filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
318K characters. Original on sec.gov · Markdown
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
| OUR BUSINESS | |
| Executive Overview | 44 |
| Our Operations | 44 |
| Other Relationships | 45 |
| Our Business Risks | 45 |
| OUR FINANCIAL RESULTS | |
| Results of Operations – Consolidated Review | 49 |
| Non-GAAP Measures | 52 |
| Items Affecting Comparability | 55 |
| Results of Operations – Division Review | 59 |
| Frito-Lay North America | 60 |
| Quaker Foods North America | 61 |
| North America Beverages | 62 |
| Latin America | 63 |
| Europe Sub-Saharan Africa | 64 |
| Asia, Middle East and North Africa | 65 |
| Our Liquidity and Capital Resources | 67 |
| Return on Invested Capital | 71 |
| OUR CRITICAL ACCOUNTING POLICIES | |
| Revenue Recognition | 72 |
| Goodwill and Other Intangible Assets | 72 |
| Income Tax Expense and Accruals | 73 |
| Pension and Retiree Medical Plans | 75 |
| Consolidated Statement of Income | 78 |
| Consolidated Statement of Comprehensive Income | 79 |
| Consolidated Statement of Cash Flows | 80 |
| Consolidated Balance Sheet | 81 |
| Consolidated Statement of Equity | 82 |
| Notes to Consolidated Financial Statements | |
| Note 1 – Basis of Presentation and Our Divisions | 83 |
| Note 2 – Our Significant Accounting Policies | 86 |
| Note 3 – Restructuring and Impairment Charges | 92 |
| Note 4 – Property, Plant and Equipment and Intangible Assets | 95 |
| Note 5 – Income Taxes | 98 |
| Note 6 – Share-Based Compensation | 102 |
| Note 7 – Pension, Retiree Medical and Savings Plans | 105 |
| Note 8 – Debt Obligations | 112 |
| Note 9 – Financial Instruments | 114 |
| Note 10 – Net Income Attributable to PepsiCo per Common Share | 119 |
| Note 11 – Preferred Stock | 119 |
| Note 12 – Accumulated Other Comprehensive Loss Attributable to PepsiCo | 120 |
| Note 13 – Restricted Cash | 122 |
| Note 14 – Acquisitions and Divestitures | 122 |
| Note 15 – Supplemental Financial Information | 124 |
| Management’s Responsibility for Financial Reporting | 126 |
| Report of Independent Registered Public Accounting Firm | 128 |
| GLOSSARY | 130 |
Our discussion and analysis is intended to help the reader understand our results of operations and financial condition and is provided as an addition to, and should be read in connection with, our consolidated financial statements and the accompanying notes. Definitions of key terms can be found in the glossary. Tabular dollars are presented in millions, except per share amounts. All per share amounts reflect common stock per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Percentage changes are based on unrounded amounts.
OUR BUSINESS
Executive Overview
We are a leading global food and beverage company with a complementary portfolio of brands, including Frito-Lay, Gatorade, Pepsi-Cola, Quaker and Tropicana. Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories.
At PepsiCo, we are focused on an approach called Winning with Purpose that will help make our company faster, stronger and better at meeting the needs of our customers, consumers, partners and communities, while caring for our planet and inspiring our associates.
Our strategies are designed to address key challenges facing our Company, including: shifting consumer preferences and behaviors; a highly competitive operating environment; a rapidly changing retail landscape, including the growth in e-commerce; continued macroeconomic and political volatility; and an evolving regulatory landscape.
We intend to focus on the following areas to address and adapt to these challenges:
| • | Winning in the marketplace and accelerating growth by strengthening and broadening our portfolio, while focusing on locally meeting the needs of our consumers and customers; |
| • | Continuing to implement our productivity initiatives to improve our operational efficiency and enhance our competitive advantage while continuing to transform our core capabilities with technology and building and retaining a talented workforce to drive cost savings; and |
| • | Continuing to lead with purpose by focusing on our impact on the planet and our people, assisting in establishing a more sustainable food system, minimizing our impact on the environment, protecting human rights and securing supply while positioning our Company for sustainable growth. |
We believe these priorities will position our Company for long-term sustainable growth.
See also “Item 1A. Risk Factors” for additional information about risks and uncertainties that the Company faces.
Our Operations
See “Item 1. Business” for information on our divisions and a description of our distribution network, ingredients and other supplies, brands and intellectual property rights, seasonality, customers and competition. In addition, see Note 1 to our consolidated financial statements for financial information about our divisions and geographic areas.
Other Relationships
Certain members of our Board of Directors also serve on the boards of certain vendors and customers. These Board members do not participate in our vendor selection and negotiations nor in our customer negotiations. Our transactions with these vendors and customers are in the normal course of business and are consistent with terms negotiated with other vendors and customers. In addition, certain of our employees serve on the boards of Pepsi Bottling Ventures LLC and other affiliated companies of PepsiCo and do not receive incremental compensation for such services.
Our Business Risks
We are subject to risks in the normal course of business. During 2018 and 2017, certain jurisdictions in which our products are made, manufactured, distributed or sold operated in a challenging environment, experiencing unstable economic, political and social conditions, civil unrest, natural disasters, debt and credit issues, and currency fluctuations. We continue to monitor the economic, operating and political environment in these markets closely and to identify actions to potentially mitigate any unfavorable impacts on our future results.
In addition, certain jurisdictions in which our products are made, manufactured, distributed or sold have either imposed, or are considering imposing, new or increased taxes or regulations on the manufacture, distribution or sale of our products or their packaging, ingredients or substances contained in, or attributes of, our products or their packaging, commodities used in the production of our products or their packaging or the recyclability or recoverability of our packaging. These taxes and regulations vary in scope and form. For example, some taxes apply to all beverages, including non-caloric beverages, while others apply only to beverages with a caloric sweetener (e.g., sugar). In addition, some regulations apply to all products using certain types of packaging (e.g., plastic), while others are designed to increase the sustainability of packaging and encourage waste reduction and increased recycling rates.
We sell a wide variety of beverages, foods and snacks in more than 200 countries and territories and the profile of the products we sell, the amount of revenue attributable to such products and the type of packaging used varies by jurisdiction. Because of this, we cannot predict the scope or form potential taxes, regulations or other limitations on our products or their packaging may take, and therefore cannot predict the impact of such taxes, regulations or limitations on our financial results. In addition, taxes, regulations and limitations may impact us and our competitors differently. We continue to monitor existing and proposed taxes and regulations in the jurisdictions in which our products are made, manufactured, distributed and sold and to consider actions we may take to potentially mitigate the unfavorable impact, if any, of such taxes, regulations or limitations, including advocating alternative measures with respect to the imposition, form and scope of any such taxes, regulations or limitations.
In addition, our industry continues to be affected by disruption of the retail landscape, including the rapid growth in sales through e-commerce websites and mobile commerce applications, including through subscription services, the integration of physical and digital operations among retailers and the international expansion of hard discounters. We continue to monitor changes in the retail landscape and to identify actions we may take to build our global e-commerce capabilities, distribute our products effectively through all existing and emerging channels of trade and potentially mitigate any unfavorable impacts on our future results.
During the fourth quarter of 2017, the TCJ Act was enacted in the United States. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion in the fourth quarter of 2017. In 2018, we recognized a net tax benefit of $28 million in connection with the TCJ Act. See further information in “Items Affecting Comparability.” While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amounts in future periods. For
additional information, see “Our Liquidity and Capital Resources,” “Our Critical Accounting Policies” and Note 5 to our consolidated financial statements.
See also “Item 1A. Risk Factors,” “Executive Overview” above and “Market Risks” below for more information about these risks and the actions we have taken to address key challenges.
Risk Management Framework
The achievement of our strategic and operating objectives involves taking risks and that those risks may evolve over time. To identify, assess, prioritize, address, manage, monitor and communicate these risks across the Company’s operations, we leverage an integrated risk management framework. This framework includes the following:
| • | PepsiCo’s Board of Directors has oversight responsibility for PepsiCo’s integrated risk management framework. One of the Board’s primary responsibilities is overseeing and interacting with senior management with respect to key aspects of the Company’s business, including risk assessment and risk mitigation of the Company’s top risks. The Board receives updates on key risks throughout the year, including risks related to cybersecurity. In addition, the Board has tasked designated Committees of the Board with oversight of certain categories of risk management, and the Committees report to the Board regularly on these matters. |
| ◦ | The Audit Committee of the Board reviews and assesses the guidelines and policies governing PepsiCo’s risk management and oversight processes, and assists the Board’s oversight of financial, compliance and employee safety risks facing PepsiCo; |
| ◦ | The Compensation Committee of the Board reviews PepsiCo’s employee compensation policies and practices to assess whether such policies and practices could lead to unnecessary risk-taking behavior; |
| ◦ | The Nominating and Corporate Governance Committee assists the Board in its oversight of the Company’s governance structure and other corporate governance matters, including succession planning; and |
| ◦ | The Public Policy and Sustainability Committee of the Board assists the Board in its oversight of PepsiCo’s policies, programs and related risks that concern key public policy and sustainability matters. |
| • | The PepsiCo Risk Committee (PRC), which is comprised of a cross-functional, geographically diverse, senior management group, including PepsiCo’s Chairman of the Board and Chief Executive Officer, meets regularly to identify, assess, prioritize and address top strategic, financial, operating, compliance, safety, reputational and other risks. The PRC is also responsible for reporting progress on our risk mitigation efforts to the Board; |
| • | Division and key country risk committees, comprised of cross-functional senior management teams, meet regularly to identify, assess, prioritize and address division and country-specific business risks; |
| • | PepsiCo’s Risk Management Office, which manages the overall risk management process, provides ongoing guidance, tools and analytical support to the PRC and the division and key country risk committees, identifies and assesses potential risks and facilitates ongoing communication between the parties, as well as with PepsiCo’s Board of Directors and the Audit Committee of the Board; |
| • | PepsiCo’s Corporate Audit Department evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and |
| • | PepsiCo’s Compliance & Ethics and Law Departments lead and coordinate our compliance policies and practices. |
Market Risks
We are exposed to market risks arising from adverse changes in:
| • | commodity prices, affecting the cost of our raw materials and energy; |
| • | foreign exchange rates and currency restrictions; and |
| • | interest rates. |
In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements. See “Item 1A. Risk Factors” for further discussion of our market risks, and see “Our Liquidity and Capital Resources” for further information on our non-cancelable purchasing commitments.
The fair value of our derivatives fluctuates based on market rates and prices. The sensitivity of our derivatives to these market fluctuations is discussed below. See Note 9 to our consolidated financial statements for further discussion of these derivatives and our hedging policies. See “Our Critical Accounting Policies” for a discussion of the exposure of our pension and retiree medical plan assets and liabilities to risks related to market fluctuations.
Inflationary, deflationary and recessionary conditions impacting these market risks also impact the demand for and pricing of our products. See “Item 1A. Risk Factors” for further discussion.
Commodity Prices
Our commodity derivatives had a total notional value of $1.1 billion as of December 29, 2018 and $0.9 billion as of December 30, 2017. At the end of 2018, the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have increased our net unrealized losses in 2018 by $100 million.
Foreign Exchange
Our operations outside of the United States generated 43% of our consolidated net revenue in 2018, with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our consolidated net revenue in 2018. As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold. During 2018, unfavorable foreign exchange reduced net revenue growth by one percentage point due to declines in the Russian ruble, Turkish lira and Brazilian real. Currency declines against the U.S. dollar which are not offset could adversely impact our future financial results.
In addition, volatile economic, political and social conditions and civil unrest in certain markets in which our products are made, manufactured, distributed or sold, including in Argentina, Brazil, China, India, Mexico, the Middle East, Russia and Turkey, and currency fluctuations in certain of these international markets continue to result in challenging operating environments. We also continue to monitor the economic and political developments related to the United Kingdom’s pending withdrawal from the European Union, including how the United Kingdom will interact with other European Union countries following its departure, as well as the economic, operating and political environment in Russia, and the potential impact for the ESSA segment and our other businesses.
Our foreign currency derivatives had a total notional value of $2.0 billion as of December 29, 2018 and $1.6 billion as of December 30, 2017. The total notional amount of our debt instruments designated as net
investment hedges was $0.9 billion as of December 29, 2018 and $1.5 billion as of December 30, 2017. At the end of 2018, we estimate that an unfavorable 10% change in the underlying exchange rates would have decreased our net unrealized gains in 2018 by $149 million.
Interest Rates
Our interest rate derivatives had a total notional value of $10.5 billion as of December 29, 2018 and $14.2 billion as of December 30, 2017. Assuming year-end 2018 investment levels and variable rate debt, a 1-percentage-point increase in interest rates would have increased our net interest expense in 2018 by $7 million due to lower cash and cash equivalents and short-term investments levels as compared with our variable rate debt.
OUR FINANCIAL RESULTS
Results of Operations — Consolidated Review
In the discussions of net revenue and operating profit below, “effective net pricing” reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries, and “net pricing” reflects the year-over-year combined impact of list price changes, weight changes per package, discounts and allowances. Additionally, “acquisitions and divestitures,” except as otherwise noted, reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees.
Volume
Our beverage volume in the NAB, Latin America, ESSA and AMENA segments reflects sales to authorized bottlers, independent distributors and retailers, as well as the sale of beverages bearing Company-owned or licensed trademarks that have been sold through our authorized independent bottlers. Bottler case sales (BCS) and concentrate shipments and equivalents (CSE) are not necessarily equal during any given period due to seasonality, timing of product launches, product mix, bottler inventory practices and other factors. While our beverage revenues are not entirely based on BCS volume, as there are independent bottlers in the supply chain, we believe that BCS is a valuable measure as it quantifies the sell-through of our beverage products at the consumer level. Sales of products from our unconsolidated joint ventures are reflected in our reported volume. NAB, Latin America, ESSA and AMENA, either independently or in conjunction with third parties, make, market, distribute and sell ready-to-drink tea products through a joint venture with Unilever (under the Lipton brand name), and NAB, either independently or in conjunction with third parties, makes, markets, distributes and sells ready-to-drink coffee products through a joint venture with Starbucks. In addition, AMENA licenses the Tropicana brand for use in China on co-branded juice products in connection with a strategic alliance with Tingyi.
Our food and snack volume in the FLNA, QFNA, Latin America, ESSA and AMENA segments is reported on a system-wide basis, which includes our own sales and the sales by our noncontrolled affiliates of snacks bearing Company-owned or licensed trademarks.
Servings
Since our divisions each use different measures of physical unit volume (i.e., kilos, gallons, pounds and case sales), a common servings metric is necessary to reflect our consolidated physical unit volume. Our divisions’ physical volume measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products.
In 2018, total servings increased 1% compared to 2017. In 2017, total servings decreased 1% compared to 2016. Excluding the impact of the 53rd reporting week in 2016, total servings in 2017 was even with the prior year. Servings growth reflects adjustments to the prior year results for divestitures and other structural changes.
Consolidated Net Revenue and Operating Profit
| Change | |||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | |||||||||||||
| Net revenue | $ | 64,661 | $ | 63,525 | $ | 62,799 | 2 | % | 1 | % | |||||||
| Operating profit (a) | $ | 10,110 | $ | 10,276 | $ | 9,804 | (2 | )% | 5 | % | |||||||
| Operating profit margin (a) | 15.6 | % | 16.2 | % | 15.6 | % | (0.5 | ) | 0.6 |
| (a) | In 2017 and 2016, operating profit and operating profit margin reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. |
See “Results of Operations – Division Review” for a tabular presentation and discussion of key drivers of net revenue.
2018
Operating profit decreased 2% and operating profit margin declined 0.5 percentage points. The operating profit performance was driven by certain operating cost increases and a 6-percentage-point impact of higher commodity costs, partially offset by productivity savings of more than $1 billion and net revenue growth.
The impact of refranchising a portion of our beverage business in Jordan in 2017 and a prior-year gain associated with the sale of our minority stake in Britvic negatively impacted operating profit performance by 2.5 percentage points. These impacts were offset by a 2-percentage-point positive impact of refranchising a portion of our beverage business in Thailand and our entire beverage bottling operations and snack distribution operations in CHS in 2018. Items affecting comparability (see “Items Affecting Comparability”) negatively impacted operating profit performance by 3 percentage points and decreased operating profit margin by 0.5 percentage points, primarily due to higher mark-to-market net impact on commodity derivatives included in corporate unallocated expenses.
2017
Operating profit increased 5% and operating profit margin improved 0.6 percentage points. Operating profit growth was driven by productivity savings of more than $1 billion and effective net pricing, partially offset by certain operating cost increases, a 7-percentage-point impact of higher commodity costs and unfavorable foreign exchange.
The impact of refranchising a portion of our beverage business in Jordan and a gain associated with the sale of our minority stake in Britvic each contributed 1 percentage point to operating profit growth. Items affecting comparability (see “Items Affecting Comparability”) also contributed 2 percentage points to operating profit growth and increased operating profit margin by 0.2 percentage points, primarily reflecting a prior-year impairment charge to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value.
Other Consolidated Results
| Change | |||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | |||||||||||||||
| Other pension and retiree medical benefits income/(expense) (a) | $ | 298 | $ | 233 | $ | (19 | ) | $ | 65 | $ | 252 | ||||||||
| Net interest expense | $ | (1,219 | ) | $ | (907 | ) | $ | (1,232 | ) | $ | (312 | ) | $ | 325 | |||||
| Annual tax rate (b) | (36.7 | )% | 48.9 | % | 25.4 | % | |||||||||||||
| Net income attributable to PepsiCo | $ | 12,515 | $ | 4,857 | $ | 6,329 | 158 | % | (23 | )% | |||||||||
| Net income attributable to PepsiCo per common share – diluted | $ | 8.78 | $ | 3.38 | $ | 4.36 | 160 | % | (23 | )% | |||||||||
| Mark-to-market net impact | 0.09 | (0.01 | ) | (0.08 | ) | ||||||||||||||
| Restructuring and impairment charges | 0.18 | 0.16 | 0.09 | ||||||||||||||||
| Merger and integration charges | 0.05 | — | — | ||||||||||||||||
| Net tax (benefit)/expense related to the TCJ Act (b) | (0.02 | ) | 1.70 | — | |||||||||||||||
| Other net tax benefits (b) | (3.55 | ) | — | — | |||||||||||||||
| Charges related to cash tender and exchange offers | 0.13 | — | — | ||||||||||||||||
| Charge related to the transaction with Tingyi | — | — | 0.26 | ||||||||||||||||
| Charge related to debt redemption | — | — | 0.11 | ||||||||||||||||
| Pension-related settlement charge | — | — | 0.11 | ||||||||||||||||
| Net income attributable to PepsiCo per common share – diluted, excluding above items (c) | $ | 5.66 | $ | 5.23 | $ | 4.85 | 8 | % | 8 | % | |||||||||
| Impact of foreign exchange translation | 1 | 1 | |||||||||||||||||
| Growth in net income attributable to PepsiCo per common share – diluted, excluding above items, on a constant currency basis (c) | 9 | % | 9 | % |
| (a) | In 2017 and 2016, reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. |
| (b) | See Note 5 to our consolidated financial statements. |
| (c) | See “Non-GAAP Measures.” |
2018
Other pension and retiree medical benefits income increased $65 million, reflecting the impact of the $1.4 billion discretionary pension contribution to the PepsiCo Employees Retirement Plan A (Plan A) in the United States, as well as the recognition of net asset gains, partially offset by higher amortization of net losses.
Net interest expense increased $312 million reflecting a charge of $253 million in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes. This increase also reflects higher interest rates on debt balances, as well as losses on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest income due to higher interest rates on cash balances.
The reported tax rate decreased 85.6 percentage points, reflecting both other net tax benefits related to the reorganization of our international operations, which reduced the reported tax rate by 45 percentage points, and the prior year provisional net tax expense related to the TCJ Act, which reduced the current year reported tax rate by 25 percentage points. Additionally, the favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, collectively, reduced the reported tax rate by 7 percentage points. See Note 5 to our consolidated financial statements for further information.
Net income attributable to PepsiCo increased 158% and net income attributable to PepsiCo per common share increased 160%. Items affecting comparability (see “Items Affecting Comparability”) positively contributed 150 percentage points to net income attributable to PepsiCo growth and 152 percentage points to net income attributable to PepsiCo per common share growth.
2017
Other pension and retiree medical benefits income increased $252 million, primarily reflecting a settlement charge of $242 million related to the purchase of a group annuity contract in 2016.
Net interest expense decreased $325 million reflecting a charge of $233 million in 2016 representing the premium paid in accordance with the “make-whole” redemption provisions to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively. This decrease also reflects higher interest income due to higher interest rates and average cash balances, as well as gains on the market value of investments used to economically hedge a portion of our deferred compensation liability. These impacts were partially offset by higher interest expense due to higher average debt balances.
The reported tax rate increased 23.5 percentage points primarily as a result of the provisional net tax expense related to the TCJ Act, which contributed 26 percentage points to the increase, partially offset by the impact of the 2016 impairment charge to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value, which had no corresponding tax benefit, as well as the impact of recognizing excess tax benefits in the provision for income taxes as a result of the changes in accounting for certain aspects of share-based payments to employees in 2017. See Note 2 and Note 5 to our consolidated financial statements for additional information.
Net income attributable to PepsiCo and net income attributable to PepsiCo per common share both decreased 23%. Items affecting comparability (see “Items Affecting Comparability”) negatively impacted both net income attributable to PepsiCo performance and net income attributable to PepsiCo per common share performance by 30 percentage points, primarily as a result of the provisional net tax expense related to the TCJ Act.
