeds from the transaction were $297.0 million, which reflected the reduction for discount and issuance costs. The proceeds from this issuance were used to fund the acquisition of CIC.

 

In May 2005, we issued $250 million of notes due May 2017 with a coupon rate of 5.0 percent and $250 million of notes due May 2035 with a coupon rate of 5.5 percent. Net proceeds from these issuances were $492.3 million, which reflected the reduction for discount and issuance costs. The proceeds from these issuances were used, in part, to fund the debt tender offer in May 2005.

 

In May 2005, we completed a cash tender offer related to $550 million of our outstanding debt. The total principal amount of securities tendered was $388.0 million. The cash payment to the bondholders for this transaction, including accrued interest and premiums, was $395.3 million. As a result of the tender offer we recorded a loss on the early extinguishment of debt in fiscal year 2005 of $5.6 million, which is recorded in “Interest expense, net” on our Consolidated Statement of Income.

 

We utilize revolving credit facilities both in the U.S. and in our international operations to fund short-term financing needs, primarily for working capital. In the U.S., we have an unsecured revolving credit facility under which we can borrow up to an aggregate of $600 million. The facility is for general corporate purposes, including commercial paper backstop. It is our policy to maintain a committed bank facility as backup financing for our commercial paper program. The interest rates on the revolving credit facility, which expires in 2011, are based primarily on the London Interbank Offered Rate. Accordingly, we have a total of $600 million available under our commercial paper program and revolving credit facility combined. We had $269.5 million of commercial paper borrowings at the end of fiscal year 2007, compared to $164.5 million at the end of fiscal year 2006. Internationally, excluding Sandora, we had revolving credit facility borrowings of $8.7 million as of the end of fiscal year 2007 compared to $9.2 million as of the end of fiscal year 2006. We acquired $15.8 million of short-term debt associated with Sandora, which decreased to $14.0 million at the end of fiscal year 2007.

 

Since fiscal year 2001, we have executed a strategy to repurchase our stock. On July 21, 2005, our Board of Directors approved the repurchase of 20 million additional shares under a previously authorized repurchase program. This authorization was in addition to previous authorizations approved in both fiscal years 2001 and

2002. At the end of fiscal year 2007, 7.2 million shares remained available for repurchase under the 2005 authorization. During fiscal year 2007, we repurchased 2.7 million shares of our common stock for $59.4 million. During fiscal year 2006, we repurchased 6.3 million shares of our common stock for $150.7 million. During fiscal year 2005, we repurchased 10.1 million shares of our common stock for $239.2 million.

 

Our Board of Directors has declared quarterly dividends of $0.13 per share on PepsiAmericas common stock for each quarter in fiscal year 2007. The fourth quarter dividend was payable January 2, 2008 to shareholders of record on December 14, 2007. We paid cash dividends of $65.2 million in fiscal year 2007, which included the fourth quarter of 2006 dividend of $15.9 million. The fourth quarter of 2006 dividend was based on a dividend rate of $0.125 per share. As of the end of fiscal year 2007, $16.6 million of dividends were declared and not yet paid and were included in “Payables” in the Consolidated Balance Sheets. During fiscal year 2006 and 2005, we paid cash dividends of $59.3 million and $35.1 million, respectively, based on a quarterly dividend rate of $0.125 and $0.085 per share, respectively.

 

Our debt agreements contain a number of covenants that limit, among other things, the creation of liens, sale and leaseback transactions and the general sale of assets. Our revolving credit agreement requires us to maintain an interest coverage ratio. We are in compliance with all of our financial covenants.

 

We believe that our operating cash flows are sufficient to fund our existing operations and contractual obligations for the foreseeable future. In addition, we believe that our operating cash flows, available lines of credit, and the potential for additional debt and equity offerings will provide sufficient resources to fund our future growth and expansion. There are a number of options available to us and we continue to examine the optimal uses of our cash, including reinvesting in our existing business, pursuing acquisitions with an appropriate expected economic return, repurchasing our stock and paying dividends to our shareholders.

 

Contractual Obligations

 

The following table provides a summary of our contractual obligations as of the end of fiscal year 2007, by due date. Long-term debt obligations do not include amounts related to the fair value adjustment for interest rate swaps and unamortized discount from debt issuance. Our short-term and long-term debt, lease commitments, purchase obligations and advertising and exclusivity rights are more fully described in Notes 12, 13 and 20, respectively, in the Notes to the Consolidated Financial Statements. Our interest obligations relate to our contractual obligations under our fixed-rate long-term debt.

 

 

Not included in the table above are contingent payments for uncertain tax positions of $36.4 million. These amounts were not included due to our inability to predict the timing of the settlement of these amounts.