Non-GAAP Measures
Certain financial measures contained in this Form 10-K adjust for the impact of specified items and are not in accordance with U.S. Generally Accepted Accounting Principles (GAAP). We use non-GAAP financial measures internally to make operating and strategic decisions, including the preparation of our annual operating plan, evaluation of our overall business performance and as a factor in determining compensation for certain employees. We believe presenting non-GAAP financial measures in this Form 10-K provides additional information to facilitate comparison of our historical operating results and trends in our underlying operating results, and provides additional transparency on how we evaluate our business. We also believe presenting these measures in this Form 10-K allows investors to view our performance using the same measures that we use in evaluating our financial and business performance and trends.
We consider quantitative and qualitative factors in assessing whether to adjust for the impact of items that may be significant or that could affect an understanding of our ongoing financial and business performance or trends. Examples of items for which we may make adjustments include: amounts related to mark-to-market gains or losses (non-cash); charges related to restructuring programs; charges or adjustments related to the enactment of new laws, rules or regulations, such as significant tax law changes; amounts related to the resolution of tax positions; tax benefits related to reorganizations of our operations; gains or losses associated with mergers, acquisitions, divestitures and other structural changes; debt redemptions, cash tender or exchange offers; pension and retiree medical related items; asset impairments (non-cash); and
remeasurements of net monetary assets. See below and “Items Affecting Comparability” for a description of adjustments to our U.S. GAAP financial measures in this Form 10-K.
Non-GAAP information should be considered as supplemental in nature and is not meant to be considered in isolation or as a substitute for the related financial information prepared in accordance with U.S. GAAP. In addition, our non-GAAP financial measures may not be the same as or comparable to similar non-GAAP measures presented by other companies.
The following non-GAAP financial measures are contained in this Form 10-K:
| • | cost of sales, gross profit, selling, general and administrative expenses, other pension and retiree medical benefits income/expense, interest expense, benefit from/provision for income taxes and noncontrolling interests, each adjusted for items affecting comparability; |
| • | operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share – diluted, adjusted for items affecting comparability, and the corresponding constant currency growth rates; |
| • | organic revenue growth; |
| • | free cash flow; and |
| • | return on invested capital (ROIC) and net ROIC, excluding items affecting comparability. |
Cost of Sales, Gross Profit, Selling, General and Administrative Expenses, Other Pension and Retiree Medical Benefits Income/Expense, Interest Expense, Benefit from/Provision for Income Taxes, Annual Tax Rate and Noncontrolling Interests, Adjusted for Items Affecting Comparability; Operating Profit, Adjusted for Items Affecting Comparability, and Net Income Attributable to PepsiCo per Common Share – Diluted, Adjusted for Items Affecting Comparability, and the Corresponding Constant Currency Growth Rates
These measures exclude the net impact of mark-to-market gains and losses on centrally managed commodity derivatives that do not qualify for hedge accounting, restructuring and impairment charges related to our 2019 and 2014 Productivity Plans, merger and integration charges associated with our acquisition of SodaStream, net tax benefit/expense associated with the enactment of the TCJ Act, other net tax benefits, charges related to cash tender and exchange offers, a charge related to the transaction with Tingyi, a charge related to debt redemption, and a pension-related settlement charge (see “Items Affecting Comparability” for a detailed description of each of these items). We also evaluate performance on operating profit, adjusted for items affecting comparability, and net income attributable to PepsiCo per common share – diluted, adjusted for items affecting comparability, on a constant currency basis, which measure our financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior-year average foreign exchange rates. We believe these measures provide useful information in evaluating the results of our business because they exclude items that we believe are not indicative of our ongoing performance. We are not able to reconcile our full year projected 2019 annual tax rate, excluding items affecting comparability, to our full year projected 2019 reported annual tax rate because we are unable to predict the 2019 impact of foreign exchange or the mark-to-market net impact on commodity derivatives due to the unpredictability of future changes in foreign exchange rates and commodity prices. Therefore, we are unable to provide a reconciliation of this measure.
Organic Revenue Growth
We define organic revenue growth as net revenue growth adjusted for the impact of foreign exchange translation, as well as the impact from acquisitions, divestitures and other structural changes. Our 2018 reported results reflect the accounting policy election taken in conjunction with the adoption of the revenue
recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excludes the impact of approximately $75 million of these taxes previously recognized in net revenue. In addition, our fiscal 2016 reported results included an extra week of results. Our 2017 organic revenue growth excludes the impact of the 53rd reporting week from our 2016 results.
We believe organic revenue provides useful information in evaluating the results of our business because it excludes items that we believe are not indicative of ongoing performance or that we believe impact comparability with the prior year.
See “Net Revenue and Organic Revenue Growth” in “Results of Operations – Division Review.”
Free Cash Flow
We define free cash flow as net cash provided by operating activities less capital spending, plus sales of property, plant and equipment. Since net capital spending is essential to our product innovation initiatives and maintaining our operational capabilities, we believe that it is a recurring and necessary use of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operating activities. Free cash flow is used by us primarily for financing activities, including debt repayments, dividends and share repurchases. Free cash flow is not a measure of cash available for discretionary expenditures since we have certain non-discretionary obligations such as debt service that are not deducted from the measure.
See “Free Cash Flow” in “Our Liquidity and Capital Resources.”
ROIC and Net ROIC, Excluding Items Affecting Comparability
We define ROIC as net income attributable to PepsiCo plus interest expense after-tax divided by the sum of quarterly average debt obligations and quarterly average common shareholders’ equity. Although ROIC is a common financial metric, numerous methods exist for calculating ROIC. Accordingly, the method used by management to calculate ROIC may differ from the methods other companies use to calculate their ROIC.
We believe this metric serves as a measure of how well we use our capital to generate returns. In addition, we use net ROIC, excluding items affecting comparability, to compare our performance over various reporting periods on a consistent basis because it removes from our operating results the impact of items that are not indicative of our ongoing performance and reflects how management evaluates our operating results and trends. We define net ROIC, excluding items affecting comparability, as ROIC, adjusted for quarterly average cash, cash equivalents and short-term investments, after-tax interest income and items affecting comparability. We believe the calculation of ROIC and net ROIC, excluding items affecting comparability, provides useful information to investors and is an additional relevant comparison of our performance to consider when evaluating our capital allocation efficiency.
See “Return on Invested Capital” in “Our Liquidity and Capital Resources.”
Items Affecting Comparability
Our reported financial results in this Form 10-K are impacted by the following items in each of the following years:
| 2018 | |||||||||||||||||||||||||||||||||||
| Cost of sales | Gross profit | Selling, general and administrative expenses | Operating profit | Other pension and retiree medical benefits income | Interest expense | (Benefit from)/provision for income taxes(a) | Net income attributable to noncontrolling interests | Net income attributable to PepsiCo | |||||||||||||||||||||||||||
| Reported, GAAP Measure | $ | 29,381 | $ | 35,280 | $ | 25,170 | $ | 10,110 | $ | 298 | $ | 1,525 | $ | (3,370 | ) | $ | 44 | $ | 12,515 | ||||||||||||||||
| Items Affecting Comparability | |||||||||||||||||||||||||||||||||||
| Mark-to-market net impact | (83 | ) | 83 | (80 | ) | 163 | — | — | 38 | — | 125 | ||||||||||||||||||||||||
| Restructuring and impairment charges | (3 | ) | 3 | (269 | ) | 272 | 36 | — | 56 | 1 | 251 | ||||||||||||||||||||||||
| Merger and integration charges | — | — | (75 | ) | 75 | — | — | — | — | 75 | |||||||||||||||||||||||||
| Net tax benefit related to the TCJ Act | — | — | — | — | — | — | 28 | — | (28 | ) | |||||||||||||||||||||||||
| Other net tax benefits | — | — | — | — | — | — | 5,064 | — | (5,064 | ) | |||||||||||||||||||||||||
| Charges related to cash tender and exchange offers | — | — | — | — | — | (253 | ) | 62 | — | 191 | |||||||||||||||||||||||||
| Core, Non-GAAP Measure | $ | 29,295 | $ | 35,366 | $ | 24,746 | $ | 10,620 | $ | 334 | $ | 1,272 | $ | 1,878 | $ | 45 | $ | 8,065 |
| 2017(b) | |||||||||||||||||||||||||||
| Cost of sales | Gross profit | Selling, general and administrative expenses | Operating profit | Other pension and retiree medical benefits income | Provision for income taxes(a) | Net income attributable to PepsiCo | |||||||||||||||||||||
| Reported, GAAP Measure | $ | 28,796 | $ | 34,729 | $ | 24,453 | $ | 10,276 | $ | 233 | $ | 4,694 | $ | 4,857 | |||||||||||||
| Items Affecting Comparability | |||||||||||||||||||||||||||
| Mark-to-market net impact | 8 | (8 | ) | 7 | (15 | ) | — | (7 | ) | (8 | ) | ||||||||||||||||
| Restructuring and impairment charges | — | — | (229 | ) | 229 | 66 | 71 | 224 | |||||||||||||||||||
| Provisional net tax expense related to the TCJ Act | — | — | — | — | — | (2,451 | ) | 2,451 | |||||||||||||||||||
| Core, Non-GAAP Measure | $ | 28,804 | $ | 34,721 | $ | 24,231 | $ | 10,490 | $ | 299 | $ | 2,307 | $ | 7,524 |
| 2016(b) | |||||||||||||||||||||||||||||||||||
| Cost of sales | Gross profit | Selling, general and administrative expenses | Operating profit | Other pension and retiree medical benefits (expense)/income | Interest expense | Provision for income taxes(a) | Net income attributable to noncontrolling interests | Net income attributable to PepsiCo | |||||||||||||||||||||||||||
| Reported, GAAP Measure | $ | 28,222 | $ | 34,577 | $ | 24,773 | $ | 9,804 | $ | (19 | ) | $ | 1,342 | $ | 2,174 | $ | 50 | $ | 6,329 | ||||||||||||||||
| Items Affecting Comparability | |||||||||||||||||||||||||||||||||||
| Mark-to-market net impact | 78 | (78 | ) | 89 | (167 | ) | — | — | (56 | ) | — | (111 | ) | ||||||||||||||||||||||
| Restructuring and impairment charges | — | — | (155 | ) | 155 | 5 | — | 26 | 3 | 131 | |||||||||||||||||||||||||
| Charge related to the transaction with Tingyi | — | — | (373 | ) | 373 | — | — | — | — | 373 | |||||||||||||||||||||||||
| Charge related to debt redemption | — | — | — | — | — | (233 | ) | 77 | — | 156 | |||||||||||||||||||||||||
| Pension-related settlement charge | — | — | — | — | 242 | — | 80 | — | 162 | ||||||||||||||||||||||||||
| Core, Non-GAAP Measure | $ | 28,300 | $ | 34,499 | $ | 24,334 | $ | 10,165 | $ | 228 | $ | 1,109 | $ | 2,301 | $ | 53 | $ | 7,040 |
| (a) | Benefit from/provision for income taxes is the expected tax benefit/charge on the underlying item based on the tax laws and income tax rates applicable to the underlying item in its corresponding tax jurisdiction and tax year. |
| (b) | Reflects the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. |
Mark-to-Market Net Impact
We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses.
Restructuring and Impairment Charges
2019 Multi-Year Productivity Plan
Our 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; simplify our organization and optimize our manufacturing and supply chain footprint. In connection with this program, we expect to incur pre-tax charges of approximately $2.5 billion, of which $138 million is included in our 2018 results, approximately $800 million is expected to be reflected in our 2019 results and the balance to be reflected in our 2020 through 2023 results. These pre-tax charges will consist of approximately 70% of severance and other employee-related costs, 15% for asset impairments (all non-cash) resulting from plant closures and related actions, and 15% for other costs associated with the implementation of our initiatives. We expect that these pre-tax charges will result in cash expenditures of approximately $1.6 billion, of which we expect approximately $450 million to be reflected in our 2019 cash flows and the balance to be reflected in our 2020 through 2023 cash flows. We expect to incur the majority of the pre-tax charges and cash expenditures in our 2019 and 2020 results.
The total expected program pre-tax charges are expected to be incurred by division approximately as follows:
| FLNA | QFNA | NAB | Latin America | ESSA | AMENA | Corporate | ||||||||||||||
| Expected pre-tax charges | 10 | % | 3 | % | 35 | % | 12 | % | 25 | % | 13 | % | 2 | % |
2014 Multi-Year Productivity Plan
To build on the successful implementation of the 2014 Productivity Plan, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives of the 2014 Productivity Plan to further strengthen our beverage, food and snack businesses. In connection with this program, we expect to incur pre-tax charges and cash expenditures of approximately $1.3 billion and $960 million, respectively. This total pre-tax charge is expected to consist of approximately 55% of severance and other employee-related costs, 15% for asset impairments (all non-cash) resulting from plant closures and related actions, and 30% for other costs associated with the implementation of our initiatives. To date, we have incurred $1.2 billion of pre-tax charges and $814 million of cash expenditures. We expect to complete the program and incur the program’s remaining pre-tax charges and cash expenditures before the end of 2019.
The total expected program pre-tax charges are expected to be incurred by division approximately as follows:
| FLNA | QFNA | NAB | Latin America | ESSA | AMENA | Corporate | ||||||||||||||
| Expected pre-tax charges | 14 | % | 3 | % | 30 | % | 15 | % | 20 | % | 6 | % | 12 | % |
See Note 3 to our consolidated financial statements for further information related to our 2019 and 2014 Productivity Plans.
We regularly evaluate productivity initiatives beyond the productivity plans and other initiatives discussed above and in Note 3 to our consolidated financial statements.
Merger and Integration Charges
In 2018, we incurred merger and integration charges of $75 million ($0.05 per share) related to our acquisition of SodaStream, including $57 million recorded in the ESSA segment and $18 million recorded in corporate unallocated expenses. These charges include closing costs, advisory fees and employee-related costs.
See Note 14 to our consolidated financial statements.
Net Tax (Benefit)/Expense Related to the TCJ Act
During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018.
In 2017, we recorded a provisional net tax expense of $2.5 billion ($1.70 per share) associated with the enactment of the TCJ Act. Included in the provisional net tax expense of $2.5 billion was a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate.
In 2018, we recorded a net tax benefit of $28 million ($0.02 per share) in connection with the TCJ Act.
See Note 5 to our consolidated financial statements.
Other Net Tax Benefits
In 2018, we reorganized our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $4.3 billion ($3.05 per share). Also in 2018, we recognized non-cash tax benefits associated with both the conclusion of certain international tax audits and our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013. The conclusion of certain international tax audits and the resolution with the IRS resulted in non-cash tax benefits of $364 million ($0.26 per share) and $353 million ($0.24 per share), respectively.
See Note 5 to our consolidated financial statements.
Charges Related to Cash Tender and Exchange Offers
In 2018, we recorded a pre-tax charge of $253 million ($191 million after-tax or $0.13 per share) to interest expense in connection with our cash tender and exchange offers, primarily representing the tender price paid over the carrying value of the tendered notes.
See Note 8 to our consolidated financial statements.
Charge Related to the Transaction with Tingyi
In 2016, we recorded a pre- and after-tax impairment charge of $373 million ($0.26 per share) in the AMENA segment to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value.
See Note 9 to our consolidated financial statements.
Charge Related to Debt Redemption
In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ($156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the “make-whole” redemption provisions.
See Note 8 to our consolidated financial statements.
Pension-Related Settlement Charge
In 2016, we recorded a pre-tax pension settlement charge in corporate unallocated expenses of $242 million ($162 million after-tax or $0.11 per share) related to the purchase of a group annuity contract.
See Note 7 to our consolidated financial statements.
Results of Operations — Division Review
The results and discussions below are based on how our Chief Executive Officer monitors the performance of our divisions. See “Non-GAAP Measures” and “Items Affecting Comparability” for a discussion of items to consider when evaluating our results and related information regarding non-GAAP measures.
Net Revenue and Organic Revenue Growth
Organic revenue growth is a non-GAAP financial measure. For further information on organic revenue growth, see “Non-GAAP Measures.”
| 2018 | |||||||||||||||||||
| Impact of | Impact of | ||||||||||||||||||
| Net revenue growth | Foreign exchange translation | Acquisitions and divestitures | Sales and certain other taxes | Organic revenue growth(a) | Volume(b) | Effective net pricing(c) | |||||||||||||
| FLNA | 3.5 | % | — | — | — | 3 | % | 1 | 2 | ||||||||||
| QFNA | (1.5 | )% | — | — | — | (2 | )% | (0.5 | ) | (1 | ) | ||||||||
| NAB | 1 | % | — | — | — | 0.5 | % | (1 | ) | 2 | |||||||||
| Latin America | 2 | % | 6 | — | — | 8 | % | 1 | 7 | ||||||||||
| ESSA | 4 | % | 2 | — | 0.5 | 7 | % | 4 | 3 | ||||||||||
| AMENA | (2 | )% | 1 | 8 | — | 7 | % | 3 | 3 | ||||||||||
| Total | 2 | % | 1 | 1 | — | 4 | % | 1 | 3 |
| 2017 | ||||||||||||||||||||
| Impact of | Impact of | |||||||||||||||||||
| Net revenue growth | Foreign exchange translation | Acquisitions and divestitures | 53rd reporting week(d) | Organic revenue growth(a) | Volume(b) | Effective net pricing(c) | ||||||||||||||
| FLNA | 2 | % | — | — | 2 | 3 | % | 1 | 2.5 | |||||||||||
| QFNA | (2 | )% | — | — | 2 | (1 | )% | — | (1 | ) | ||||||||||
| NAB | (2 | )% | — | (1 | ) | 1 | (2 | )% | (2.5 | ) | 1 | |||||||||
| Latin America | 6 | % | (1 | ) | 0.5 | — | 5 | % | (2 | ) | 7 | |||||||||
| ESSA | 8 | % | (3 | ) | — | — | 6 | % | 3 | 2 | ||||||||||
| AMENA | (5 | )% | 10 | — | — | 5 | % | — | 5 | |||||||||||
| Total | 1 | % | — | — | 1 | 2 | % | — | 3 |
| (a) | Amounts may not sum due to rounding. |
| (b) | Excludes the impact of acquisitions and divestitures. In certain instances, volume growth varies from the amounts disclosed in the following divisional discussions due to nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE, as well as the mix of beverage volume sold by our Company-owned and franchise-owned bottlers. Our net revenue excludes nonconsolidated joint venture volume, and, for our franchise-owned beverage businesses, is based on CSE. |
| (c) | Includes the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries. |
| (d) | Our fiscal 2016 results included a 53rd reporting week which increased 2016 net revenue by $657 million, including $294 million in our FLNA segment, $43 million in our QFNA segment, $300 million in our NAB segment and $20 million in our ESSA segment. Our 2017 organic revenue growth excludes the impact of the 53rd reporting week from our 2016 results. |
Frito-Lay North America
| % Change | |||||||||||||||||
| 2018 | 2017(a) | 2016(a) | 2018 | 2017 | |||||||||||||
| Net revenue | $ | 16,346 | $ | 15,798 | $ | 15,549 | 3.5 | 2 | |||||||||
| Impact of foreign exchange translation | — | — | |||||||||||||||
| Impact of acquisitions and divestitures | — | — | |||||||||||||||
| Impact of 53rd reporting week | — | 2 | |||||||||||||||
| Organic revenue growth (b) | 3 | (d) | 3 | (d) | |||||||||||||
| Operating profit | $ | 5,008 | $ | 4,793 | $ | 4,612 | 4.5 | 4 | |||||||||
| Restructuring and impairment charges (c) | 36 | 54 | 12 | ||||||||||||||
| Operating profit excluding above item (b) | $ | 5,044 | $ | 4,847 | $ | 4,624 | 4 | 5 | |||||||||
| Impact of foreign exchange translation | — | — | |||||||||||||||
| Operating profit growth excluding above item, on a constant currency basis (b) | 4 | 5 |
| (a) | In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. |
| (b) | See “Non-GAAP Measures.” |
| (c) | See “Items Affecting Comparability.” |
| (d) | Does not sum due to rounding. |
2018
Net revenue grew 3.5%, primarily reflecting effective net pricing and volume growth. Volume grew 1%, reflecting mid-single-digit growth in variety packs and low-single-digit growth in trademark Doritos, partially offset by a double-digit decline in Santitas.
Operating profit grew 4.5%, primarily reflecting the net revenue growth and productivity savings, partially offset by certain operating cost increases and a 1-percentage-point impact of a bonus extended to certain U.S. employees in connection with the TCJ Act.
2017
Net revenue grew 2%, primarily reflecting effective net pricing, partially offset by the impact of the 53rd reporting week in 2016, which reduced net revenue growth by 2 percentage points. Volume declined 1%, reflecting mid-single-digit declines in trademark Lay’s and Fritos and a low-single-digit decline in trademark Doritos, partially offset by high-single-digit growth in variety packs. The 53rd reporting week in 2016 negatively impacted volume performance by 2 percentage points.
Operating profit grew 4%, primarily reflecting productivity savings, the effective net pricing and a 1-percentage-point impact of 2016 incremental investments into our business. These impacts were partially offset by certain operating cost increases, including strategic initiatives, and a 1-percentage-point impact of higher commodity costs, primarily cooking oil. The 53rd reporting week in 2016 reduced operating profit growth by 2 percentage points.