 

Discontinued Operations.  We continue to be subject to certain indemnification obligations, net of insurance, under agreements related to previously sold subsidiaries, including indemnification expenses for potential environmental and tort liabilities of these former subsidiaries. There is significant uncertainty in

assessing our potential expenses for complying with our indemnification obligations, as the determination of such amounts is subject to various factors, including possible insurance recoveries and the allocation of liabilities among other potentially responsible and financially viable parties. Accordingly, the ultimate settlement and timing of cash requirements related to such indemnification obligations may vary significantly from the estimates included in our financial statements. As of the end of fiscal year 2007, we had recorded $40.2 million in liabilities for future remediation and other related costs arising out of our indemnification obligations. This amount excludes possible insurance recoveries and is determined on an undiscounted cash flow basis. In addition, we have funded coverage pursuant to an insurance policy (the “Finite Funding”) purchased in fiscal year 2002, which reduces the cash required to be paid by us for certain environmental sites pursuant to our indemnification obligations. The Finite Funding receivable amount recorded was $11.5 million as of the end of fiscal year 2007, of which $4.7 million is expected to be recovered in 2008 based on our expenditures, and thus, was included as a current asset in the Consolidated Balance Sheet.

 

During fiscal years 2007 and 2006, we paid, net of taxes, $10.4 million and $11.1 million, respectively, related to such indemnification obligations, including the offsetting benefit of insurance recovery settlements of $4.9 million and $6.5 million, respectively, on an after-tax basis. We expect to spend approximately $19 million on a pretax basis in fiscal year 2008 related to our indemnification obligations, excluding possible insurance recoveries and the benefit of income taxes (See “Environmental Matters” in Item 1 and Note 20 to the Consolidated Financial Statements for further discussion of discontinued operations and related environmental liabilities).

 

Off-Balance Sheet Arrangements

 

It is not our business practice to enter into off-balance sheet arrangements, other than in the normal course of business, nor is it our policy to issue guarantees to nonconsolidated affiliates or third parties.

 

Critical Accounting Policies

 

The preparation of the Consolidated Financial Statements in conformity with U.S generally accepted accounting principles requires management to use estimates. We base our estimates on historical experience, available information and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates, and revisions to estimates are included in our results for the period in which the actual amounts or revisions become known. Presented in our notes to the Consolidated Financial Statements is a summary of our most significant accounting policies used in the preparation of such statements. Significant estimates in the Consolidated Financial Statements include recoverability of goodwill and intangible assets with indefinite lives, environmental liabilities, income taxes, casualty insurance costs and pension and post-retirement benefits, which are described in further detail below:

 

Recoverability of Goodwill and Intangible Assets with Indefinite Lives.  Goodwill and intangible assets with indefinite useful lives are not amortized, but instead tested annually for impairment or more frequently if events or changes in circumstances indicate that an asset might be impaired.

 

Goodwill is tested for impairment using a two-step approach at the reporting unit level: U.S., CEE and the Caribbean. First, we estimate the fair value of the reporting units primarily using discounted estimated future cash flows. If the carrying amount exceeds the fair value of the reporting unit, the second step of the goodwill impairment test is performed to measure the amount of the potential loss. Goodwill impairment is measured by comparing the “implied fair value” of goodwill with its carrying amount.

 

Our identified intangible assets with indefinite lives principally arise from the allocation of the purchase price of businesses acquired, and consist primarily of trademarks and tradenames and franchise and distribution agreements. Impairment is measured as the amount by which the carrying amount of the intangible asset exceeds its estimated fair value. The estimated fair value is generally determined on the basis of discounted future cash flows.

The impairment evaluation requires the use of considerable management judgment to determine the fair value of the goodwill and intangible assets with indefinite lives using discounted future cash flows, including estimates and assumptions regarding the amount and timing of cash flows, cost of capital and growth rates.

 

Environmental Liabilities.  We continue to be subject to certain indemnification obligations under agreements related to previously sold subsidiaries, including potential environmental liabilities (see “Environmental Matters” in Item 1 and Note 20 to the Consolidated Financial Statements for further discussion). We have recorded our best estimate of our probable liability under those indemnification obligations. The estimated indemnification liabilities include expenses for the remediation of identified sites, payments to third parties for claims and expenses (including product liability and toxic tort claims), administrative expenses, and the expense of on-going evaluations and litigation. Such estimates and the recorded liabilities are subject to various factors, including possible insurance recoveries, the allocation of liabilities among other potentially responsible parties, the advancement of technology for means of remediation, possible changes in the scope of work at the contaminated sites, as well as possible changes in related laws, regulations, and agency requirements. We do not discount environmental liabilities.