Quaker Foods North America
| % Change | ||||||||||||||||||
| 2018 | 2017(a) | 2016(a) | 2018 | 2017 | ||||||||||||||
| Net revenue | $ | 2,465 | $ | 2,503 | $ | 2,564 | (1.5 | ) | (2 | ) | ||||||||
| Impact of foreign exchange translation | — | — | ||||||||||||||||
| Impact of acquisitions and divestitures | — | — | ||||||||||||||||
| Impact of 53rd reporting week | — | 2 | ||||||||||||||||
| Organic revenue growth (b) | (2 | ) | (d) | (1 | ) | (d) | ||||||||||||
| Operating profit | $ | 637 | $ | 640 | $ | 649 | — | (1 | ) | |||||||||
| Restructuring and impairment charges (c) | 7 | 9 | 1 | |||||||||||||||
| Operating profit excluding above item (b) | $ | 644 | $ | 649 | $ | 650 | (1 | ) | — | |||||||||
| Impact of foreign exchange translation | — | — | ||||||||||||||||
| Operating profit growth excluding above item, on a constant currency basis (b) | (1 | ) | — |
| (a) | In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. |
| (b) | See “Non-GAAP Measures.” |
| (c) | See “Items Affecting Comparability.” |
| (d) | Does not sum due to rounding. |
2018
Net revenue declined 1.5% and volume declined 0.5%. The net revenue performance reflects unfavorable net pricing and mix and the volume decline. The volume decline was driven by a double-digit decline in trademark Gamesa and a mid-single-digit decline in ready-to-eat cereals, partially offset by mid-single-digit growth in oatmeal.
Operating profit decreased slightly, reflecting certain operating cost increases, the net revenue performance and a 3-percentage-point impact of higher commodity costs. These impacts were partially offset by productivity savings, lower advertising and marketing expenses and a 1-percentage-point positive contribution from insurance settlement recoveries related to the 2017 earthquake in Mexico.
2017
Net revenue declined 2%, reflecting the impact of the 53rd reporting week in 2016, which negatively impacted net revenue performance by 2 percentage points, as well as unfavorable mix. Volume declined 2%, reflecting a low-single-digit decline in ready-to-eat cereals and high-single-digit declines in trademark Roni and Gamesa, in part reflecting the impact of the 53rd reporting week in 2016 which negatively impacted volume performance by 2 percentage points.
Operating profit decreased 1%, reflecting certain operating cost increases and the net revenue performance. The 53rd reporting week in 2016 negatively impacted operating profit performance by 2 percentage points. These impacts were partially offset by productivity savings, lower advertising and marketing expenses and a 1.5-percentage-point impact of 2016 incremental investments into our business. Higher restructuring and impairment charges negatively impacted operating profit performance by 1 percentage point.
North America Beverages
| % Change | |||||||||||||||||
| 2018 | 2017(a) | 2016(a) | 2018 | 2017 | |||||||||||||
| Net revenue | $ | 21,072 | $ | 20,936 | $ | 21,312 | 1 | (2 | ) | ||||||||
| Impact of foreign exchange translation | — | — | |||||||||||||||
| Impact of acquisitions and divestitures | — | (1 | ) | ||||||||||||||
| Impact of sales and certain other taxes (b) | — | — | |||||||||||||||
| Impact of 53rd reporting week | — | 1 | |||||||||||||||
| Organic revenue growth (b) | 0.5 | (d) | (2 | ) | |||||||||||||
| Operating profit | $ | 2,276 | $ | 2,700 | $ | 2,947 | (16 | ) | (8 | ) | |||||||
| Restructuring and impairment charges (c) | 88 | 43 | 33 | ||||||||||||||
| Operating profit excluding above item (b) | $ | 2,364 | $ | 2,743 | $ | 2,980 | (14 | ) | (8 | ) | |||||||
| Impact of foreign exchange translation | — | — | |||||||||||||||
| Operating profit growth excluding above item, on a constant currency basis (b) | (14 | ) | (8 | ) |
| (a) | In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. |
| (b) | See “Non-GAAP Measures.” |
| (c) | See “Items Affecting Comparability.” |
| (d) | Does not sum due to rounding. |
2018
Net revenue grew 1%, driven by effective net pricing, partially offset by a decline in volume. Volume decreased 1%, driven by a 3% decline in CSD volume, partially offset by a 2% increase in non-carbonated beverage volume. The non-carbonated beverage volume increase primarily reflected a high-single-digit increase in our overall water portfolio. Additionally, a low-single-digit increase in Gatorade sports drinks was offset by a low-single-digit decline in our juice and juice drinks portfolio.
Operating profit decreased 16%, reflecting certain operating cost increases, including increased transportation costs, a 7-percentage-point impact of higher commodity costs and higher advertising and marketing expenses. These impacts were partially offset by productivity savings and the net revenue growth. Higher gains on asset sales positively contributed 1.5 percentage points to operating profit performance. A bonus extended to certain U.S. employees in connection with the TCJ Act negatively impacted operating profit performance by 1.5 percentage points and was partially offset by prior-year costs related to hurricanes which positively contributed 1 percentage point to operating profit performance.
2017
Net revenue decreased 2%, primarily reflecting a decline in volume, partially offset by effective net pricing, as well as acquisitions which positively contributed 1 percentage point to the net revenue performance. The 53rd reporting week in 2016 negatively impacted net revenue performance by 1 percentage point. Volume decreased 3.5%, driven by a 5% decline in CSD volume and a 1% decline in non-carbonated beverage volume. The non-carbonated beverage volume decrease primarily reflected mid-single-digit declines in Gatorade sports drinks and in our juice and juice drinks portfolio, partially offset by a mid-single-digit increase in our overall water portfolio and a low-single-digit increase in Lipton ready-to-drink teas. Acquisitions had a nominal positive contribution to the volume performance. The 53rd reporting week in 2016 negatively impacted volume performance by 1.5 percentage points.
Operating profit decreased 8%, primarily reflecting certain operating cost increases, the net revenue performance and a 2-percentage-point impact of higher commodity costs. These impacts were partially offset by productivity savings and lower advertising and marketing expenses. Costs related to the hurricanes that occurred in 2017 negatively impacted operating profit performance by 1 percentage point and were offset by a gain associated with a sale of an asset. In addition, the 53rd reporting week in 2016 negatively impacted operating profit performance by 1 percentage point and was offset by incremental investments in our business in 2016.
Latin America
| % Change | |||||||||||||||||
| 2018 | 2017(a) | 2016(a) | 2018 | 2017 | |||||||||||||
| Net revenue | $ | 7,354 | $ | 7,208 | $ | 6,820 | 2 | 6 | |||||||||
| Impact of foreign exchange translation | 6 | (1 | ) | ||||||||||||||
| Impact of acquisitions and divestitures | — | 0.5 | |||||||||||||||
| Organic revenue growth (b) | 8 | 5 | (d) | ||||||||||||||
| Operating profit | $ | 1,049 | $ | 924 | $ | 904 | 13 | 2 | |||||||||
| Restructuring and impairment charges (c) | 40 | 56 | 27 | ||||||||||||||
| Operating profit excluding above item (b) | $ | 1,089 | $ | 980 | $ | 931 | 11 | 5 | |||||||||
| Impact of foreign exchange translation | 2 | 1 | |||||||||||||||
| Operating profit growth excluding above item, on a constant currency basis (b) | 13 | 6 |
| (a) | In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. |
| (b) | See “Non-GAAP Measures.” |
| (c) | See “Items Affecting Comparability.” |
| (d) | Does not sum due to rounding. |
2018
Net revenue grew 2%, reflecting effective net pricing, partially offset by a 6-percentage-point impact of unfavorable foreign exchange.
Snacks volume grew 1%, reflecting low-single-digit growth in Mexico, partially offset by a mid-single-digit decline in Brazil.
Beverage volume declined 1%, reflecting a high-single-digit decline in Brazil, a low-single-digit decline in Mexico and a mid-single-digit decline in Argentina, partially offset by double-digit growth in Colombia, mid-single-digit growth in Guatemala and low-single-digit growth in Honduras.
Operating profit increased 13%, reflecting the net revenue growth, productivity savings and a 4-percentage-point impact of insurance settlement recoveries related to the 2017 earthquake in Mexico. These impacts were partially offset by certain operating cost increases, a 14-percentage-point impact of higher commodity costs and higher advertising and marketing expenses.
2017
Net revenue increased 6%, reflecting effective net pricing, partially offset by volume declines. Favorable foreign exchange contributed 1 percentage point to net revenue growth.
Snacks volume declined 1.5%, reflecting low-single-digit declines in Brazil and Mexico.
Beverage volume declined 2%, reflecting a mid-single-digit decline in Brazil and a low-single-digit decline in Argentina, partially offset by high-single-digit growth in Guatemala. Additionally, Mexico experienced a slight decline.
Operating profit increased 2%, reflecting the effective net pricing and productivity savings. These impacts were partially offset by certain operating cost increases, the volume declines and a 16-percentage-point impact of higher commodity costs. Higher restructuring and impairment charges reduced operating profit growth by 3 percentage points.
Europe Sub-Saharan Africa
| % Change | |||||||||||||||||
| 2018 | 2017(a) | 2016(a) | 2018 | 2017 | |||||||||||||
| Net revenue | $ | 11,523 | $ | 11,050 | $ | 10,216 | 4 | 8 | |||||||||
| Impact of foreign exchange translation | 2 | (3 | ) | ||||||||||||||
| Impact of acquisitions and divestitures | — | — | |||||||||||||||
| Impact of sales and certain other taxes (b) | 0.5 | — | |||||||||||||||
| Impact of 53rd reporting week | — | — | |||||||||||||||
| Organic revenue growth (b) | 7 | (d) | 6 | (d) | |||||||||||||
| Operating profit | $ | 1,364 | $ | 1,316 | $ | 1,061 | 4 | 24 | |||||||||
| Restructuring and impairment charges (c) | 63 | 53 | 60 | ||||||||||||||
| Merger and integration charges (c) | 57 | — | — | ||||||||||||||
| Operating profit excluding above items (b) | $ | 1,484 | $ | 1,369 | $ | 1,121 | 8 | 22 | |||||||||
| Impact of foreign exchange translation | 3 | — | |||||||||||||||
| Operating profit growth excluding above items, on a constant currency basis (b) | 11 | 22 |
| (a) | In 2017 and 2016, operating profit and restructuring and impairment charges reflect the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 to our consolidated financial statements. |
| (b) | See “Non-GAAP Measures.” |
| (c) | See “Items Affecting Comparability.” |
| (d) | Does not sum due to rounding. |
2018
Net revenue increased 4%, reflecting volume growth and effective net pricing, partially offset by a 2-percentage-point impact of unfavorable foreign exchange.
Snacks volume grew 3%, reflecting mid-single-digit growth in the Netherlands, partially offset by low-single-digit declines in the United Kingdom and South Africa. Additionally, Russia and Turkey experienced low-single-digit growth.
Beverage volume grew 7%, reflecting double-digit growth in Germany and Poland and high-single-digit growth in France and Nigeria, partially offset by a low-single-digit decline in the United Kingdom. Additionally, Russia and Turkey experienced mid-single-digit growth.
Operating profit increased 4%, reflecting the net revenue growth, productivity savings and a 4-percentage-point net impact of refranchising our entire beverage bottling operations and snack distribution operations in CHS. These impacts were partially offset by certain operating cost increases and an 8-percentage-point impact of higher commodity costs. Additionally, a prior-year gain on the sale of our minority stake in Britvic
and the merger and integration charges related to our acquisition of SodaStream reduced operating profit growth by 7 percentage points and 4 percentage points, respectively.
2017
Net revenue increased 8%, reflecting volume growth and effective net pricing, as well as favorable foreign exchange, which contributed 3 percentage points to net revenue growth.
Snacks volume grew 5%, reflecting high-single-digit growth in Russia, partially offset by a slight decline in the United Kingdom and a low-single-digit decline in Spain. Additionally, Turkey, South Africa and the Netherlands experienced mid-single-digit growth.
Beverage volume grew 1%, reflecting mid-single-digit growth in Poland and Nigeria and low-single-digit growth in Turkey and France, partially offset by mid-single-digit declines in Russia and Germany, and a low-single-digit decline in the United Kingdom.
Operating profit increased 24%, reflecting the net revenue growth and productivity savings. Additionally, a gain on the sale of our minority stake in Britvic in 2017 contributed 8 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases, higher advertising and marketing expenses and a 7-percentage-point impact of higher commodity costs.
Asia, Middle East and North Africa
| % Change | ||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | ||||||||||||||
| Net revenue | $ | 5,901 | $ | 6,030 | $ | 6,338 | (2 | ) | (5 | ) | ||||||||
| Impact of foreign exchange translation | 1 | 10 | ||||||||||||||||
| Impact of acquisitions and divestitures | 8 | — | ||||||||||||||||
| Impact of sales and certain other taxes (a) | — | — | ||||||||||||||||
| Organic revenue growth (a) | 7 | 5 | ||||||||||||||||
| Operating profit | $ | 1,172 | $ | 1,073 | $ | 619 | 9 | 73 | ||||||||||
| Restructuring and impairment charges (b) | 28 | (3 | ) | 14 | ||||||||||||||
| Charge related to the transaction with Tingyi (b) | — | — | 373 | |||||||||||||||
| Operating profit excluding above items (a) | $ | 1,200 | $ | 1,070 | $ | 1,006 | 12 | 6 | ||||||||||
| Impact of foreign exchange translation | (1 | ) | 8 | |||||||||||||||
| Operating profit growth excluding above items, on a constant currency basis (a) | 11 | 15 | (c) |
| (a) | See “Non-GAAP Measures.” |
| (b) | See “Items Affecting Comparability.” |
| (c) | Does not sum due to rounding. |
2018
Net revenue declined 2%, reflecting an 8-percentage-point impact of refranchising a portion of our beverage businesses in Thailand in 2018 and Jordan in 2017, partially offset by net volume growth and effective net pricing.
Snacks volume grew 5%, reflecting double-digit growth in India, China and Pakistan, partially offset by a mid-single-digit decline in the Middle East. Additionally, Australia experienced low-single-digit growth.
Beverage volume declined slightly, reflecting a mid-single-digit decline in the Middle East and a double-digit decline in the Philippines, partially offset by double-digit growth in Vietnam, mid-single-digit growth in India and low-single-digit growth in Pakistan and China.
Operating profit grew 9%, primarily reflecting the effective net pricing, productivity savings and the net volume growth, partially offset by certain operating cost increases, higher advertising and marketing expenses and a 4-percentage-point impact of higher commodity costs. The net impact of refranchising a portion of our beverage business in Thailand in 2018 contributed 13 percentage points to operating profit growth and was offset by a 16-percentage-point negative impact of the prior year refranchising of a portion of our beverage business in Jordan.
2017
Net revenue decreased 5%, reflecting unfavorable foreign exchange, which negatively impacted net revenue performance by 10 percentage points, primarily driven by a weak Egyptian pound. This impact was partially offset by effective net pricing.
Snacks volume grew 5%, driven by high-single-digit growth in China and India and double-digit growth in Pakistan. Additionally, the Middle East experienced low-single-digit growth and Australia experienced mid-single-digit growth.
Beverage volume declined 1%, reflecting a double-digit decline in India and a mid-single-digit decline in the Middle East, partially offset by mid-single-digit growth in China, high-single-digit growth in Pakistan and low-single-digit growth in the Philippines.
Operating profit improvement primarily reflected a 2016 impairment charge to reduce the value of our 5% indirect equity interest in KSFB to its estimated fair value. The effective net pricing and productivity savings also increased operating profit growth. Additionally, the impact of refranchising a portion of our beverage business in Jordan contributed 14 percentage points to operating profit growth. These impacts were partially offset by certain operating cost increases and a 32-percentage-point impact of higher commodity costs, primarily due to transaction-related foreign exchange on raw material purchases driven by the weak Egyptian pound. Unfavorable foreign exchange translation reduced operating profit growth by 8 percentage points.
Our Liquidity and Capital Resources
We believe that our cash generating capability and financial condition, together with our revolving credit facilities and other available methods of debt financing, such as commercial paper borrowings and long-term debt financing, will be adequate to meet our operating, investing and financing needs. Our primary sources of cash available to fund cash outflows, such as our anticipated share repurchases, dividend payments, debt repayments and transition tax liability under the TCJ Act, include cash from operations, proceeds obtained from issuances of commercial paper and long-term debt and cash, cash equivalents and short-term investments. However, there can be no assurance that volatility in the global capital and credit markets will not impair our ability to access these markets on terms commercially acceptable to us, or at all. See Note 8 to our consolidated financial statements for a description of our credit facilities. See also “Item 1A. Risk Factors” and “Our Business Risks” for further discussion.
As of December 29, 2018, we had cash, cash equivalents, short-term investments and restricted cash in our consolidated subsidiaries of $5.7 billion outside the United States. The restricted cash of approximately $2.0 billion held outside the United States relates to our acquisition of SodaStream. Refer to Note 13 to our consolidated financial statements for further discussion of restricted cash. The TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings, including $18.9 billion held in our consolidated subsidiaries outside the United States as of December 30, 2017. As of December 29, 2018, our mandatory transition tax liability is $3.8 billion. Under the provisions of the TCJ Act, this transition tax liability must be paid over eight years; we currently expect to pay approximately $0.4 billion of this liability in 2019 and the remainder over the period 2020 to 2026. See “Credit Facilities and Long-Term Contractual Commitments.” While our accounting for the recorded impact of the TCJ Act is deemed to be complete, this amount is based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amount in future periods. The IRS issued additional guidance in the first quarter of 2019 and we are currently evaluating the impact of this guidance.
In connection with the TCJ Act, during 2018 we repatriated $20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability. The repatriated cash was used primarily for repayment of commercial paper and to fund discretionary benefit plan contributions, debt repayments, dividend payments, share repurchases and our acquisition of SodaStream. See “Item 1A. Risk Factors,” “Our Business Risks,” “Items Affecting Comparability,” “Our Critical Accounting Policies,” as well as Note 5 to our consolidated financial statements.
As of December 29, 2018, cash, cash equivalents and short-term investments in our consolidated subsidiaries subject to currency controls or currency exchange restrictions were not material.
Furthermore, our cash provided from operating activities is somewhat impacted by seasonality. Working capital needs are impacted by weekly sales, which are generally highest in the third quarter due to seasonal and holiday-related sales patterns, and generally lowest in the first quarter. On a continuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, dividends, share repurchases, productivity and other efficiency initiatives, and other structural changes. These transactions may result in future cash proceeds or payments.
The table below summarizes our cash activity:
| 2018 | 2017 | 2016 | |||||||||
| Net cash provided by operating activities | $ | 9,415 | $ | 10,030 | $ | 10,663 | |||||
| Net cash provided by/(used for) investing activities | $ | 4,564 | $ | (4,403 | ) | $ | (7,150 | ) | |||
| Net cash used for financing activities | $ | (13,769 | ) | $ | (4,186 | ) | $ | (3,211 | ) |
Operating Activities
During 2018, net cash provided by operating activities was $9.4 billion, compared to $10.0 billion in the prior year. The operating cash flow performance primarily reflects the discretionary contributions of $1.5 billion to our pension and retiree medical plans in the current year, partially offset by lower net cash tax payments in the current year.
During 2017, net cash provided by operating activities was $10 billion, compared to $10.7 billion in 2016. The operating cash flow performance primarily reflects unfavorable working capital comparisons to 2016. This decrease is mainly due to higher current year payments to vendors and customers, coupled with higher net cash tax payments in 2017, partially offset by lower pension and retiree medical plan contributions in 2017.
See Note 7 to our consolidated financial statements for further discussion of pension contributions.
Investing Activities
During 2018, net cash provided by investing activities was $4.6 billion, primarily reflecting net maturities and sales of debt securities with maturities greater than three months of $8.7 billion, partially offset by net capital spending of $3.1 billion and $1.2 billion of cash paid, net of cash and cash equivalents acquired, in connection with our acquisition of SodaStream.
During 2017, net cash used for investing activities was $4.4 billion, primarily reflecting net capital spending of $2.8 billion and net purchases of debt securities with maturities greater than three months of $1.9 billion.
See Note 1 to our consolidated financial statements for further discussion of capital spending by division; see Note 9 to our consolidated financial statements for further discussion of our investments in debt securities.
We expect 2019 net capital spending to be approximately $4.5 billion.
Financing Activities
During 2018, net cash used for financing activities was $13.8 billion, primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.9 billion, payments of long-term debt borrowings of $4.0 billion, cash tender and exchange offers of $1.6 billion and net payments of short-term borrowings of $1.4 billion.
During 2017, net cash used for financing activities was $4.2 billion, primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.5 billion and net payments of short-term borrowings of $1.1 billion, partially offset by net proceeds from long-term debt of $3.1 billion and proceeds from exercises of stock options of $0.5 billion.
See Note 8 to our consolidated financial statements for further discussion of debt obligations.
We annually review our capital structure with our Board of Directors, including our dividend policy and share repurchase activity. On February 11, 2015, we announced a share repurchase program providing for the repurchase of up to $12.0 billion of PepsiCo common stock which commenced on July 1, 2015 and expired on June 30, 2018 (2015 share repurchase program). The 2015 share repurchase program had approximately $4.3 billion of authorized repurchase capacity unused at expiration. On February 13, 2018, we announced the 2018 share repurchase program providing for the repurchase of up to $15.0 billion of PepsiCo common stock which commenced on July 1, 2018 and will expire on June 30, 2021. On February 15, 2019, we announced a 3% increase in our annualized dividend to $3.82 per share from $3.71 per share, effective with the dividend expected to be paid in June 2019. We expect to return a total of approximately $8 billion to shareholders in 2019 through share repurchases of approximately $3 billion and dividends of approximately $5 billion.
Free Cash Flow
Free cash flow is a non-GAAP financial measure. For further information on free cash flow see “Non-GAAP Measures.”
The table below reconciles net cash provided by operating activities, as reflected in our cash flow statement, to our free cash flow.
| % Change | |||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | |||||||||||||
| Net cash provided by operating activities | $ | 9,415 | $ | 10,030 | $ | 10,663 | (6 | ) | (6 | ) | |||||||
| Capital spending | (3,282 | ) | (2,969 | ) | (3,040 | ) | |||||||||||
| Sales of property, plant and equipment | 134 | 180 | 99 | ||||||||||||||
| Free cash flow (a) | $ | 6,267 | $ | 7,241 | $ | 7,722 | (13 | ) | (6 | ) |
| (a) | See “Non-GAAP Measures.” In addition, when evaluating free cash flow, we also consider the following items impacting comparability: $1.5 billion, $6 million and $459 million in discretionary pension and retiree medical contributions and associated net cash tax benefits of $473 million, $1 million and $151 million in 2018, 2017 and 2016, respectively; $266 million, $113 million and $125 million of payments related to restructuring charges and associated net cash tax benefits of $45 million, $30 million and $22 million in 2018, 2017 and 2016, respectively; tax payments related to the TCJ Act of $115 million in 2018; certain other items of $47 million in 2018; net cash tax benefit related to debt redemption charge of $83 million in 2016; and net cash received related to interest rate swaps of $5 million in 2016. We will also consider payments related to the transition tax liability of $3.8 billion as of December 29, 2018, which we currently expect to be paid over the period 2019 to 2026 under the provisions of the TCJ Act, as an item impacting comparability. |
We use free cash flow primarily for financing activities, including debt repayments, dividends and share repurchases. We expect to continue to return free cash flow to our shareholders through dividends and share repurchases while maintaining Tier 1 commercial paper access, which we believe will facilitate appropriate financial flexibility and ready access to global capital and credit markets at favorable interest rates. However, see “Item 1A. Risk Factors” and “Our Business Risks” for certain factors that may impact our credit ratings or our operating cash flows.
Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, whether or not as a result of our actions or factors which are beyond our control, could increase our future borrowing costs and impair our ability to access capital and credit markets on terms commercially acceptable to us, or at all. In addition, any downgrade of our current short-term credit ratings could impair our ability to access the commercial paper market with the same flexibility that we have experienced historically, and therefore require us to rely more heavily on more expensive types of debt financing. See “Item 1A. Risk Factors,” “Our Business Risks” and Note 8 to our consolidated financial statements for further discussion.
Credit Facilities and Long-Term Contractual Commitments
See Note 8 to our consolidated financial statements for a description of our credit facilities.
The following table summarizes our long-term contractual commitments by period:
| Payments Due by Period(a) | |||||||||||||||||||
| Total | 2019 | 2020 – 2021 | 2022 – 2023 | 2024 and beyond | |||||||||||||||
| Long-term debt obligations (b) | $ | 28,351 | $ | — | $ | 7,166 | $ | 5,093 | $ | 16,092 | |||||||||
| Interest on debt obligations (c) | 11,157 | 1,044 | 1,759 | 1,322 | 7,032 | ||||||||||||||
| Operating leases (d) | 1,840 | 459 | 700 | 371 | 310 | ||||||||||||||
| Purchasing commitments (e) | 2,602 | 982 | 1,221 | 252 | 147 | ||||||||||||||
| Marketing commitments (e) | 1,686 | 452 | 796 | 234 | 204 | ||||||||||||||
| $ | 45,636 | $ | 2,937 | $ | 11,642 | $ | 7,272 | $ | 23,785 |
| (a) | Based on year-end foreign exchange rates. Reserves for uncertain tax positions are excluded from the table above as we are unable to reasonably predict the ultimate amount or timing of any such settlements. However, under the provisions of the TCJ Act, our transition tax liability of $3.8 billion, of which $3.4 billion is recorded in other liabilities on our balance sheet, must be paid over eight years. We expect to pay approximately $0.4 billion in 2019, $0.3 billion per year in 2020-2023, $0.6 billion in 2024, $0.7 billion in 2025 and $0.9 billion in 2026 and these amounts are excluded from the table above. |
| (b) | Excludes $3,953 million related to current maturities of debt, $56 million related to the fair value adjustments for debt acquired in acquisitions and interest rate swaps and payments of $119 million related to unamortized net discounts. |
| (c) | Interest payments on floating-rate debt are estimated using interest rates effective as of December 29, 2018. |
| (d) | See Note 15 to our consolidated financial statements for additional information on operating leases. |
| (e) | Primarily reflects non-cancelable commitments as of December 29, 2018. |
Long-term contractual commitments, except for our long-term debt obligations and transition tax liability, are generally not recorded on our balance sheet. Operating leases primarily represent building leases. Non-cancelable purchasing commitments are primarily for oranges, orange juice and certain other commodities. Non-cancelable marketing commitments are primarily for sports marketing. Bottler funding to independent bottlers is not reflected in our long-term contractual commitments as it is negotiated on an annual basis. Accrued liabilities for pension and retiree medical plans are not reflected in our long-term contractual commitments. See Note 7 to our consolidated financial statements for additional information regarding our pension and retiree medical obligations.
Off-Balance-Sheet Arrangements
We do not have guarantees or other off-balance-sheet financing arrangements, including variable interest entities, that we believe could have a material impact on our financial condition or liquidity.
We coordinate, on an aggregate basis, the contract negotiations of raw material requirements, including sweeteners, aluminum cans and plastic bottles and closures for us and certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, transactions between our independent bottlers and suppliers are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our independent bottlers, but we consider this exposure to be remote.
Return on Invested Capital
ROIC is a non-GAAP financial measure. For further information on ROIC, see “Non-GAAP Measures.”
| 2018 | 2017 | 2016 | ||||||||||||
| Net income attributable to PepsiCo | $ | 12,515 | (a) | $ | 4,857 | (a) | $ | 6,329 | ||||||
| Interest expense | 1,525 | 1,151 | 1,342 | |||||||||||
| Tax on interest expense | (339 | ) | (415 | ) | (483 | ) | ||||||||
| $ | 13,701 | $ | 5,593 | $ | 7,188 | |||||||||
| Average debt obligations (b) | $ | 38,169 | $ | 38,707 | $ | 35,308 | ||||||||
| Average common shareholders’ equity (c) | 11,368 | 12,004 | 11,943 | |||||||||||
| Average invested capital | $ | 49,537 | $ | 50,711 | $ | 47,251 | ||||||||
| Return on invested capital | 27.7 | % | (a) | 11.0 | % | (a) | 15.2 | % |
| (a) | Our fiscal 2018 results include other net tax benefits related to the reorganization of our international operations. Our fiscal 2018 and 2017 results include the impact of the TCJ Act. See Note 5 to our consolidated financial statements. |
| (b) | Average debt obligations includes a quarterly average of short-term and long-term debt obligations. |
| (c) | Average common shareholders’ equity includes a quarterly average of common stock, capital in excess of par value, retained earnings, accumulated other comprehensive loss and repurchased common stock. |
The table below reconciles ROIC as calculated above to net ROIC, excluding items affecting comparability.
| 2018 | 2017 | 2016 | |||||||
| ROIC | 27.7 | % | 11.0 | % | 15.2 | % | |||
| Impact of: | |||||||||
| Average cash, cash equivalents and short-term investments | 7.8 | 7.6 | 6.0 | ||||||
| Interest income | (0.6 | ) | (0.5 | ) | (0.2 | ) | |||
| Tax on interest income | 0.1 | 0.2 | 0.1 | ||||||
| Mark-to-market net impact | 0.2 | — | (0.2 | ) | |||||
| Restructuring and impairment charges | 0.4 | 0.3 | 0.1 | ||||||
| Merger and integration charges | 0.1 | — | — | ||||||
| Net tax (benefit)/expense related to the TCJ Act | (1.1 | ) | 4.5 | — | |||||
| Other net tax benefits | (9.7 | ) | 0.1 | 0.1 | |||||
| Charges related to cash tender and exchange offers | (0.1 | ) | — | — | |||||
| Charges related to the transaction with Tingyi | — | (0.1 | ) | 0.6 | |||||
| Pension-related settlement charge | — | — | 0.3 | ||||||
| Venezuela impairment charges | — | (0.2 | ) | (0.5 | ) | ||||
| Net ROIC, excluding items affecting comparability | 24.8 | % | 22.9 | % | 21.5 | % |
OUR CRITICAL ACCOUNTING POLICIES
An appreciation of our critical accounting policies is necessary to understand our financial results. These policies may require management to make difficult and subjective judgments regarding uncertainties, and as a result, such estimates may significantly impact our financial results. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. Other than our accounting for pension and retiree medical plans, our critical accounting policies do not involve a choice between alternative methods of accounting. We applied our critical accounting policies and estimation methods consistently in all material respects and for all periods presented. We have discussed our critical accounting policies with our Audit Committee.
Our critical accounting policies are:
| • | revenue recognition; |
| • | goodwill and other intangible assets; |
| • | income tax expense and accruals; and |
| • | pension and retiree medical plans. |
Revenue Recognition
We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products.
Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment.
We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data.
Our policy is to provide customers with product when needed. In fact, our commitment to freshness and product dating serves to regulate the quantity of product shipped or delivered. In addition, DSD products are placed on the shelf by our employees with customer shelf space and storerooms limiting the quantity of product. For product delivered through other distribution networks, we monitor customer inventory levels.
As discussed in “Our Customers” in “Item 1. Business,” we offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities.
See Note 2 to our consolidated financial statements for additional information on our revenue recognition and related policies, including total marketplace spending.
Goodwill and Other Intangible Assets
We sell products under a number of brand names, many of which were developed by us. Brand development costs are expensed as incurred. We also purchase brands and other intangible assets in acquisitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands and other intangible assets, based on estimated fair values, with any excess recorded as goodwill. Determining fair value requires significant estimates and assumptions based on an evaluation of a number of factors, such as marketplace participants, product life cycles, market share, consumer awareness, brand history and future
expansion expectations, amount and timing of future cash flows and the discount rate applied to the cash flows.
We believe that a brand has an indefinite life if it has a history of strong revenue and cash flow performance and we have the intent and ability to support the brand with marketplace spending for the foreseeable future. If these indefinite-lived brand criteria are not met, brands are amortized over their expected useful lives, which generally range from 20 to 40 years. Determining the expected life of a brand requires management judgment and is based on an evaluation of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environment of the countries in which the brand is sold.
In connection with previous acquisitions, we reacquired certain franchise rights which provided the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these franchise rights, many factors were considered, including the pre-existing perpetual bottling arrangements, the indefinite period expected for these franchise rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of these franchise rights to us, including legal, regulatory, contractual, competitive, economic or other factors. Therefore, certain of these franchise rights are considered as indefinite-lived. Franchise rights that are not considered indefinite-lived are amortized over the remaining contractual period of the contract in which the right was granted.
Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed.
In the quantitative assessment, estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with management’s strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in “Item 1A. Risk Factors” and “Our Business Risks.”
Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows.
See Note 2 and Note 4 to our consolidated financial statements.
Income Tax Expense and Accruals
Our annual tax rate is based on our income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Significant judgment is required in determining our annual tax rate and in evaluating our tax positions. We establish reserves when, despite our belief that our tax return positions are fully supportable, we believe that certain positions are subject to challenge and that we likely
will not succeed. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances, such as the progress of a tax audit. See “Item 1A. Risk Factors” for further discussion.
An estimated annual effective tax rate is applied to our quarterly operating results. In the event there is a significant or unusual item recognized in our quarterly operating results, the tax attributable to that item is separately calculated and recorded at the same time as that item. We consider the tax adjustments from the resolution of prior year tax matters to be among such items.
Tax law requires items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, our annual tax rate reflected in our financial statements is different than that reported in our tax returns (our cash tax rate). Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences reverse over time, such as depreciation expense. These temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax returns in future years for which we have already recorded the tax benefit on our income statement. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax liabilities generally represent tax expense recognized in our financial statements for which payment has been deferred, or expense for which we have already taken a deduction in our tax return but have not yet recognized as expense in our financial statements.
During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. As a result of the enactment
of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion ($1.70 per share) in the fourth quarter of 2017.
Included in the provisional net tax expense of $2.5 billion recognized in 2017 is a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act and reflected in our provision for income taxes.
During 2018, we recognized a net tax benefit of $28 million ($0.02 per share) in connection with the TCJ Act. See further information in “Items Affecting Comparability.”
While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amounts in future periods. As a result of the TCJ Act, we currently expect our annual tax rate, excluding items affecting comparability, in percentage terms, to be in the low twenties in 2019. However, we continue to evaluate the impact of the TCJ Act on our annual tax rate due to certain provisions, such as the global intangible low-tax income (GILTI) provision, which may impact our tax rate in future years.
In 2018, our annual tax rate was (36.7)% compared to 48.9% in 2017, as discussed in “Other Consolidated Results.” The tax rate decreased 85.6 percentage points compared to 2017, reflecting both other net tax benefits related to the reorganization of our international operations, which reduced the reported tax rate by 45 percentage points, and the prior year provisional net tax expense related to the TCJ Act, which reduced the current year reported tax rate by 25 percentage points. Additionally, the favorable conclusion of certain international tax audits and the favorable resolution with the IRS of all open matters related to the audits of
taxable years 2012 and 2013, collectively, reduced the reported tax rate by 7 percentage points. See Note 5 to our consolidated financial statements.
Pension and Retiree Medical Plans
Our pension plans cover certain employees in the United States and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. Certain U.S. and Canada retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the cost. In addition, we have been phasing out certain subsidies of retiree medical benefits.
In 2016, we approved an amendment to reorganize the U.S. qualified defined benefit pension plans that resulted in the combination of two plans effective December 31, 2016, and the spinoff of a portion of the combined plan into a pre-existing plan effective January 1, 2017. The benefits offered to the plans’ participants were unchanged. The result of the reorganization was the creation of Plan A and the PepsiCo Employees Retirement Plan I (Plan I). The reorganization was made to facilitate a targeted investment strategy over time and to provide additional flexibility in evaluating opportunities to reduce risk and volatility. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of these changes, the pre-tax net periodic benefit cost decreased by $42 million ($27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See Note 7 to our consolidated financial statements.
In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ($162 million after-tax or $0.11 per share). See “Items Affecting Comparability” and Note 7 to our consolidated financial statements.
Our Assumptions
The determination of pension and retiree medical expenses and obligations requires the use of assumptions to estimate the amount of benefits that employees earn while working, as well as the present value of those benefits. Annual pension and retiree medical expense amounts are principally based on four components: (1) the value of benefits earned by employees for working during the year (service cost), (2) the increase in the projected benefit obligation due to the passage of time (interest cost), and (3) other gains and losses as discussed in Note 7 to our consolidated financial statements, reduced by (4) the expected return on assets for our funded plans.
Significant assumptions used to measure our annual pension and retiree medical expenses include:
| • | certain employee-related demographic factors, such as turnover, retirement age and mortality; |
| • | the expected return on assets in our funded plans; |
| • | for pension expense, the rate of salary increases for plans where benefits are based on earnings; |
| • | for retiree medical expense, health care cost trend rates; and |
| • | for pension and retiree medical expense, the spot rates along the yield curve used to determine service and interest costs and the present value of liabilities. |
Certain assumptions reflect our historical experience and management’s best judgment regarding future expectations. All actuarial assumptions are reviewed annually, except in the case of an interim remeasurement due to a significant event such as a curtailment or settlement. Due to the significant management judgment involved, our assumptions could have a material impact on the measurement of our pension and retiree medical expenses and obligations.
At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt securities with maturities comparable to those of our liabilities. Our U.S. obligation and pension and retiree medical expense is based on the discount rates determined using the Mercer Above Mean Curve. This curve includes bonds that closely match the timing and amount of our expected benefit payments and reflects the portfolio of investments we would consider to settle our liabilities.
See Note 7 to our consolidated financial statements for information about the expected rate of return on plan assets and our plans’ investment strategy. Although we review our expected long-term rates of return on an annual basis, our asset returns in a given year do not significantly influence our evaluation of long-term rates of return.
The health care trend rate used to determine our retiree medical plans’ liability and expense is reviewed annually. Our review is based on our claims experience, information provided by our health plans and actuaries, and our knowledge of the health care industry. Our review of the trend rate considers factors such as demographics, plan design, new medical technologies and changes in medical carriers.
Weighted-average assumptions for pension and retiree medical expense are as follows:
| 2019 | 2018 | 2017 | ||||||
| Pension | ||||||||
| Service cost discount rate | 4.4 | % | 3.7 | % | 4.3 | % | ||
| Interest cost discount rate | 3.9 | % | 3.2 | % | 3.5 | % | ||
| Expected rate of return on plan assets | 6.8 | % | 6.9 | % | 7.2 | % | ||
| Expected rate of salary increases | 3.2 | % | 3.2 | % | 3.2 | % | ||
| Retiree medical | ||||||||
| Service cost discount rate | 4.3 | % | 3.6 | % | 4.0 | % | ||
| Interest cost discount rate | 3.8 | % | 3.0 | % | 3.2 | % | ||
| Expected rate of return on plan assets | 6.6 | % | 6.5 | % | 7.5 | % | ||
| Current health care cost trend rate | 5.7 | % | 5.8 | % | 5.9 | % |
Based on our assumptions, we expect our total pension and retiree medical expense to increase in 2019 primarily driven by the recognition of prior experience losses on return on plan assets, partially offset by the impact of higher discount rates and discretionary plan contributions.
Sensitivity of Assumptions
A decrease in each of the collective discount rates or in the expected rate of return assumptions would increase expense for our benefit plans. A 25-basis-point decrease in each of the above discount rates and expected rate of return assumptions would individually increase 2019 pre-tax pension and retiree medical expense as follows:
| Assumption | Amount | |
| Discount rates used in the calculation of expense | $42 | |
| Expected rate of return | $40 |
Funding
We make contributions to pension trusts that provide plan benefits for certain pension plans. These contributions are made in accordance with applicable tax regulations that provide for current tax deductions for our contributions and taxation to the employee only upon receipt of plan benefits. Generally, we do not fund our pension plans when our contributions would not be currently tax deductible. As our retiree medical plans are not subject to regulatory funding requirements, we generally fund these plans on a pay-as-you-go basis, although we periodically review available options to make additional contributions toward these benefits.
Our pension and retiree medical contributions are subject to change as a result of many factors, such as changes in interest rates, deviations between actual and expected asset returns and changes in tax or other benefit laws. We regularly evaluate different opportunities to reduce risk and volatility associated with our pension and retiree medical plans. See Note 7 to our consolidated financial statements for our past and expected contributions and estimated future benefit payments.
Consolidated Statement of Income
PepsiCo, Inc. and Subsidiaries
Fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016
(in millions except per share amounts)
| 2018 | 2017 | 2016 | |||||||||
| Net Revenue | $ | 64,661 | $ | 63,525 | $ | 62,799 | |||||
| Cost of sales | 29,381 | 28,796 | 28,222 | ||||||||
| Gross profit | 35,280 | 34,729 | 34,577 | ||||||||
| Selling, general and administrative expenses | 25,170 | 24,453 | 24,773 | ||||||||
| Operating Profit | 10,110 | 10,276 | 9,804 | ||||||||
| Other pension and retiree medical benefits income/(expense) | 298 | 233 | (19 | ) | |||||||
| Interest expense | (1,525 | ) | (1,151 | ) | (1,342 | ) | |||||
| Interest income and other | 306 | 244 | 110 | ||||||||
| Income before income taxes | 9,189 | 9,602 | 8,553 | ||||||||
| (Benefit from)/provision for income taxes (See Note 5) | (3,370 | ) | 4,694 | 2,174 | |||||||
| Net income | 12,559 | 4,908 | 6,379 | ||||||||
| Less: Net income attributable to noncontrolling interests | 44 | 51 | 50 | ||||||||
| Net Income Attributable to PepsiCo | $ | 12,515 | $ | 4,857 | $ | 6,329 | |||||
| Net Income Attributable to PepsiCo per Common Share | |||||||||||
| Basic | $ | 8.84 | $ | 3.40 | $ | 4.39 | |||||
| Diluted | $ | 8.78 | $ | 3.38 | $ | 4.36 | |||||
| Weighted-average common shares outstanding | |||||||||||
| Basic | 1,415 | 1,425 | 1,439 | ||||||||
| Diluted | 1,425 | 1,438 | 1,452 |
See accompanying notes to the consolidated financial statements.
Consolidated Statement of Comprehensive Income
PepsiCo, Inc. and Subsidiaries
Fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016
(in millions)
| 2018 | 2017 | 2016 | |||||||||
| Net income | $ | 12,559 | $ | 4,908 | $ | 6,379 | |||||
| Other comprehensive income/(loss), net of taxes: | |||||||||||
| Net currency translation adjustment | (1,641 | ) | 1,109 | (302 | ) | ||||||
| Net change on cash flow hedges | 40 | (36 | ) | 46 | |||||||
| Net pension and retiree medical adjustments | (467 | ) | (159 | ) | (316 | ) | |||||
| Net change on available-for-sale securities | 6 | (68 | ) | (24 | ) | ||||||
| Other | — | 16 | — | ||||||||
| (2,062 | ) | 862 | (596 | ) | |||||||
| Comprehensive income | 10,497 | 5,770 | 5,783 | ||||||||
| Comprehensive income attributable to noncontrolling interests | (44 | ) | (51 | ) | (54 | ) | |||||
| Comprehensive Income Attributable to PepsiCo | $ | 10,453 | $ | 5,719 | $ | 5,729 |
See accompanying notes to the consolidated financial statements.