 

Income Taxes.  Our effective income tax rate is based on income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. We have established valuation allowances against a portion of the foreign net operating losses and state-related net operating losses to reflect the uncertainty of our ability to fully utilize these benefits given the limited carryforward periods permitted by the various jurisdictions. The evaluation of the realizability of our net operating losses requires the use of considerable management judgment to estimate the future taxable income for the various jurisdictions, for which the ultimate amounts and timing of such realization may differ. The valuation allowance can also be impacted by changes in the tax regulations.

 

Significant judgment is required in determining our uncertain tax positions. We have established accruals for uncertain tax positions using management’s best judgment and adjust these liabilities as warranted by changing facts and circumstances. A change in our uncertain tax positions in any given period could have a significant impact on our results of operations and cash flows for that period.

 

Casualty Insurance Costs.  Due to the nature of our business, we require insurance coverage for certain casualty risks. We are self-insured for workers compensation, product and general liability up to $1 million per occurrence and automobile liability up to $2 million per occurrence. The casualty insurance costs for our self-insurance program represent the ultimate net cost of all reported and estimated unreported losses incurred during the fiscal year. We do not discount casualty insurance liabilities.

 

Our liability for casualty costs is estimated using individual case-based valuations and statistical analyses and is based upon historical experience, actuarial assumptions and professional judgment. These estimates are subject to the effects of trends in loss severity and frequency and are based on the best data available to us. These estimates, however, are also subject to a significant degree of inherent variability. We evaluate these estimates on an annual basis and we believe that they are appropriate and within acceptable industry ranges, although an increase or decrease in the estimates or economic events outside our control could have a material impact on our results of operations and cash flows. Accordingly, the ultimate settlement of these costs may vary significantly from the estimates included in our Consolidated Financial Statements.

 

Pension and Postretirement Benefits.  Our pension and other postretirement benefit obligations and related costs are calculated using actuarial assumptions. Two critical assumptions, the discount rate and the expected return on plan assets, are important elements of plan expense and liability measurement. We evaluate these critical assumptions annually. Other assumptions involve demographic factors such as retirement, mortality, turnover, health care cost trends and rate of compensation increases.

 

The discount rate is used to calculate the present value of expected future pension and postretirement cash flows as of the measurement date. The guideline for establishing this rate is high-quality, long-term bond rates. A lower discount rate increases the present value of benefit obligations and increases pension

expense. The expected long-term rate of return on plan assets is based on current and expected asset allocations, as well as historical and expected returns on various categories of plan assets. A lower-than-expected rate of return on pension plan assets will increase pension expense. A 100 basis point increase in the discount rate would decrease our annual pension expense by $1.6 million. A 100 basis point decrease in the discount rate would increase our annual pension expense by $2.4 million. A 100 basis point increase in our expected return on plan assets would decrease our annual pension expense by $1.8 million. A 100 basis point decrease in our expected return on plan assets would increase our annual pension expense by $1.8 million. See Note 15 to the Consolidated Financial Statements for additional information regarding these assumptions.

 

Related Party Transactions

 

Transactions with PepsiCo

 

PepsiCo is considered a related party due to the nature of our franchise relationship and PepsiCo’s ownership interest in us. As of the end of fiscal year 2007, PepsiCo beneficially owned approximately 44 percent of PepsiAmericas’ outstanding common stock. These shares are subject to a shareholder agreement with our company. During fiscal year 2007, approximately 90 percent of our total net sales were derived from the sale of PepsiCo products. We have entered into transactions and agreements with PepsiCo from time to time, and we expect to enter into additional transactions and agreements with PepsiCo in the future. Material agreements and transactions between our company and PepsiCo are described below.

 

Pepsi franchise agreements are subject to termination only upon failure to comply with their terms. Termination of these agreements can occur as a result of any of the following: our bankruptcy or insolvency; change of control of greater than 15 percent of any class of our voting securities; untimely payments for concentrate purchases; quality control failure; or failure to carry out the approved business plan communicated to PepsiCo.

 