Consolidated Statement of Cash Flows
PepsiCo, Inc. and Subsidiaries
Fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016
(in millions)
| 2018 | 2017 | 2016 | |||||||||
| Operating Activities | |||||||||||
| Net income | $ | 12,559 | $ | 4,908 | $ | 6,379 | |||||
| Depreciation and amortization | 2,399 | 2,369 | 2,368 | ||||||||
| Share-based compensation expense | 256 | 292 | 284 | ||||||||
| Restructuring and impairment charges | 308 | 295 | 160 | ||||||||
| Cash payments for restructuring charges | (255 | ) | (113 | ) | (125 | ) | |||||
| Charge related to the transaction with Tingyi | — | — | 373 | ||||||||
| Pension and retiree medical plan expenses | 221 | 221 | 501 | ||||||||
| Pension and retiree medical plan contributions | (1,708 | ) | (220 | ) | (695 | ) | |||||
| Deferred income taxes and other tax charges and credits | (531 | ) | 619 | 452 | |||||||
| Other net tax benefits related to international reorganizations | (4,347 | ) | — | — | |||||||
| Net tax (benefit)/expense related to the TCJ Act | (28 | ) | 2,451 | — | |||||||
| Change in assets and liabilities: | |||||||||||
| Accounts and notes receivable | (253 | ) | (202 | ) | (349 | ) | |||||
| Inventories | (174 | ) | (168 | ) | (75 | ) | |||||
| Prepaid expenses and other current assets | 9 | 20 | 10 | ||||||||
| Accounts payable and other current liabilities | 882 | 201 | 981 | ||||||||
| Income taxes payable | 333 | (338 | ) | 329 | |||||||
| Other, net | (256 | ) | (305 | ) | 70 | ||||||
| Net Cash Provided by Operating Activities | 9,415 | 10,030 | 10,663 | ||||||||
| Investing Activities | |||||||||||
| Capital spending | (3,282 | ) | (2,969 | ) | (3,040 | ) | |||||
| Sales of property, plant and equipment | 134 | 180 | 99 | ||||||||
| Acquisition of SodaStream, net of cash and cash equivalents acquired | (1,197 | ) | — | — | |||||||
| Other acquisitions and investments in noncontrolled affiliates | (299 | ) | (61 | ) | (212 | ) | |||||
| Divestitures | 505 | 267 | 85 | ||||||||
| Short-term investments, by original maturity: | |||||||||||
| More than three months - purchases | (5,637 | ) | (18,385 | ) | (12,504 | ) | |||||
| More than three months - maturities | 12,824 | 15,744 | 8,399 | ||||||||
| More than three months - sales | 1,498 | 790 | — | ||||||||
| Three months or less, net | 16 | 2 | 16 | ||||||||
| Other investing, net | 2 | 29 | 7 | ||||||||
| Net Cash Provided by/(Used for) Investing Activities | 4,564 | (4,403 | ) | (7,150 | ) | ||||||
| Financing Activities | |||||||||||
| Proceeds from issuances of long-term debt | — | 7,509 | 7,818 | ||||||||
| Payments of long-term debt | (4,007 | ) | (4,406 | ) | (3,105 | ) | |||||
| Cash tender and exchange offers/debt redemptions | (1,589 | ) | — | (2,504 | ) | ||||||
| Short-term borrowings, by original maturity: | |||||||||||
| More than three months - proceeds | 3 | 91 | 59 | ||||||||
| More than three months - payments | (17 | ) | (128 | ) | (27 | ) | |||||
| Three months or less, net | (1,352 | ) | (1,016 | ) | 1,505 | ||||||
| Cash dividends paid | (4,930 | ) | (4,472 | ) | (4,227 | ) | |||||
| Share repurchases - common | (2,000 | ) | (2,000 | ) | (3,000 | ) | |||||
| Share repurchases - preferred | (2 | ) | (5 | ) | (7 | ) | |||||
| Proceeds from exercises of stock options | 281 | 462 | 465 | ||||||||
| Withholding tax payments on RSUs, PSUs and PEPunits converted | (103 | ) | (145 | ) | (130 | ) | |||||
| Other financing | (53 | ) | (76 | ) | (58 | ) | |||||
| Net Cash Used for Financing Activities | (13,769 | ) | (4,186 | ) | (3,211 | ) | |||||
| Effect of exchange rate changes on cash and cash equivalents and restricted cash | (98 | ) | 47 | (252 | ) | ||||||
| Net Increase in Cash and Cash Equivalents and Restricted Cash | 112 | 1,488 | 50 | ||||||||
| Cash and Cash Equivalents and Restricted Cash, Beginning of Year | 10,657 | 9,169 | 9,119 | ||||||||
| Cash and Cash Equivalents and Restricted Cash, End of Year | $ | 10,769 | $ | 10,657 | $ | 9,169 |
See accompanying notes to the consolidated financial statements.
Consolidated Balance Sheet
PepsiCo, Inc. and Subsidiaries
December 29, 2018 and December 30, 2017
(in millions except per share amounts)
| 2018 | 2017 | ||||||
| ASSETS | |||||||
| Current Assets | |||||||
| Cash and cash equivalents | $ | 8,721 | $ | 10,610 | |||
| Short-term investments | 272 | 8,900 | |||||
| Restricted cash | 1,997 | — | |||||
| Accounts and notes receivable, net | 7,142 | 7,024 | |||||
| Inventories | 3,128 | 2,947 | |||||
| Prepaid expenses and other current assets | 633 | 1,546 | |||||
| Total Current Assets | 21,893 | 31,027 | |||||
| Property, Plant and Equipment, net | 17,589 | 17,240 | |||||
| Amortizable Intangible Assets, net | 1,644 | 1,268 | |||||
| Goodwill | 14,808 | 14,744 | |||||
| Other indefinite-lived intangible assets | 14,181 | 12,570 | |||||
| Indefinite-Lived Intangible Assets | 28,989 | 27,314 | |||||
| Investments in Noncontrolled Affiliates | 2,409 | 2,042 | |||||
| Deferred Income Taxes | 4,364 | — | |||||
| Other Assets | 760 | 913 | |||||
| Total Assets | $ | 77,648 | $ | 79,804 | |||
| LIABILITIES AND EQUITY | |||||||
| Current Liabilities | |||||||
| Short-term debt obligations | $ | 4,026 | $ | 5,485 | |||
| Accounts payable and other current liabilities | 18,112 | 15,017 | |||||
| Total Current Liabilities | 22,138 | 20,502 | |||||
| Long-Term Debt Obligations | 28,295 | 33,796 | |||||
| Deferred Income Taxes | 3,499 | 3,242 | |||||
| Other Liabilities | 9,114 | 11,283 | |||||
| Total Liabilities | 63,046 | 68,823 | |||||
| Commitments and contingencies | |||||||
| Preferred Stock, no par value | — | 41 | |||||
| Repurchased Preferred Stock | — | (197 | ) | ||||
| PepsiCo Common Shareholders’ Equity | |||||||
| Common stock, par value 12/3¢ per share (authorized 3,600 shares; issued, net of repurchased common stock at par value: 1,409 and 1,420 shares, respectively) | 23 | 24 | |||||
| Capital in excess of par value | 3,953 | 3,996 | |||||
| Retained earnings | 59,947 | 52,839 | |||||
| Accumulated other comprehensive loss | (15,119 | ) | (13,057 | ) | |||
| Repurchased common stock, in excess of par value (458 and 446 shares, respectively) | (34,286 | ) | (32,757 | ) | |||
| Total PepsiCo Common Shareholders’ Equity | 14,518 | 11,045 | |||||
| Noncontrolling interests | 84 | 92 | |||||
| Total Equity | 14,602 | 10,981 | |||||
| Total Liabilities and Equity | $ | 77,648 | $ | 79,804 |
See accompanying notes to the consolidated financial statements.
Consolidated Statement of Equity
PepsiCo, Inc. and Subsidiaries
Fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016
(in millions)
| 2018 | 2017 | 2016 | ||||||||||||||||||
| Shares | Amount | Shares | Amount | Shares | Amount | |||||||||||||||
| Preferred Stock | ||||||||||||||||||||
| Balance, beginning of year | 0.8 | $ | 41 | 0.8 | $ | 41 | 0.8 | $ | 41 | |||||||||||
| Conversion to common stock | (0.1 | ) | (6 | ) | — | — | — | — | ||||||||||||
| Retirement of preferred stock | (0.7 | ) | (35 | ) | — | — | — | — | ||||||||||||
| Balance, end of year | — | — | 0.8 | 41 | 0.8 | 41 | ||||||||||||||
| Repurchased Preferred Stock | ||||||||||||||||||||
| Balance, beginning of year | (0.7 | ) | (197 | ) | (0.7 | ) | (192 | ) | (0.7 | ) | (186 | ) | ||||||||
| Redemptions | — | (2 | ) | — | (5 | ) | — | (6 | ) | |||||||||||
| Retirement of preferred stock | 0.7 | 199 | — | — | — | — | ||||||||||||||
| Balance, end of year | — | — | (0.7 | ) | (197 | ) | (0.7 | ) | (192 | ) | ||||||||||
| Common Stock | ||||||||||||||||||||
| Balance, beginning of year | 1,420 | 24 | 1,428 | 24 | 1,448 | 24 | ||||||||||||||
| Share issued in connection with preferred stock conversion to common stock | 1 | — | — | — | — | — | ||||||||||||||
| Change in repurchased common stock | (12 | ) | (1 | ) | (8 | ) | — | (20 | ) | — | ||||||||||
| Balance, end of year | 1,409 | 23 | 1,420 | 24 | 1,428 | 24 | ||||||||||||||
| Capital in Excess of Par Value | ||||||||||||||||||||
| Balance, beginning of year | 3,996 | 4,091 | 4,076 | |||||||||||||||||
| Share-based compensation expense | 250 | 290 | 289 | |||||||||||||||||
| Equity issued in connection with preferred stock conversion to common stock | 6 | — | — | |||||||||||||||||
| Stock option exercises, RSUs, PSUs and PEPunits converted (a) | (193 | ) | (236 | ) | (138 | ) | ||||||||||||||
| Withholding tax on RSUs, PSUs and PEPunits converted | (103 | ) | (145 | ) | (130 | ) | ||||||||||||||
| Other | (3 | ) | (4 | ) | (6 | ) | ||||||||||||||
| Balance, end of year | 3,953 | 3,996 | 4,091 | |||||||||||||||||
| Retained Earnings | ||||||||||||||||||||
| Balance, beginning of year | 52,839 | 52,518 | 50,472 | |||||||||||||||||
| Cumulative effect of accounting changes | (145 | ) | — | — | ||||||||||||||||
| Net income attributable to PepsiCo | 12,515 | 4,857 | 6,329 | |||||||||||||||||
| Cash dividends declared - common (b) | (5,098 | ) | (4,536 | ) | (4,282 | ) | ||||||||||||||
| Cash dividends declared - preferred | — | — | (1 | ) | ||||||||||||||||
| Retirement of preferred stock | (164 | ) | — | — | ||||||||||||||||
| Balance, end of year | 59,947 | 52,839 | 52,518 | |||||||||||||||||
| Accumulated Other Comprehensive Loss | ||||||||||||||||||||
| Balance, beginning of year | (13,057 | ) | (13,919 | ) | (13,319 | ) | ||||||||||||||
| Other comprehensive (loss)/income attributable to PepsiCo | (2,062 | ) | 862 | (600 | ) | |||||||||||||||
| Balance, end of year | (15,119 | ) | (13,057 | ) | (13,919 | ) | ||||||||||||||
| Repurchased Common Stock | ||||||||||||||||||||
| Balance, beginning of year | (446 | ) | (32,757 | ) | (438 | ) | (31,468 | ) | (418 | ) | (29,185 | ) | ||||||||
| Share repurchases | (18 | ) | (2,000 | ) | (18 | ) | (2,000 | ) | (29 | ) | (3,000 | ) | ||||||||
| Stock option exercises, RSUs, PSUs and PEPunits converted | 6 | 469 | 10 | 708 | 9 | 712 | ||||||||||||||
| Other | — | 2 | — | 3 | — | 5 | ||||||||||||||
| Balance, end of year | (458 | ) | (34,286 | ) | (446 | ) | (32,757 | ) | (438 | ) | (31,468 | ) | ||||||||
| Total PepsiCo Common Shareholders’ Equity | 14,518 | 11,045 | 11,246 | |||||||||||||||||
| Noncontrolling Interests | ||||||||||||||||||||
| Balance, beginning of year | 92 | 104 | 107 | |||||||||||||||||
| Net income attributable to noncontrolling interests | 44 | 51 | 50 | |||||||||||||||||
| Distributions to noncontrolling interests | (49 | ) | (62 | ) | (55 | ) | ||||||||||||||
| Currency translation adjustment | — | — | 4 | |||||||||||||||||
| Other, net | (3 | ) | (1 | ) | (2 | ) | ||||||||||||||
| Balance, end of year | 84 | 92 | 104 | |||||||||||||||||
| Total Equity | $ | 14,602 | $ | 10,981 | $ | 11,199 |
(a) Includes total tax benefits of $110 million in 2016.
(b) Cash dividends declared per common share were $3.5875, $3.1675 and $2.96 for 2018, 2017 and 2016, respectively.
See accompanying notes to the consolidated financial statements.
Notes to Consolidated Financial Statements
Note 1 — Basis of Presentation and Our Divisions
Basis of Presentation
The accompanying financial statements have been prepared in accordance with U.S. GAAP and include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates using the equity method based on our economic ownership interest, our ability to exercise significant influence over the operating or financial decisions of these affiliates or our ability to direct their economic resources. We do not control these other affiliates, as our ownership in these other affiliates is generally 50% or less. Intercompany balances and transactions are eliminated. As a result of exchange restrictions and other operating restrictions, we do not have control over our Venezuelan subsidiaries. As such, our Venezuelan subsidiaries are not included within our consolidated financial results for any period presented.
Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to production planning, inspection costs and raw materials handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product, including merchandising activities, are included in selling, general and administrative expenses.
The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, tax reserves, share-based compensation, pension and retiree medical accruals, amounts and useful lives for intangible assets and future cash flows associated with impairment testing for perpetual brands, goodwill and other long-lived assets. We evaluate our estimates on an ongoing basis using our historical experience, as well as other factors we believe appropriate under the circumstances, such as current economic conditions, and adjust or revise our estimates as circumstances change. As future events and their effect cannot be determined with precision, actual results could differ significantly from these estimates.
Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. Our fiscal 2016 results included an extra week. While our North America results are reported on a weekly calendar basis, most of our international operations report on a monthly calendar basis. Certain operations in our ESSA segment report on a weekly calendar basis. The following chart details our quarterly reporting schedule:
| Quarter | United States and Canada | International | ||
| First Quarter | 12 weeks | January, February | ||
| Second Quarter | 12 weeks | March, April and May | ||
| Third Quarter | 12 weeks | June, July and August | ||
| Fourth Quarter | 16 weeks (17 weeks for 2016) | September, October, November and December |
See “Our Divisions” below, and for additional unaudited information on items affecting the comparability of our consolidated results, see further unaudited information in “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Unless otherwise noted, tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless otherwise noted, and are based on unrounded amounts. Certain reclassifications were made to the prior years’ financial statements to conform to the current year presentation, including the adoption of the recently issued accounting pronouncements disclosed in Note 2.
Our Divisions
Through our operations, authorized bottlers, contract manufacturers and other third parties, we make, market, distribute and sell a wide variety of convenient beverages, foods and snacks, serving customers and consumers in more than 200 countries and territories with our largest operations in North America, Mexico, Russia, the United Kingdom and Brazil. Division results are based on how our Chief Executive Officer assesses the performance of and allocates resources to our divisions and are considered our reportable segments. For additional unaudited information on our divisions, see “Our Operations” contained in “Item 1. Business.” The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies:
| • | share-based compensation expense; |
| • | pension and retiree medical expense; and |
| • | derivatives. |
Share-Based Compensation Expense
Our divisions are held accountable for share-based compensation expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost.
The allocation of share-based compensation expense of each division is as follows:
| 2018 | 2017 | 2016 | ||||||
| FLNA | 13 | % | 13 | % | 14 | % | ||
| QFNA | 1 | % | 1 | % | 2 | % | ||
| NAB | 18 | % | 18 | % | 22 | % | ||
| Latin America | 8 | % | 7 | % | 7 | % | ||
| ESSA | 9 | % | 9 | % | 11 | % | ||
| AMENA | 8 | % | 9 | % | 10 | % | ||
| Corporate unallocated expenses | 43 | % | 43 | % | 34 | % |
The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which reflect market conditions over which division management has no control. Therefore, any variances between allocated expense and our actual expense are recognized in corporate unallocated expenses.
Pension and Retiree Medical Expense
Pension and retiree medical service costs measured at fixed discount rates are reflected in division results. The variance between the fixed discount rate used to determine the service cost reflected in division results and the discount rate as disclosed in Note 7 is reflected in corporate unallocated expenses.
Derivatives
We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include energy, agricultural products and metals. Commodity derivatives that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. These derivatives hedge underlying commodity price risk and were not entered into for trading or speculative purposes.
Net revenue and operating profit of each division are as follows:
| Net Revenue | Operating Profit(b) | ||||||||||||||||||||||
| 2018(a) | 2017 | 2016 | 2018 | 2017(c) | 2016(c) | ||||||||||||||||||
| FLNA | $ | 16,346 | $ | 15,798 | $ | 15,549 | $ | 5,008 | $ | 4,793 | $ | 4,612 | |||||||||||
| QFNA | 2,465 | 2,503 | 2,564 | 637 | 640 | 649 | |||||||||||||||||
| NAB | 21,072 | 20,936 | 21,312 | 2,276 | 2,700 | 2,947 | |||||||||||||||||
| Latin America | 7,354 | 7,208 | 6,820 | 1,049 | 924 | 904 | |||||||||||||||||
| ESSA | 11,523 | 11,050 | 10,216 | 1,364 | 1,316 | 1,061 | |||||||||||||||||
| AMENA | 5,901 | 6,030 | 6,338 | 1,172 | 1,073 | 619 | |||||||||||||||||
| Total division | 64,661 | 63,525 | 62,799 | 11,506 | 11,446 | 10,792 | |||||||||||||||||
| Corporate unallocated expenses | — | — | — | (1,396 | ) | (1,170 | ) | (988 | ) | ||||||||||||||
| $ | 64,661 | $ | 63,525 | $ | 62,799 | $ | 10,110 | $ | 10,276 | $ | 9,804 |
| (a) | Our primary performance obligation is the distribution and sales of beverage products and food and snack products to our customers, each comprising approximately 50% of our consolidated net revenue. Internationally, our Latin America segment is predominantly a food and snack business, ESSA’s beverage business and food and snack business are each approximately 50% of the segment’s net revenue and AMENA’s beverage business and food and snack business are approximately 35% and 65%, respectively, of the segment’s net revenue. Beverage revenue from company-owned bottlers, which primarily includes our consolidated bottling operations in our NAB and ESSA segments, is approximately 40% of our consolidated net revenue. Generally, our finished goods beverage operations produce higher net revenue, but lower operating margins as compared to concentrate sold to authorized bottling partners for the manufacture of finished goods beverages. See Note 2 for additional information. |
| (b) | For further unaudited information on certain items that impacted our financial performance, see “Item 6. Selected Financial Data.” |
| (c) | Reflects the retrospective adoption of guidance requiring the presentation of non-service cost components of net periodic benefit cost below operating profit. See Note 2 for additional information. |
Corporate Unallocated Expenses
Corporate unallocated expenses include costs of our corporate headquarters, centrally managed initiatives such as commodity derivative gains and losses, foreign exchange transaction gains and losses, our ongoing business transformation initiatives, unallocated research and development costs, unallocated insurance and benefit programs, and certain other items.
Other Division Information
Total assets and capital spending of each division are as follows:
| Total Assets | Capital Spending | ||||||||||||||||||
| 2018 | 2017 | 2018 | 2017 | 2016 | |||||||||||||||
| FLNA | $ | 6,577 | $ | 5,979 | $ | 840 | $ | 665 | $ | 801 | |||||||||
| QFNA | 870 | 804 | 53 | 44 | 41 | ||||||||||||||
| NAB | 29,878 | 28,592 | 945 | 904 | 769 | ||||||||||||||
| Latin America | 6,458 | 4,976 | 492 | 481 | 507 | ||||||||||||||
| ESSA (a) | 17,410 | 13,556 | 479 | 481 | 439 | ||||||||||||||
| AMENA | 6,433 | 5,668 | 323 | 308 | 381 | ||||||||||||||
| Total division | 67,626 | 59,575 | 3,132 | 2,883 | 2,938 | ||||||||||||||
| Corporate (b) | 10,022 | 20,229 | 150 | 86 | 102 | ||||||||||||||
| $ | 77,648 | $ | 79,804 | $ | 3,282 | $ | 2,969 | $ | 3,040 |
| (a) | In 2018, the change in assets was primarily related to our acquisition of SodaStream. |
| (b) | Corporate assets consist principally of certain cash and cash equivalents, restricted cash, short-term investments, derivative instruments, property, plant and equipment and tax assets. In 2018, the change in assets was primarily due to a decrease in short-term investments and cash and cash equivalents. Refer to the cash flow statement for additional information. |
Amortization of intangible assets and depreciation and other amortization of each division are as follows:
| Amortization of Intangible Assets | Depreciation and Other Amortization | ||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | ||||||||||||||||||
| FLNA | $ | 7 | $ | 7 | $ | 7 | $ | 457 | $ | 449 | $ | 435 | |||||||||||
| QFNA | — | — | — | 45 | 47 | 50 | |||||||||||||||||
| NAB | 31 | 31 | 37 | 821 | 780 | 809 | |||||||||||||||||
| Latin America | 5 | 5 | 5 | 253 | 245 | 211 | |||||||||||||||||
| ESSA | 23 | 22 | 18 | 331 | 329 | 321 | |||||||||||||||||
| AMENA | 3 | 3 | 3 | 237 | 257 | 294 | |||||||||||||||||
| Total division | 69 | 68 | 70 | 2,144 | 2,107 | 2,120 | |||||||||||||||||
| Corporate | — | — | — | 186 | 194 | 178 | |||||||||||||||||
| $ | 69 | $ | 68 | $ | 70 | $ | 2,330 | $ | 2,301 | $ | 2,298 |
Net revenue and long-lived assets by country are as follows:
| Net Revenue | Long-Lived Assets(a) | ||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | |||||||||||||||
| United States | $ | 37,148 | $ | 36,546 | $ | 36,732 | $ | 29,169 | $ | 28,418 | |||||||||
| Mexico | 3,878 | 3,650 | 3,431 | 1,404 | 1,205 | ||||||||||||||
| Russia (b) | 3,191 | 3,232 | 2,648 | 3,926 | 4,708 | ||||||||||||||
| Canada | 2,736 | 2,691 | 2,692 | 2,565 | 2,739 | ||||||||||||||
| United Kingdom | 1,743 | 1,650 | 1,737 | 759 | 817 | ||||||||||||||
| Brazil | 1,335 | 1,427 | 1,305 | 639 | 777 | ||||||||||||||
| All other countries (c) | 14,630 | 14,329 | 14,254 | 12,169 | 9,200 | ||||||||||||||
| $ | 64,661 | $ | 63,525 | $ | 62,799 | $ | 50,631 | $ | 47,864 |
| (a) | Long-lived assets represent property, plant and equipment, indefinite-lived intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. |
| (b) | Change in net revenue in 2017 primarily reflects appreciation of the Russian ruble. Change in long-lived assets in 2018 primarily reflects depreciation of the Russian ruble. |
| (c) | Change in long-lived assets in 2018 primarily related to our acquisition of SodaStream. |
Note 2 — Our Significant Accounting Policies
Revenue Recognition
We recognize revenue when our performance obligation is satisfied. Our primary performance obligation (the distribution and sales of beverage products and food and snack products) is satisfied upon the shipment or delivery of products to our customers, which is also when control is transferred. Merchandising activities are performed after a customer obtains control of the product, are accounted for as fulfillment of our performance obligation to ship or deliver product to our customers and are recorded in selling, general and administrative expenses. Merchandising activities are immaterial in the context of our contracts.
The transfer of control of products to our customers is typically based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled products is to remove and replace damaged and out-of-date products from store shelves to ensure that consumers receive the product quality and freshness they expect. Similarly, our policy for certain warehouse-distributed products is to replace damaged and out-of-date products. As a result, we record reserves, based on estimates, for anticipated damaged and out-of-date products.
In addition, upon adoption of the revenue recognition guidance (see subsequent discussion of “Recently Issued Accounting Pronouncements - Adopted”), we exclude from net revenue and cost of sales, all sales,
use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions.
Our products are sold for cash or on credit terms. Our credit terms, which are established in accordance with local and industry practices, typically require payment within 30 days of delivery in the United States, and generally within 30 to 90 days internationally, and may allow discounts for early payment.
We estimate and reserve for our bad debt exposure based on our experience with past due accounts and collectibility, the aging of accounts receivable and our analysis of customer data. Bad debt expense is classified within selling, general and administrative expenses on our income statement.
We are exposed to concentration of credit risk from our major customers, including Walmart. In 2018, sales to Walmart (including Sam’s) represented approximately 13% of our consolidated net revenue, including concentrate sales to our independent bottlers, which were used in finished goods sold by them to Walmart. We have not experienced credit issues with these customers.
Total Marketplace Spending
We offer sales incentives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activities. Sales incentives and discounts are primarily accounted for as a reduction of revenue and include payments to customers for performing activities on our behalf, such as payments for in-store displays, payments to gain distribution of new products, payments for shelf space and discounts to promote lower retail prices. Sales incentives and discounts also include support provided to our independent bottlers through funding of advertising and other marketing activities.
A number of our sales incentives, such as bottler funding to independent bottlers and customer volume rebates, are based on annual targets, and accruals are established during the year for the expected payout. These accruals are based on contract terms and our historical experience with similar programs and require management judgment with respect to estimating customer participation and performance levels. Differences between estimated expense and actual incentive costs are normally insignificant and are recognized in earnings in the period such differences are determined. In addition, certain advertising and marketing costs are also based on annual targets and recognized during the year as incurred.
The terms of most of our incentive arrangements do not exceed a year, and, therefore, do not require highly uncertain long-term estimates. Certain arrangements, such as fountain pouring rights, may extend beyond one year. Upfront payments to customers under these arrangements are recognized over the shorter of the economic or contractual life, primarily as a reduction of revenue, and the remaining balances of $218 million as of December 29, 2018 and $262 million as of December 30, 2017 are included in prepaid expenses and other current assets and other assets on our balance sheet. For additional unaudited information on our sales incentives, see “Our Customers” in “Item 1. Business.”
For interim reporting, our policy is to allocate our forecasted full-year sales incentives for most of our programs to each of our interim reporting periods in the same year that benefits from the programs. The allocation methodology is based on our forecasted sales incentives for the full year and the proportion of each interim period’s actual gross revenue or volume, as applicable, to our forecasted annual gross revenue or volume, as applicable. Based on our review of the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized beginning in the interim period that they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for certain advertising and other marketing activities. Our annual financial statements are not impacted by this interim allocation methodology.
Advertising and other marketing activities, reported as selling, general and administrative expenses, totaled $4.2 billion in 2018, $4.1 billion in 2017 and $4.2 billion in 2016, including advertising expenses of $2.6 billion in 2018, $2.4 billion in 2017 and $2.5 billion in 2016. Deferred advertising costs are not expensed until the year first used and consist of:
| • | media and personal service prepayments; |
| • | promotional materials in inventory; and |
| • | production costs of future media advertising. |
Deferred advertising costs of $47 million and $46 million as of December 29, 2018 and December 30, 2017, respectively, are classified as prepaid expenses and other current assets on our balance sheet.
Distribution Costs
Distribution costs, including the costs of shipping and handling activities, which include certain merchandising activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $10.5 billion in 2018, $9.9 billion in 2017 and $9.7 billion in 2016.
Cash Equivalents
Cash equivalents are highly liquid investments with original maturities of three months or less.
Software Costs
We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use when both the preliminary project stage is completed and it is probable that the software will be used as intended. Capitalized software costs include (i) external direct costs of materials and services utilized in developing or obtaining computer software, (ii) compensation and related benefits for employees who are directly associated with the software projects and (iii) interest costs incurred while developing internal-use computer software. Capitalized software costs are included in property, plant and equipment on our balance sheet and amortized on a straight-line basis when placed into service over the estimated useful lives of the software, which approximate five to 10 years. Software amortization totaled $204 million in 2018, $224 million in 2017 and $214 million in 2016. Net capitalized software and development costs were $577 million and $686 million as of December 29, 2018 and December 30, 2017, respectively.
Commitments and Contingencies
We are subject to various claims and contingencies related to lawsuits, certain taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional unaudited information on our commitments, see “Our Liquidity and Capital Resources” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Research and Development
We engage in a variety of research and development activities and continue to invest to accelerate growth and to drive innovation globally. Consumer research is excluded from research and development costs and included in other marketing costs. Research and development costs were $680 million, $737 million and $760 million in 2018, 2017 and 2016, respectively, and are reported within selling, general and administrative expenses.
See “Research and Development” in “Item 1. Business” for additional unaudited information about our research and development activities.
Goodwill and Other Intangible Assets
Indefinite-lived intangible assets and goodwill are not amortized and, as a result, are assessed for impairment at least annually, using either a qualitative or quantitative approach. We perform this annual assessment during our third quarter. Where we use the qualitative assessment, first we determine if, based on qualitative factors, it is more likely than not that an impairment exists. Factors considered include macroeconomic, industry and competitive conditions, legal and regulatory environment, historical financial performance and significant changes in the brand or reporting unit. If the qualitative assessment indicates that it is more likely than not that an impairment exists, then a quantitative assessment is performed.
In the quantitative assessment of indefinite lived-intangible assets and goodwill, an assessment is performed to determine the fair value of the indefinite-lived intangible asset and the reporting unit, respectively. Estimated fair value is determined using discounted cash flows and requires an analysis of several estimates including future cash flows or income consistent with management’s strategic business plans, annual sales growth rates, perpetuity growth assumptions and the selection of assumptions underlying a discount rate (weighted-average cost of capital) based on market data available at the time. Significant management judgment is necessary to estimate the impact of competitive operating, macroeconomic and other factors to estimate future levels of sales, operating profit or cash flows. All assumptions used in our impairment evaluations for indefinite-lived intangible assets and goodwill, such as forecasted growth rates and weighted-average cost of capital, are based on the best available market information and are consistent with our internal forecasts and operating plans. These assumptions could be adversely impacted by certain of the risks described in “Item 1A. Risk Factors” and “Our Business Risks” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Amortizable intangible assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. If an evaluation of the undiscounted future cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on its discounted future cash flows.
See also Note 4, and for additional unaudited information on goodwill and other intangible assets, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Other Significant Accounting Policies
Our other significant accounting policies are disclosed as follows:
| • | Basis of Presentation – Note 1 includes a description of our policies regarding use of estimates, basis of presentation and consolidation. |
| • | Property, Plant and Equipment – Note 4. |
| • | Income Taxes – Note 5, and for additional unaudited information, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
| • | Share-Based Compensation – Note 6. |
| • | Pension, Retiree Medical and Savings Plans – Note 7, and for additional unaudited information, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
| • | Financial Instruments – Note 9, and for additional unaudited information, see “Our Business Risks” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
| • | Inventories – Note 15. Inventories are valued at the lower of cost or net realizable value. Cost is determined using the average; first-in, first-out (FIFO) or, in limited instances, last-in, first-out (LIFO) methods. |
| • | Translation of Financial Statements of Foreign Subsidiaries – Financial statements of foreign subsidiaries are translated into U.S. dollars using period-end exchange rates for assets and liabilities |
and weighted-average exchange rates for revenues and expenses. Adjustments resulting from translating net assets are reported as a separate component of accumulated other comprehensive loss within common shareholders’ equity as currency translation adjustment.
Recently Issued Accounting Pronouncements - Adopted
In 2017, the Financial Accounting Standards Board (FASB) issued guidance to retrospectively present the service cost component of net periodic benefit cost for pension and retiree medical plans along with other compensation costs in operating profit and present the other components of net periodic benefit cost separately below operating profit in the income statement. The guidance also allows only the service cost component of net periodic benefit cost to be eligible for capitalization within inventory or fixed assets on a prospective basis. We adopted the provisions of this guidance retrospectively in the first quarter of 2018, using historical information previously disclosed in our pension and retiree medical benefits footnote as the estimation basis. We also updated our allocation of service costs to our divisions to better approximate actual service cost. The impact from retrospective adoption of this guidance resulted in an increase to cost of sales and selling, general and administrative expenses of $11 million and $222 million, respectively, for the year ended December 30, 2017 and an increase of $13 million and a decrease of $32 million, respectively, for the year ended December 31, 2016. We recorded a corresponding increase of $233 million and decrease of $19 million for the years ended December 30, 2017 and December 31, 2016, respectively, to other pension and retiree medical benefits income/(expense) below operating profit.
The (decreases)/increases to operating profit for each division and to corporate unallocated expenses are as follows:
| 2017(a) | 2016(b) | |||||||
| FLNA | $ | (30 | ) | $ | (47 | ) | ||
| QFNA | (2 | ) | (4 | ) | ||||
| NAB | (7 | ) | (12 | ) | ||||
| Latin America | 16 | 17 | ||||||
| ESSA | (38 | ) | (47 | ) | ||||
| AMENA | — | — | ||||||
| Corporate unallocated expenses | (172 | ) | 112 | (c) | ||||
| Total | $ | (233 | ) | $ | 19 |
| (a) | Includes restructuring charges of $66 million, including $13 million in our FLNA segment, $2 million in our QFNA segment, $11 million in our NAB segment, $7 million in our Latin America segment and $33 million in corporate unallocated expenses. See “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
| (b) | Includes restructuring charges of $5 million, including $1 million in our FLNA segment, $2 million in our NAB segment and $2 million in corporate unallocated expenses. See “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
| (c) | Reflects a settlement charge of $242 million related to a group annuity contract purchase. See “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
The changes described above had no impact on our consolidated net revenue, net income or earnings per share. See Note 7 for further information on our service cost and other components of net periodic benefit cost for pension and retiree medical plans.
In 2016, the FASB issued guidance to clarify how restricted cash should be presented in the cash flow statement. We adopted the provisions of this guidance retrospectively during the first quarter of 2018; the adoption did not have a material impact on our financial statements and primarily related to collateral posted against our derivative asset or liability positions. See Note 9 and Note 13 for further information.
In 2016, the FASB issued guidance that requires companies to account for the income tax effects of intercompany transfers of assets, other than inventory, when the transfer occurs versus deferring income tax effects until the transferred asset is sold to an outside party or otherwise recognized. We adopted the provisions of this guidance during the first quarter of 2018; the adoption did not have a material impact on our financial statements and we recorded an adjustment of $8 million to beginning retained earnings.
In 2016, the FASB issued guidance that requires companies to measure investments in certain equity securities at fair value and recognize any changes in fair value in net income. We adopted the provisions of this guidance during the first quarter of 2018; the adoption did not have an impact on our financial statements. See Note 9 for further information on our investments in equity securities.
In 2014, the FASB issued guidance on revenue recognition, with final amendments issued in 2016. The guidance provides for a five-step model to determine the revenue recognized for the transfer of goods or services to customers that reflects the expected entitled consideration in exchange for those goods or services. It also provides clarification for principal versus agent considerations and identifying performance obligations. In addition, the FASB introduced practical expedients related to disclosures of remaining performance obligations, as well as other amendments related to guidance on collectibility, non-cash consideration and the presentation of sales and other similar taxes. Financial statement disclosures required under the guidance will enable users to understand the nature, amount, timing, judgments and uncertainty of revenue and cash flows relating to customer contracts. The two permitted transition methods under the guidance are the full retrospective approach or a cumulative effect adjustment to the opening retained earnings in the year of adoption (cumulative effect approach). We adopted the guidance applied to all contracts using the cumulative effect approach during the first quarter of 2018; the adoption did not have a material impact on our financial statements.
We utilized a comprehensive approach to assess the impact of the guidance on our contract portfolio by reviewing our current accounting policies and practices to identify potential differences that would result from applying the new requirements to our revenue contracts, including evaluation of our performance obligations, principal versus agent considerations and variable consideration. We completed our contract and business process reviews and implemented changes to our controls and disclosures under the new guidance.
As a result of the implementation of the guidance, which did not have a material impact on our accounting policies upon adoption, in the first quarter of 2018, we recorded an adjustment of $137 million to beginning retained earnings to reflect marketplace spending that our customers and independent bottlers expect to be entitled to in line with revenue recognition. In addition, we excluded from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions that were not already excluded. The impact of these taxes previously recognized in net revenue and cost of sales was approximately $75 million for the fiscal year ended December 30, 2017, with no impact on operating profit.
Recently Issued Accounting Pronouncements - Not Yet Adopted
In 2018, the FASB issued guidance related to the TCJ Act for the optional reclassification of the residual tax effects, arising from the change in corporate tax rate, in accumulated other comprehensive loss to retained earnings. The reclassification is the difference between the amount previously recorded in other comprehensive income at the historical U.S. federal tax rate that remains in accumulated other comprehensive loss at the time the TCJ Act was effective and the amount that would have been recorded using the newly enacted rate. If elected, the guidance can be applied retrospectively to each period during which the impact of the TCJ Act is recognized or in the period of adoption. We will adopt the guidance when it becomes effective in the first quarter of 2019, but we are not planning to make the optional reclassification.
In 2017, the FASB issued guidance to amend and simplify the application of hedge accounting guidance to better portray the economic results of risk management activities in the financial statements. The guidance expands the ability to hedge nonfinancial and financial risk components, reduces complexity in fair value hedges of interest rate risk, eliminates the requirement to separately measure and report hedge ineffectiveness, as well as eases certain hedge effectiveness assessment requirements. Under this guidance, certain of our derivatives used to hedge commodity price risk that did not previously qualify for hedge accounting treatment will qualify prospectively. We will adopt the guidance when it becomes effective in the first quarter of 2019. The guidance is not expected to have a material impact on our financial statements or disclosures. See Note 9 for further information.
In 2016, the FASB issued guidance on leases, with amendments issued in 2018. The guidance requires lessees to recognize most leases on the balance sheet but record expenses in the income statement in a manner similar to current accounting. For lessors, the guidance modifies the classification criteria and the accounting for sales-type and direct financing leases. The two permitted transition methods under the guidance are the modified retrospective transition approach, which requires application of the guidance for all comparative periods presented, and the cumulative effect adjustment approach, which requires prospective application at the adoption date.
We continue to utilize a comprehensive approach to assess the impact of this guidance on our financial statements and related disclosures, including the increase in the assets and liabilities on our balance sheet and the impact on our current lease portfolio from both a lessor and lessee perspective. We are substantially complete with our comprehensive review of our lease portfolio including significant leases by geography and by asset type that will be impacted by the new guidance, and enhancing our controls. In addition, we are progressing on the implementation of a new software platform, and corresponding controls, for administering our leases and facilitating compliance with the new guidance.
As part of our adoption, we will not reassess historical lease classification, will not recognize short-term leases on our balance sheet, will utilize the portfolio approach to group leases with similar characteristics and will not separate lease and non-lease components for our real estate leases. We will adopt the guidance prospectively when it becomes effective in the first quarter of 2019. The guidance is not expected to have a material impact on our financial statements, with an expected increase of approximately 2% to each of our total assets and total liabilities on our balance sheet, subject to completion of our assessment. See Note 15 for our minimum lease payments under non-cancelable operating leases.
Note 3 — Restructuring and Impairment Charges
A summary of our restructuring and impairment charges and other productivity initiatives is as follows:
| 2018 | 2017 | 2016 | |||||||||
| 2019 Productivity Plan | $ | 138 | $ | — | $ | — | |||||
| 2014 Productivity Plan | 170 | 295 | 160 | ||||||||
| Total restructuring and impairment charges | 308 | 295 | 160 | ||||||||
| Other productivity initiatives | 8 | 16 | 12 | ||||||||
| Total restructuring and impairment charges and other productivity initiatives | $ | 316 | $ | 311 | $ | 172 |
2019 Multi-Year Productivity Plan
The 2019 Productivity Plan, publicly announced on February 15, 2019, will leverage new technology and business models to further simplify, harmonize and automate processes; re-engineer our go-to-market and information systems, including deploying the right automation for each market; simplify our organization and optimize our manufacturing and supply chain footprint.
A summary of our 2019 Productivity Plan charges is as follows:
| 2018 | |||
| Costs of sales | $ | 3 | |
| Selling, general and administrative expenses | 100 | ||
| Other pension and retiree medical benefits expense | 35 | ||
| Total restructuring and impairment charges | $ | 138 | |
| After-tax amount | $ | 109 | |
| Net income attributable to PepsiCo per common share | $ | 0.08 |
| 2018 | |||
| FLNA | $ | 31 | |
| QFNA | 5 | ||
| NAB | 40 | ||
| Latin America | 9 | ||
| ESSA | 8 | ||
| AMENA | 3 | ||
| Corporate | 7 | ||
| 103 | |||
| Other pension and retiree medical benefits expense | 35 | ||
| $ | 138 |
A summary of our 2019 Productivity Plan activity is as follows:
| Severance and Other Employee Costs | Asset Impairments | Other Costs(a) | Total | ||||||||||||
| 2018 restructuring charges | $ | 137 | $ | — | $ | 1 | $ | 138 | |||||||
| Non-cash charges and translation | (32 | ) | — | — | (32 | ) | |||||||||
| Liability as of December 29, 2018 | $ | 105 | $ | — | $ | 1 | $ | 106 |
| (a) | Includes other costs associated with the implementation of our initiatives, including consulting and other professional fees. |
Substantially all of the restructuring accrual at December 29, 2018 is expected to be paid by the end of 2019.
2014 Multi-Year Productivity Plan
The 2014 Productivity Plan, publicly announced on February 13, 2014, includes the next generation of productivity initiatives that we believe will strengthen our beverage, food and snack businesses by: accelerating our investment in manufacturing automation; further optimizing our global manufacturing footprint, including closing certain manufacturing facilities; re-engineering our go-to-market systems in developed markets; expanding shared services; and implementing simplified organization structures to drive efficiency. To build on the 2014 Productivity Plan, in the fourth quarter of 2017, we expanded and extended the program through the end of 2019 to take advantage of additional opportunities within the initiatives described above to further strengthen our beverage, food and snack businesses.