Bottling Agreements and Purchases of Concentrate and Finished Product.  We purchase concentrates from PepsiCo and manufacture, package, distribute and sell cola and non-cola beverages under various bottling agreements with PepsiCo. These agreements give us the right to manufacture, package, sell and distribute beverage products of PepsiCo in both bottles and cans and fountain syrup in specified territories. These agreements include a Master Bottling Agreement and a Master Fountain Syrup Agreement for beverages bearing the “Pepsi-Cola” and “Pepsi” trademarks, including Diet Pepsi, in the United States. The agreements also include bottling and distribution agreements for non-cola products in the United States, and international bottling agreements for countries outside the United States. These agreements provide PepsiCo with the ability to set prices of concentrates, as well as the terms of payment and other terms and conditions under which we purchase such concentrates. Concentrate purchases from PepsiCo included in cost of goods sold totaled $892.4 million, $829.8 million and $763.2 million for the fiscal years 2007, 2006 and 2005, respectively. In addition, we bottle water under the “Aquafina” trademark pursuant to an agreement with PepsiCo that provides for payment of a royalty fee to PepsiCo, which totaled $54.3 million, $50.2 million and $36.9 million for the fiscal years 2007, 2006 and 2005, respectively, and was included in cost of goods sold. We also purchase finished beverage products from PepsiCo and certain of its affiliates, including tea, concentrate and finished beverage products from a Pepsi/Lipton partnership, as well as finished beverage products from a PepsiCo/Starbucks partnership. Such purchases are reflected in cost of goods sold and totaled $210.0 million, $188.0 million and $161.0 million for the fiscal years 2007, 2006 and 2005, respectively.

 

Bottler Incentives and Other Support Arrangements.  We share a business objective with PepsiCo of increasing availability and consumption of Pepsi-Cola beverages. Accordingly, PepsiCo provides us with various forms of bottler incentives to promote its brands. The level of this support is negotiated regularly and can be increased or decreased at the discretion of PepsiCo. To support volume and market share growth, the bottler incentives cover a variety of initiatives, including direct marketplace, shared media and advertising support. Worldwide bottler incentives from PepsiCo totaled approximately $230.2 million, $226.8 million, and $203.3 million for the fiscal years ended 2007, 2006 and 2005, respectively. There are no conditions or requirements that could result in the repayment of any support payments we have received.

In accordance with Emerging Issues Task Force (“EITF”) Issue No. 02-16, “Accounting by a Customer (including a Reseller) for Certain Consideration Received from a Vendor,” bottler incentives that are directly attributable to incremental expenses incurred are reported as either an increase to net sales or a reduction to SD&A expenses, commensurate with the recognition of the related expense. Such bottler incentives include amounts received for direct support of advertising commitments and exclusivity agreements with various customers. All other bottler incentives are recognized as a reduction of cost of goods sold when the related products are sold based on the agreements with vendors. Such bottler incentives primarily include base level funding amounts which are fixed based on the previous year’s volume and variable amounts that are reflective of the current year’s volume performance.

 

Based on information received from PepsiCo, PepsiCo also provided indirect marketing support to our marketplace, which consisted primarily of media expenses. This indirect support is not reflected or included in our Consolidated Financial Statements, as these amounts were paid by PepsiCo on our behalf to third parties.

 

Manufacturing and National Account Services.  We provide manufacturing services to PepsiCo in connection with the production of certain finished beverage products, and also provide certain manufacturing, delivery and equipment maintenance services to PepsiCo’s national account customers. Net amounts paid or payable by PepsiCo to us for these services were $19.6 million, $19.3 million, and $17.2 million for fiscal years 2007, 2006 and 2005, respectively.

 

Sandora Joint Venture.  During fiscal year 2007, we entered into a joint venture agreement with PepsiCo to purchase the outstanding common stock of Sandora. We hold a 60 percent interest in the joint venture and PepsiCo holds a 40 percent interest. The joint venture financial statements have been consolidated in our Consolidated Financial Statements.

 

Other Transactions.  PepsiCo provides procurement services to us pursuant to a shared services agreement. Under this agreement, PepsiCo acts as our agent and negotiates with various suppliers the cost of certain raw materials by entering into raw material contracts on our behalf. The raw material contracts obligate us to purchase certain minimum volumes. PepsiCo also collects and remits to us certain rebates from the various suppliers related to our procurement volume. In addition, PepsiCo executes certain derivative contracts on our behalf and in accordance with our hedging strategies. In fiscal years 2007, 2006 and 2005, we paid $3.9 million, $3.9 million, and $3.4 million, respectively, to PepsiCo for such services.

 

Net amounts paid to PepsiCo and its affiliates for snack food products recorded in cost of goods sold were $17.6 million, $12.5 million and $11.4 million in fiscal years 2007, 2006 and 2005 respectively.

 

During fiscal year 2005, we received payment of $2.1 million related to the settlement of the fructose lawsuit for the former Heartland territories, which we acquired in 1999. The payment was originally made to PepsiCo out of the settlement trust, and then the funds were remitted to us by PepsiCo. The amount is included in “Fructose settlement income” on the Consolidated Statement of Income.

 

As of the end of fiscal years 2007 and 2006, net amounts due from PepsiCo were $3.1 million and $24.2 million, respectively.

In summary, the Consolidated Statements of Income include the following income and (expense) transactions with PepsiCo (in millions):