A summary of our 2014 Productivity Plan charges is as follows:
| 2018 | 2017 | 2016 | |||||||||
| Selling, general and administrative expenses | $ | 169 | $ | 229 | $ | 155 | |||||
| Other pension and retiree medical benefits expense | 1 | 66 | 5 | ||||||||
| Total restructuring and impairment charges | $ | 170 | $ | 295 | $ | 160 | |||||
| After-tax amount | $ | 143 | $ | 224 | $ | 134 | |||||
| Net income attributable to PepsiCo per common share | $ | 0.10 | $ | 0.16 | $ | 0.09 |
| 2018 | 2017 | 2016 | Plan to Date | ||||||||||||
| FLNA | $ | 8 | $ | 67 | $ | 13 | $ | 171 | |||||||
| QFNA | 2 | 11 | 1 | 34 | |||||||||||
| NAB | 51 | 54 | 35 | 352 | |||||||||||
| Latin America | 30 | 63 | 27 | 182 | |||||||||||
| ESSA | 55 | 53 | 60 | 282 | |||||||||||
| AMENA (a) | 25 | (3 | ) | 14 | 69 | ||||||||||
| Corporate (b) | (1 | ) | 50 | 10 | 114 | ||||||||||
| $ | 170 | $ | 295 | $ | 160 | $ | 1,204 |
| (a) | In 2017, income amount primarily reflects a gain on the sale of property, plant and equipment. |
| (b) | In 2018, income amount primarily relates to other pension and retiree medical benefits. |
| Severance and Other Employee Costs | Asset Impairments | Other Costs(a) | Total | ||||||||||||
| Plan to Date | $ | 713 | $ | 182 | $ | 309 | $ | 1,204 |
| (a) | Includes other costs associated with the implementation of our initiatives, including certain consulting and contract termination costs. |
A summary of our 2014 Productivity Plan activity is as follows:
| Severance and Other Employee Costs | Asset Impairments | Other Costs | Total | ||||||||||||
| Liability as of December 26, 2015 | $ | 61 | $ | — | $ | 20 | $ | 81 | |||||||
| 2016 restructuring charges | 88 | 36 | 36 | 160 | |||||||||||
| Cash payments | (46 | ) | — | (49 | ) | (95 | ) | ||||||||
| Non-cash charges and translation | (15 | ) | (36 | ) | 1 | (50 | ) | ||||||||
| Liability as of December 31, 2016 | 88 | — | 8 | 96 | |||||||||||
| 2017 restructuring charges | 280 | 21 | (6 | ) | (a) | 295 | |||||||||
| Cash payments | (91 | ) | — | (22 | ) | (113 | ) | ||||||||
| Non-cash charges and translation | (65 | ) | (21 | ) | 34 | (52 | ) | ||||||||
| Liability as of December 30, 2017 | 212 | — | 14 | 226 | |||||||||||
| 2018 restructuring charges | 86 | 28 | 56 | 170 | |||||||||||
| Cash payments (b) | (203 | ) | — | (52 | ) | (255 | ) | ||||||||
| Non-cash charges and translation | (4 | ) | (28 | ) | 5 | (27 | ) | ||||||||
| Liability as of December 29, 2018 | $ | 91 | $ | — | $ | 23 | $ | 114 |
| (a) | Income amount represents adjustments for changes in estimates and a gain on the sale of property, plant, and equipment. |
| (b) | Excludes cash expenditures of $11 million reported in the cash flow statement in pension and retiree medical plan contributions. |
Substantially all of the restructuring accrual at December 29, 2018 is expected to be paid by the end of 2019.
Other Productivity Initiatives
There were no material charges related to other productivity and efficiency initiatives outside the scope of the 2019 and 2014 Productivity Plans.
We regularly evaluate different productivity initiatives beyond the productivity plans and other initiatives described above.
See additional unaudited information in “Items Affecting Comparability” and “Results of Operations – Division Review” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Note 4 — Property, Plant and Equipment and Intangible Assets
A summary of our property, plant and equipment is as follows:
| Average Useful Life (Years) | 2018 | 2017 | 2016 | ||||||||||
| Property, plant and equipment, net | |||||||||||||
| Land | $ | 1,078 | $ | 1,148 | |||||||||
| Buildings and improvements | 15 - 44 | 8,941 | 8,796 | ||||||||||
| Machinery and equipment, including fleet and software | 5 - 15 | 27,715 | 27,018 | ||||||||||
| Construction in progress | 2,430 | 2,144 | |||||||||||
| 40,164 | 39,106 | ||||||||||||
| Accumulated depreciation | (22,575 | ) | (21,866 | ) | |||||||||
| $ | 17,589 | $ | 17,240 | ||||||||||
| Depreciation expense | $ | 2,241 | $ | 2,227 | $ | 2,217 |
Property, plant and equipment is recorded at historical cost. Depreciation and amortization are recognized on a straight-line basis over an asset’s estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service.
A summary of our amortizable intangible assets is as follows:
| 2018 | 2017 | 2016 | |||||||||||||||||||||||||||
| Amortizable intangible assets, net | Average Useful Life (Years) | Gross | Accumulated Amortization | Net | Gross | Accumulated Amortization | Net | ||||||||||||||||||||||
| Acquired franchise rights | 56 – 60 | $ | 838 | $ | (140 | ) | $ | 698 | $ | 858 | $ | (128 | ) | $ | 730 | ||||||||||||||
| Reacquired franchise rights | 5 – 14 | 106 | (105 | ) | 1 | 106 | (104 | ) | 2 | ||||||||||||||||||||
| Brands | 20 – 40 | 1,306 | (1,032 | ) | 274 | 1,322 | (1,026 | ) | 296 | ||||||||||||||||||||
| Other identifiable intangibles (a) | 10 – 24 | 959 | (288 | ) | 671 | 521 | (281 | ) | 240 | ||||||||||||||||||||
| $ | 3,209 | $ | (1,565 | ) | $ | 1,644 | $ | 2,807 | $ | (1,539 | ) | $ | 1,268 | ||||||||||||||||
| Amortization expense | $ | 69 | $ | 68 | $ | 70 |
| (a) | The change in 2018 is primarily related to our acquisition of SodaStream. |
Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 29, 2018 and using average 2018 foreign exchange rates, is expected to be as follows:
| 2019 | 2020 | 2021 | 2022 | 2023 | |||||||||||||||
| Five-year projected amortization | $ | 89 | $ | 89 | $ | 87 | $ | 85 | $ | 83 |
Depreciable and amortizable assets are evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future
cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. For additional unaudited information on our policies for amortizable brands, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Indefinite-Lived Intangible Assets
We did not recognize any impairment charges for goodwill in each of the fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016. We recognized no material impairment charges for indefinite-lived intangible assets in each of the fiscal years ended December 29, 2018, December 30, 2017 and December 31, 2016. As of December 29, 2018, the estimated fair values of our indefinite-lived reacquired and acquired franchise rights recorded at NAB exceeded their carrying values. However, there could be an impairment of the carrying value of NAB’s reacquired and acquired franchise rights if future revenues and their contribution to the operating results of NAB’s CSD business do not achieve our expected future cash flows or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. We have also analyzed the impact of the macroeconomic conditions in Russia and Brazil on the estimated fair value of our indefinite-lived intangible assets in these countries and have concluded that there were no material impairments for the year ended December 29, 2018. However, there could be an impairment of the carrying value of certain brands in these countries if there is a deterioration in these conditions, if future revenues and their contributions to the operating results do not achieve our expected future cash flows, if there are significant changes in the decisions regarding assets that do not perform consistent with our expectations, or if macroeconomic conditions result in a future increase in the weighted-average cost of capital used to estimate fair value. For additional information on our policies for indefinite-lived intangible assets, see Note 2.
The change in the book value of indefinite-lived intangible assets is as follows:
| Balance, Beginning 2017 | Translation and Other | Balance, End of 2017 | Acquisitions/ (Divestitures) | Translation and Other | Balance, End of 2018 | ||||||||||||||||||
| FLNA | |||||||||||||||||||||||
| Goodwill | $ | 270 | $ | 10 | $ | 280 | $ | 28 | $ | (11 | ) | $ | 297 | ||||||||||
| Brands | 23 | 2 | 25 | 138 | (2 | ) | 161 | ||||||||||||||||
| 293 | 12 | 305 | 166 | (13 | ) | 458 | |||||||||||||||||
| QFNA | |||||||||||||||||||||||
| Goodwill | 175 | — | 175 | 9 | — | 184 | |||||||||||||||||
| Brands | — | — | — | 25 | — | 25 | |||||||||||||||||
| 175 | — | 175 | 34 | — | 209 | ||||||||||||||||||
| NAB (a) | |||||||||||||||||||||||
| Goodwill | 9,843 | 11 | 9,854 | — | (41 | ) | 9,813 | ||||||||||||||||
| Reacquired franchise rights | 7,064 | 62 | 7,126 | — | (68 | ) | 7,058 | ||||||||||||||||
| Acquired franchise rights | 1,512 | 13 | 1,525 | — | (15 | ) | 1,510 | ||||||||||||||||
| Brands | 314 | 39 | 353 | — | — | 353 | |||||||||||||||||
| 18,733 | 125 | 18,858 | — | (124 | ) | 18,734 | |||||||||||||||||
| Latin America | |||||||||||||||||||||||
| Goodwill | 553 | 2 | 555 | — | (46 | ) | 509 | ||||||||||||||||
| Brands | 150 | (9 | ) | 141 | — | (14 | ) | 127 | |||||||||||||||
| 703 | (7 | ) | 696 | — | (60 | ) | 636 | ||||||||||||||||
| ESSA (b) | |||||||||||||||||||||||
| Goodwill | 3,177 | 275 | 3,452 | 526 | (367 | ) | 3,611 | ||||||||||||||||
| Reacquired franchise rights | 488 | 61 | 549 | (1 | ) | (51 | ) | 497 | |||||||||||||||
| Acquired franchise rights | 184 | 11 | 195 | (25 | ) | (9 | ) | 161 | |||||||||||||||
| Brands | 2,358 | 187 | 2,545 | 1,993 | (350 | ) | 4,188 | ||||||||||||||||
| 6,207 | 534 | 6,741 | 2,493 | (777 | ) | 8,457 | |||||||||||||||||
| AMENA | |||||||||||||||||||||||
| Goodwill | 412 | 16 | 428 | — | (34 | ) | 394 | ||||||||||||||||
| Brands | 103 | 8 | 111 | — | (10 | ) | 101 | ||||||||||||||||
| 515 | 24 | 539 | — | (44 | ) | 495 | |||||||||||||||||
| Total goodwill | 14,430 | 314 | 14,744 | 563 | (499 | ) | 14,808 | ||||||||||||||||
| Total reacquired franchise rights | 7,552 | 123 | 7,675 | (1 | ) | (119 | ) | 7,555 | |||||||||||||||
| Total acquired franchise rights | 1,696 | 24 | 1,720 | (25 | ) | (24 | ) | 1,671 | |||||||||||||||
| Total brands | 2,948 | 227 | 3,175 | 2,156 | (376 | ) | 4,955 | ||||||||||||||||
| $ | 26,626 | $ | 688 | $ | 27,314 | $ | 2,693 | $ | (1,018 | ) | $ | 28,989 |
| (a) | The change in translation and other in 2018 primarily reflects the depreciation of the Canadian dollar. |
| (b) | The change in acquisitions/(divestitures) in 2018 is primarily related to the preliminary allocation of the purchase price for our acquisition of SodaStream. See Note 14 for further information. The change in translation and other in 2018 primarily reflects the depreciation of the Russian ruble, euro and Pound sterling. The change in translation and other in 2017 primarily reflects the appreciation of the Russian ruble and euro. |
Note 5 — Income Taxes
The components of income before income taxes are as follows:
| 2018 | 2017 | 2016 | ||||||||||
| United States | $ | 3,864 | $ | 3,452 | $ | 2,630 | ||||||
| Foreign | 5,325 | 6,150 | 5,923 | |||||||||
| $ | 9,189 | $ | 9,602 | $ | 8,553 | |||||||
| The (benefit from)/provision for income taxes consisted of the following: | ||||||||||||
| 2018 | 2017 | 2016 | ||||||||||
| Current: | U.S. Federal | $ | 437 | $ | 4,925 | $ | 1,219 | |||||
| Foreign | 378 | 724 | 824 | |||||||||
| State | 63 | 136 | 77 | |||||||||
| 878 | 5,785 | 2,120 | ||||||||||
| Deferred: | U.S. Federal | 140 | (1,159 | ) | 109 | |||||||
| Foreign | (4,379 | ) | (9 | ) | (33 | ) | ||||||
| State | (9 | ) | 77 | (22 | ) | |||||||
| (4,248 | ) | (1,091 | ) | 54 | ||||||||
| $ | (3,370 | ) | $ | 4,694 | $ | 2,174 |
A reconciliation of the U.S. Federal statutory tax rate to our annual tax rate is as follows:
| 2018 | 2017 | 2016 | |||||||
| U.S. Federal statutory tax rate | 21.0 | % | 35.0 | % | 35.0 | % | |||
| State income tax, net of U.S. Federal tax benefit | 0.5 | 0.9 | 0.4 | ||||||
| Lower taxes on foreign results | (2.2 | ) | (9.4 | ) | (8.0 | ) | |||
| One-time mandatory transition tax - TCJ Act | 0.1 | 41.4 | — | ||||||
| Remeasurement of deferred taxes - TCJ Act | (0.4 | ) | (15.9 | ) | — | ||||
| International reorganizations | (47.3 | ) | — | — | |||||
| Tax settlements | (7.8 | ) | — | — | |||||
| Other, net | (0.6 | ) | (3.1 | ) | (2.0 | ) | |||
| Annual tax rate | (36.7 | )% | 48.9 | % | 25.4 | % |
Tax Cuts and Jobs Act
During the fourth quarter of 2017, the TCJ Act was enacted in the United States. Among its many provisions, the TCJ Act imposed a mandatory one-time transition tax on undistributed international earnings and reduced the U.S. corporate income tax rate from 35% to 21%, effective January 1, 2018. As a result of the enactment of the TCJ Act, we recognized a provisional net tax expense of $2.5 billion ($1.70 per share) in the fourth quarter of 2017. See further unaudited information in “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Included in the provisional net tax expense of $2.5 billion recognized in the fourth quarter of 2017, was a provisional mandatory one-time transition tax of approximately $4 billion on undistributed international earnings, included in other liabilities. This provisional mandatory one-time transition tax was partially offset by a provisional $1.5 billion benefit resulting from the required remeasurement of our deferred tax assets and liabilities to the new, lower U.S. corporate income tax rate, effective January 1, 2018. The effect of the remeasurement was recorded in the fourth quarter of 2017, consistent with the enactment date of the TCJ Act, and reflected in our provision for income taxes.
During 2018, we recognized a net tax benefit of $28 million ($0.02 per share) primarily reflecting the impact of the final analysis of certain foreign exchange gains or losses, substantiation of foreign tax credits, as well as cash and cash equivalents as of November 30, 2018, the tax year-end of our foreign subsidiaries, partially offset by additional transition tax guidance issued by the United States Department of Treasury, as well as the TCJ Act impact of both the conclusion of certain international tax audits and the resolution with the IRS of all open matters related to the audits of taxable years 2012 and 2013, each discussed below.
As of December 29, 2018, our mandatory transition tax liability is $3.8 billion. Under the provisions of the TCJ Act, this transition tax liability must be paid over eight years; we currently expect to pay approximately $0.4 billion of this liability in 2019 and the remainder over the period 2020 to 2026.
The TCJ Act also created a requirement that certain income earned by foreign subsidiaries, known as GILTI, must be included in the gross income of their U.S. shareholder. The FASB allows an accounting policy election of either recognizing deferred taxes for temporary differences expected to reverse as GILTI in future years or recognizing such taxes as a current-period expense when incurred. During the first quarter of 2018, we elected to treat the tax effect of GILTI as a current-period expense when incurred.
In 2017, the SEC issued guidance related to the TCJ Act which allowed recording of provisional tax expense using a measurement period, not to exceed one year, when information necessary to complete the accounting for the effects of the TCJ Act is not available. We elected to apply the measurement period provisions of this guidance to certain income tax effects of the TCJ Act when it became effective in the fourth quarter of 2017. The provisional measurement period ended in the fourth quarter of 2018. While our accounting for the recorded impact of the TCJ Act is deemed to be complete, these amounts are based on prevailing regulations and currently available information, and any additional guidance issued by the IRS could impact the aforementioned amounts in future periods.
For further unaudited information and discussion, refer to “Item 1A. Risk Factors,” “Our Business Risks,” “Our Liquidity and Capital Resources” and “Our Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
International Reorganizations
During the fourth quarter of 2018, we reorganized certain of our international operations, including the intercompany transfer of certain intangible assets. As a result, we recognized other net tax benefits of $4.3 billion ($3.05 per share). The related deferred tax asset of $4.4 billion is expected to be amortized over a period of 15 years beginning in 2019. Additionally, the reorganization generated significant net operating loss carryforwards and related deferred tax assets that are not expected to be realized, resulting in the recording of a full valuation allowance.
Deferred tax liabilities and assets are comprised of the following:
Deferred Tax Liabilities
| 2018 | 2017 | ||||||
| Debt guarantee of wholly-owned subsidiary | $ | 578 | $ | 578 | |||
| Property, plant and equipment | 1,303 | 1,397 | |||||
| Intangible assets other than nondeductible goodwill | — | 3,169 | |||||
| Recapture of net operating losses | 414 | — | |||||
| Other | 71 | 50 | |||||
| Gross deferred tax liabilities | 2,366 | 5,194 | |||||
| Deferred tax assets | |||||||
| Net carryforwards | 4,353 | 1,400 | |||||
| Intangible assets other than nondeductible goodwill | 985 | — | |||||
| Share-based compensation | 106 | 107 | |||||
| Retiree medical benefits | 167 | 198 | |||||
| Other employee-related benefits | 303 | 338 | |||||
| Pension benefits | 221 | 22 | |||||
| Deductible state tax and interest benefits | 110 | 157 | |||||
| Other | 739 | 893 | |||||
| Gross deferred tax assets | 6,984 | 3,115 | |||||
| Valuation allowances | (3,753 | ) | (1,163 | ) | |||
| Deferred tax assets, net | 3,231 | 1,952 | |||||
| Net deferred tax (assets)/liabilities | $ | (865 | ) | $ | 3,242 |
A summary of our valuation allowance activity is as follows:
| 2018 | 2017 | 2016 | |||||||||
| Balance, beginning of year | $ | 1,163 | $ | 1,110 | $ | 1,136 | |||||
| Provision | 2,639 | 33 | 13 | ||||||||
| Other (deductions)/additions | (49 | ) | 20 | (39 | ) | ||||||
| Balance, end of year | $ | 3,753 | $ | 1,163 | $ | 1,110 |
For additional unaudited information on our income tax policies, including our reserves for income taxes, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Reserves
A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. Our major taxing jurisdictions and the related open tax audits are as follows:
| Jurisdiction | Years Open to Audit | Years Currently Under Audit | ||
| United States | 2014-2017 | 2014-2016 | ||
| Mexico | 2017 | None | ||
| United Kingdom | 2016-2017 | None | ||
| Canada (Domestic) | 2014-2017 | 2014-2015 | ||
| Canada (International) | 2010-2017 | 2010-2015 | ||
| Russia | 2014-2017 | 2014-2017 |
During 2018, we recognized a non-cash tax benefit of $364 million ($0.26 per share) resulting from the conclusion of certain international tax audits. Additionally, during 2018, we recognized non-cash tax benefits of $353 million ($0.24 per share) as a result of our agreement with the IRS resolving all open matters related to the audits of taxable years 2012 and 2013, including the associated state impact.
While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. We adjust these reserves, as well as the related interest, in light of changing facts and circumstances. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. For further unaudited information on the impact of the resolution of open tax issues, see “Other Consolidated Results” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
As of December 29, 2018, the total gross amount of reserves for income taxes, reported in other liabilities, was $1.4 billion. We accrue interest related to reserves for income taxes in our provision for income taxes and any associated penalties are recorded in selling, general and administrative expenses. The gross amount of interest accrued, reported in other liabilities, was $179 million as of December 29, 2018, which reflects a reduction of the prior year liability of $64 million of tax benefit that was recognized in 2018. The gross amount of interest accrued, reported in other liabilities, was $283 million as of December 30, 2017, of which $89 million of expense was recognized in 2017.
A reconciliation of unrecognized tax benefits is as follows:
| 2018 | 2017 | ||||||
| Balance, beginning of year | $ | 2,212 | $ | 1,885 | |||
| Additions for tax positions related to the current year | 142 | 309 | |||||
| Additions for tax positions from prior years | 197 | 86 | |||||
| Reductions for tax positions from prior years | (822 | ) | (51 | ) | |||
| Settlement payments | (233 | ) | (4 | ) | |||
| Statutes of limitations expiration | (42 | ) | (33 | ) | |||
| Translation and other | (14 | ) | 20 | ||||
| Balance, end of year | $ | 1,440 | $ | 2,212 |
Carryforwards and Allowances
Operating loss carryforwards totaling $24.9 billion at year-end 2018 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.2 billion in 2019, $20.5 billion between 2020 and 2038 and $4.2 billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Undistributed International Earnings
In connection with the enactment of the TCJ Act, during 2018, we repatriated $20.4 billion of cash, cash equivalents and short-term investments held in our foreign subsidiaries without such funds being subject to further U.S. federal income tax liability. As of December 29, 2018, we had approximately $24 billion of undistributed international earnings. We intend to continue to reinvest $24 billion of earnings outside the United States for the foreseeable future and while U.S. federal tax expense has been recognized as a result of the TCJ Act, no deferred tax liabilities with respect to items such as certain foreign exchange gains or
losses, foreign withholding taxes or state taxes have been recognized. It is not practicable for us to determine the amount of unrecognized tax expense on these reinvested international earnings.
Note 6 — Share-Based Compensation
Our share-based compensation program is designed to attract and retain employees while also aligning employees’ interests with the interests of our shareholders. PepsiCo has granted stock options, restricted stock units (RSUs), performance stock units (PSUs), PepsiCo equity performance units (PEPunits) and long-term cash awards to employees under the shareholder-approved PepsiCo, Inc. Long-Term Incentive Plan (LTIP). Executives who are awarded long-term incentives based on their performance may generally elect to receive their grant in the form of stock options or RSUs, or a combination thereof. Executives who elect stock options receive four stock options for every one RSU that would have otherwise been granted. Certain executive officers and other senior executives do not have a choice and were granted 66% PSUs and 34% long-term cash, each of which are subject to pre-established performance targets.
The Company may use authorized and unissued shares to meet share requirements resulting from the exercise of stock options and the vesting of RSUs, PSUs and PEPunits.
As of December 29, 2018, 66 million shares were available for future share-based compensation grants under the LTIP.
The following table summarizes our total share-based compensation expense and excess tax benefits recognized:
| 2018 | 2017 | 2016 | |||||||||
| Share-based compensation expense - equity awards | $ | 256 | $ | 292 | $ | 284 | |||||
| Share-based compensation expense - liability awards | 20 | 13 | 5 | ||||||||
| Restructuring and impairment charges | (6 | ) | (2 | ) | 5 | ||||||
| Total | $ | 270 | $ | 303 | $ | 294 | |||||
| Income tax benefits recognized in earnings related to share-based compensation | $ | 45 | $ | 89 | (a) | $ | 91 | ||||
| Excess tax benefits related to share-based compensation (b) | $ | 48 | $ | 115 | $ | 110 |
| (a) | Reflects tax rates effective for the 2017 tax year. |
| (b) | Included in provision for income taxes in the income statement in 2018 and 2017; included in capital in excess of par value in the equity statement in 2016. |
As of December 29, 2018, there was $282 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation cost is expected to be recognized over a weighted-average period of two years.
Method of Accounting and Our Assumptions
The fair value of share-based award grants is amortized to expense over the vesting period, primarily three years. Awards to employees eligible for retirement prior to the award becoming fully vested are amortized to expense over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. In addition, we use historical data to estimate forfeiture rates and record share-based compensation expense only for those awards that are expected to vest.
We do not backdate, reprice or grant share-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP.
Stock Options
A stock option permits the holder to purchase shares of PepsiCo common stock at a specified price. We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock option expense at the date of grant. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and generally have a 10-year term.
Our weighted-average Black-Scholes fair value assumptions are as follows:
| 2018 | 2017 | 2016 | ||||||
| Expected life | 5 years | 5 years | 6 years | |||||
| Risk-free interest rate | 2.6 | % | 2.0 | % | 1.4 | % | ||
| Expected volatility | 12 | % | 11 | % | 12 | % | ||
| Expected dividend yield | 2.7 | % | 2.7 | % | 2.7 | % |
The expected life is the period over which our employee groups are expected to hold their options. It is based on our historical experience with similar grants. The risk-free interest rate is based on the expected U.S. Treasury rate over the expected life. Volatility reflects movements in our stock price over the most recent historical period equivalent to the expected life. Dividend yield is estimated over the expected life based on our stated dividend policy and forecasts of net income, share repurchases and stock price.
A summary of our stock option activity for the year ended December 29, 2018 is as follows:
| Options(a) | Weighted-Average Exercise Price | Weighted-Average Contractual Life Remaining (years) | Aggregate Intrinsic Value(b) | |||||||||
| Outstanding at December 30, 2017 | 19,013 | $ | 74.23 | |||||||||
| Granted | 1,429 | $ | 108.88 | |||||||||
| Exercised | (4,377 | ) | $ | 62.95 | ||||||||
| Forfeited/expired | (476 | ) | $ | 94.85 | ||||||||
| Outstanding at December 29, 2018 | 15,589 | $ | 79.94 | 4.29 | $ | 474,746 | ||||||
| Exercisable at December 29, 2018 | 11,547 | $ | 70.74 | 2.92 | $ | 457,529 | ||||||
| Expected to vest as of December 29, 2018 | 3,713 | $ | 106.02 | 8.17 | $ | 16,606 |
| (a) | Options are in thousands and include options previously granted under the PBG plan. No additional options or shares were granted under the PBG plan after 2009. |
| (b) | In thousands. |
Restricted Stock Units and Performance Stock Units
Each RSU represents our obligation to deliver to the holder one share of PepsiCo common stock when the award vests at the end of the service period. PSUs are awards pursuant to which a number of shares are delivered to the holder upon vesting at the end of the service period based on PepsiCo’s performance against specified financial and/or operational performance metrics. The number of shares may be increased to the maximum or reduced to the minimum threshold based on the results of these performance metrics in accordance with the terms established at the time of the award. During the vesting period, RSUs and PSUs accrue dividend equivalents that pay out in cash (without interest) if and when the applicable RSU or PSU vests and becomes payable.
The fair value of RSUs is measured at the market price of the Company’s stock on the date of grant. The fair
value of PSUs is measured at the market price of the Company’s stock on the date of grant with the exception of awards with market conditions, for which we use the Monte-Carlo simulation model to determine the fair value. The Monte-Carlo simulation model uses the same input assumptions as the Black-Scholes model; however, it also further incorporates into the fair-value determination the possibility that the market condition may not be satisfied. Compensation costs related to these awards are recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided.
A summary of our RSU and PSU activity for the year ended December 29, 2018 is as follows:
| RSUs/PSUs(a) | Weighted-Average Grant-Date Fair Value | Weighted-Average Contractual Life Remaining (years) | Aggregate Intrinsic Value(a) | |||||||||
| Outstanding at December 30, 2017 | 7,293 | $ | 102.30 | |||||||||
| Granted (b) | 2,634 | $ | 108.75 | |||||||||
| Converted | (2,362 | ) | $ | 99.73 | ||||||||
| Forfeited | (647 | ) | $ | 105.21 | ||||||||
| Actual performance change (c) | 257 | $ | 98.92 | |||||||||
| Outstanding at December 29, 2018 (d) | 7,175 | $ | 105.13 | 1.22 | $ | 791,878 | ||||||
| Expected to vest as of December 29, 2018 | 6,667 | $ | 104.90 | 1.15 | $ | 735,813 |
| (a) | In thousands. |
| (b) | Grant activity for all PSUs are disclosed at target. |
| (c) | Reflects the net number of PSUs above and below target levels based on actual performance measured at the end of the performance period. |
| (d) | The outstanding PSUs for which the performance period has not ended as of December 29, 2018, at the threshold, target and maximum award levels were zero, 0.9 million and 1.6 million, respectively. |
PEPunits
PEPunits provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon changes in PepsiCo’s absolute stock price as well as PepsiCo’s Total Shareholder Return relative to the S&P 500 over a three-year performance period.
The fair value of PEPunits is measured using the Monte-Carlo simulation model.
PEPunits were last granted in 2015 and all 248,000 units outstanding at December 30, 2017, with a weighted average grant date fair value of $68.94, were converted to 278,000 shares during fiscal year 2018.
Long-Term Cash
Certain executive officers and other senior executives were granted long-term cash awards for which final payout is based on PepsiCo’s Total Shareholder Return relative to a specific set of peer companies and achievement of a specified performance target over a three-year performance period.
Long-term cash awards that qualify as liability awards under share-based compensation guidance are valued through the end of the performance period on a mark-to-market basis using the Monte Carlo simulation model until actual performance is determined.
A summary of our long-term cash activity for the year ended December 29, 2018 is as follows:
| Long-Term Cash Award(a) | Balance Sheet Date Fair Value(a) | Contractual Life Remaining (years) | |||||||
| Outstanding at December 30, 2017 | $ | 33,200 | |||||||
| Granted (b) | 20,926 | ||||||||
| Forfeited | (2,292 | ) | |||||||
| Actual performance change (c) | 2,876 | ||||||||
| Outstanding at December 29, 2018 (d) | $ | 54,710 | $ | 55,809 | 1.22 | ||||
| Expected to vest as of December 29, 2018 | $ | 51,159 | $ | 52,148 | 1.17 |
| (a) | In thousands. |
| (b) | Grant activity for all long-term cash awards are disclosed at target. |
| (c) | Reflects the net number of long-term cash awards above and below target levels based on actual performance measured at the end of the performance period. |
| (d) | The outstanding long-term cash awards for which the performance period has not ended as of December 29, 2018, at the threshold, target and maximum award levels were zero, 37.3 million and 74.5 million, respectively. |
Other Share-Based Compensation Data
The following is a summary of other share-based compensation data:
| 2018 | 2017 | 2016 | |||||||||
| Stock Options | |||||||||||
| Total number of options granted (a) | 1,429 | 1,481 | 1,743 | ||||||||
| Weighted-average grant-date fair value of options granted | $ | 9.80 | $ | 8.25 | $ | 6.94 | |||||
| Total intrinsic value of options exercised (a) | $ | 224,663 | $ | 327,860 | $ | 290,131 | |||||
| Total grant-date fair value of options vested (a) | $ | 15,506 | $ | 23,122 | $ | 18,840 | |||||
| RSUs/PSUs | |||||||||||
| Total number of RSUs/PSUs granted (a) | 2,634 | 2,824 | 3,054 | ||||||||
| Weighted-average grant-date fair value of RSUs/PSUs granted | $ | 108.75 | $ | 109.92 | $ | 99.06 | |||||
| Total intrinsic value of RSUs/PSUs converted (a) | $ | 260,287 | $ | 380,269 | $ | 359,401 | |||||
| Total grant-date fair value of RSUs/PSUs vested (a) | $ | 232,141 | $ | 264,923 | $ | 257,648 | |||||
| PEPunits | |||||||||||
| Total intrinsic value of PEPunits converted (a) | $ | 30,147 | $ | 39,782 | $ | 38,558 | |||||
| Total grant-date fair value of PEPunits vested (a) | $ | 9,430 | $ | 18,833 | $ | 16,572 |
| (a) | In thousands. |
As of December 29, 2018 and December 30, 2017, there were approximately 248,000 and 250,000 outstanding awards, respectively, consisting primarily of phantom stock units that were granted under the PepsiCo Director Deferral Program and will be settled in shares of PepsiCo common stock pursuant to the LTIP at the end of the applicable deferral period, not included in the tables above.
Note 7 — Pension, Retiree Medical and Savings Plans
Effective January 1, 2017, the U.S. qualified defined benefit pension plans were reorganized into Plan A and Plan I. Actuarial gains and losses associated with Plan A are amortized over the average remaining service life of the active participants, while the actuarial gains and losses associated with Plan I are amortized over the remaining life expectancy of the inactive participants. As a result of this change, the pre-tax net periodic
benefit cost decreased by $42 million ($27 million after-tax, reflecting tax rates effective for the 2017 tax year, or $0.02 per share) in 2017, primarily impacting corporate unallocated expenses. See “Our Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
In 2016, the U.S. qualified defined benefit pension plans purchased a group annuity contract whereby an unrelated insurance company assumed the obligation to pay and administer future annuity payments for certain retirees. In 2016, we made discretionary contributions of $452 million primarily to fund the transfer of the obligation. This transaction triggered a pre-tax settlement charge of $242 million ($162 million after-tax or $0.11 per share). See additional unaudited information in “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Gains and losses resulting from actual experience differing from our assumptions, including the difference between the actual return on plan assets and the expected return on plan assets, as well as changes in our assumptions, are determined at each measurement date. These differences are recognized as a component of net gain or loss in accumulated other comprehensive loss. If this net accumulated gain or loss exceeds 10% of the greater of the market-related value of plan assets or plan liabilities, a portion of the net gain or loss is included in other pension and retiree medical benefits income/(expense) for the following year based upon the average remaining service life for participants in Plan A (approximately 10 years) and retiree medical (approximately 7 years), or the remaining life expectancy for participants in Plan I (approximately 25 years). The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in other pension and retiree medical benefits income/(expense) on a straight-line basis over the average remaining service life for participants in Plan A or the remaining life expectancy for participants in Plan I.
Selected financial information for our pension and retiree medical plans is as follows:
| Pension | Retiree Medical | ||||||||||||||||||||||
| U.S. | International | ||||||||||||||||||||||
| 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | ||||||||||||||||||
| Change in projected benefit liability | |||||||||||||||||||||||
| Liability at beginning of year | $ | 14,777 | $ | 13,192 | $ | 3,490 | $ | 3,124 | $ | 1,187 | $ | 1,208 | |||||||||||
| Service cost | 431 | 401 | 92 | 91 | 32 | 28 | |||||||||||||||||
| Interest cost | 482 | 468 | 93 | 89 | 34 | 36 | |||||||||||||||||
| Plan amendments | 83 | 10 | 2 | 2 | — | (5 | ) | ||||||||||||||||
| Participant contributions | — | — | 2 | 2 | — | — | |||||||||||||||||
| Experience (gain)/loss | (972 | ) | 1,529 | (230 | ) | 5 | (147 | ) | 21 | ||||||||||||||
| Benefit payments | (956 | ) | (825 | ) | (114 | ) | (104 | ) | (108 | ) | (107 | ) | |||||||||||
| Settlement/curtailment | (74 | ) | (58 | ) | (35 | ) | (22 | ) | — | — | |||||||||||||
| Special termination benefits | 36 | 60 | 2 | — | 1 | 2 | |||||||||||||||||
| Other, including foreign currency adjustment | — | — | (204 | ) | 303 | (3 | ) | 4 | |||||||||||||||
| Liability at end of year | $ | 13,807 | $ | 14,777 | $ | 3,098 | $ | 3,490 | $ | 996 | $ | 1,187 | |||||||||||
| Change in fair value of plan assets | |||||||||||||||||||||||
| Fair value at beginning of year | $ | 12,582 | $ | 11,458 | $ | 3,460 | $ | 2,894 | $ | 321 | $ | 320 | |||||||||||
| Actual return on plan assets | (789 | ) | 1,935 | (136 | ) | 288 | (21 | ) | 52 | ||||||||||||||
| Employer contributions/funding | 1,495 | 60 | 120 | 104 | 93 | 56 | |||||||||||||||||
| Participant contributions | — | — | 2 | 2 | — | — | |||||||||||||||||
| Benefit payments | (956 | ) | (825 | ) | (114 | ) | (104 | ) | (108 | ) | (107 | ) | |||||||||||
| Settlement | (74 | ) | (46 | ) | (32 | ) | (18 | ) | — | — | |||||||||||||
| Other, including foreign currency adjustment | — | — | (210 | ) | 294 | — | — | ||||||||||||||||
| Fair value at end of year | $ | 12,258 | $ | 12,582 | $ | 3,090 | $ | 3,460 | $ | 285 | $ | 321 | |||||||||||
| Funded status | $ | (1,549 | ) | $ | (2,195 | ) | $ | (8 | ) | $ | (30 | ) | $ | (711 | ) | $ | (866 | ) |
| Amounts recognized | |||||||||||||||||||||||
| Other assets | $ | 185 | $ | 286 | $ | 81 | $ | 85 | $ | — | $ | — | |||||||||||
| Other current liabilities | (107 | ) | (74 | ) | (1 | ) | (1 | ) | (41 | ) | (75 | ) | |||||||||||
| Other liabilities | (1,627 | ) | (2,407 | ) | (88 | ) | (114 | ) | (670 | ) | (791 | ) | |||||||||||
| Net amount recognized | $ | (1,549 | ) | $ | (2,195 | ) | $ | (8 | ) | $ | (30 | ) | $ | (711 | ) | $ | (866 | ) | |||||
| Amounts included in accumulated other comprehensive loss (pre-tax) | |||||||||||||||||||||||
| Net loss/(gain) | $ | 4,093 | $ | 3,520 | $ | 780 | $ | 782 | $ | (287 | ) | $ | (189 | ) | |||||||||
| Prior service cost/(credit) | 109 | 29 | (1 | ) | (3 | ) | (51 | ) | (71 | ) | |||||||||||||
| Total | $ | 4,202 | $ | 3,549 | $ | 779 | $ | 779 | $ | (338 | ) | $ | (260 | ) | |||||||||
| Changes recognized in net loss/(gain) included in other comprehensive loss | |||||||||||||||||||||||
| Net loss/(gain) arising in current year | $ | 760 | $ | 431 | $ | 103 | $ | (115 | ) | $ | (107 | ) | $ | (9 | ) | ||||||||
| Amortization and settlement recognition | (187 | ) | (131 | ) | (56 | ) | (60 | ) | 8 | 12 | |||||||||||||
| Foreign currency translation (gain)/loss | — | — | (49 | ) | 73 | 1 | 1 | ||||||||||||||||
| Total | $ | 573 | $ | 300 | $ | (2 | ) | $ | (102 | ) | $ | (98 | ) | $ | 4 | ||||||||
| Accumulated benefit obligation at end of year | $ | 12,890 | $ | 13,732 | $ | 2,806 | $ | 2,985 |
The net loss/(gain) arising in the current year is attributed to actual asset returns different from expected returns, partially offset by the change in discount rate.
The amount we report in operating profit as pension and retiree medical cost is service cost, which is the value of benefits earned by employees for working during the year.
The amounts we report below operating profit as pension and retiree medical cost consist of the following components:
| • | Interest cost is the accrued interest on the projected benefit obligation due to the passage of time. |
| • | Expected return on plan assets is the long-term return we expect to earn on plan investments for our funded plans that will be used to settle future benefit obligations. |
| • | Amortization of prior service cost/(credit) represents the recognition in the income statement of benefit changes resulting from plan amendments. |
| • | Amortization of net loss/(gain) represents the recognition in the income statement of changes in the amount of plan assets and the projected benefit obligation based on changes in assumptions and actual experience. |
| • | Settlement/curtailment loss/(gain) represents the result of actions that effectively eliminate all or a portion of related projected benefit obligations. Settlements are triggered when payouts to settle the projected benefit obligation of a plan due to lump sums or other events exceed the annual service and interest cost. Settlements are recognized when actions are irrevocable and we are relieved of the primary responsibility and risk for projected benefit obligations. Curtailments are due to events such as plant closures or the sale of a business resulting in a reduction of future service or benefits. Curtailment losses are recognized when an event is probable and estimable, while curtailment gains are recognized when an event has occurred (when the related employees terminate or an amendment is adopted). |
| • | Special termination benefits are the additional benefits offered to employees upon departure due to actions such as restructuring. |
The components of total pension and retiree medical benefit costs are as follows:
| Pension | Retiree Medical | ||||||||||||||||||||||||||||||||||
| U.S. | International | ||||||||||||||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | |||||||||||||||||||||||||||
| Service cost | $ | 431 | $ | 401 | $ | 393 | $ | 92 | $ | 91 | $ | 80 | $ | 32 | $ | 28 | $ | 31 | |||||||||||||||||
| Interest cost | 482 | 468 | 484 | 93 | 89 | 94 | 34 | 36 | 41 | ||||||||||||||||||||||||||
| Expected return on plan assets | (943 | ) | (849 | ) | (834 | ) | (197 | ) | (176 | ) | (163 | ) | (19 | ) | (22 | ) | (24 | ) | |||||||||||||||||
| Amortization of prior service cost/(credits) | 3 | 1 | (1 | ) | — | — | — | (20 | ) | (25 | ) | (38 | ) | ||||||||||||||||||||||
| Amortization of net losses/(gains) | 179 | 123 | 168 | 45 | 53 | 40 | (8 | ) | (12 | ) | (1 | ) | |||||||||||||||||||||||
| 152 | 144 | 210 | 33 | 57 | 51 | 19 | 5 | 9 | |||||||||||||||||||||||||||
| Settlement/curtailment losses/(gain) (a) | 8 | 8 | 245 | 6 | 11 | 9 | — | — | (14 | ) | |||||||||||||||||||||||||
| Special termination benefits | 36 | 60 | 11 | 2 | — | 1 | 1 | 2 | 1 | ||||||||||||||||||||||||||
| Total | $ | 196 | $ | 212 | $ | 466 | $ | 41 | $ | 68 | $ | 61 | $ | 20 | $ | 7 | $ | (4 | ) |
| (a) | U.S. includes a settlement charge of $242 million related to the group annuity contract purchase in 2016. See additional unaudited information in “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
The following table provides the weighted-average assumptions used to determine projected benefit liability and net periodic benefit cost for our pension and retiree medical plans:
| Pension | Retiree Medical | |||||||||||||||||||||||||
| U.S. | International | |||||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | ||||||||||||||||||
| Liability discount rate | 4.4 | % | 3.7 | % | 4.4 | % | 3.4 | % | 3.0 | % | 3.1 | % | 4.2 | % | 3.5 | % | 4.0 | % | ||||||||
| Service cost discount rate | 3.8 | % | 4.5 | % | 4.6 | % | 3.5 | % | 3.6 | % | 4.1 | % | 3.6 | % | 4.0 | % | 4.3 | % | ||||||||
| Interest cost discount rate | 3.4 | % | 3.7 | % | 3.8 | % | 2.8 | % | 2.8 | % | 3.5 | % | 3.0 | % | 3.2 | % | 3.3 | % | ||||||||
| Expected return on plan assets | 7.2 | % | 7.5 | % | 7.5 | % | 6.0 | % | 6.0 | % | 6.2 | % | 6.5 | % | 7.5 | % | 7.5 | % | ||||||||
| Liability rate of salary increases | 3.1 | % | 3.1 | % | 3.1 | % | 3.7 | % | 3.7 | % | 3.6 | % | ||||||||||||||
| Expense rate of salary increases | 3.1 | % | 3.1 | % | 3.1 | % | 3.7 | % | 3.6 | % | 3.6 | % |
The following table provides selected information about plans with accumulated benefit obligation and total projected benefit liability in excess of plan assets:
| Pension | Retiree Medical | ||||||||||||||||||||||
| U.S. | International | ||||||||||||||||||||||
| 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | ||||||||||||||||||
| Selected information for plans with accumulated benefit obligation in excess of plan assets | |||||||||||||||||||||||
| Liability for service to date | $ | (8,040 | ) | $ | (8,355 | ) | $ | (155 | ) | $ | (161 | ) | |||||||||||
| Fair value of plan assets | $ | 7,223 | $ | 6,919 | $ | 121 | $ | 119 | |||||||||||||||
| Selected information for plans with projected benefit liability in excess of plan assets | |||||||||||||||||||||||
| Benefit liability | $ | (8,957 | ) | $ | (9,400 | ) | $ | (514 | ) | $ | (1,273 | ) | $ | (996 | ) | $ | (1,187 | ) | |||||
| Fair value of plan assets | $ | 7,223 | $ | 6,919 | $ | 426 | $ | 1,158 | $ | 285 | $ | 321 |
Of the total projected pension benefit liability as of December 29, 2018, approximately $830 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment.
Future Benefit Payments
Our estimated future benefit payments are as follows:
| 2019 | 2020 | 2021 | 2022 | 2023 | 2024 - 2028 | ||||||||||||||||||
| Pension | $ | 1,060 | $ | 960 | $ | 875 | $ | 915 | $ | 950 | $ | 5,265 | |||||||||||
| Retiree medical (a) | $ | 115 | $ | 105 | $ | 100 | $ | 100 | $ | 95 | $ | 395 |
| (a) | Expected future benefit payments for our retiree medical plans do not reflect any estimated subsidies expected to be received under the 2003 Medicare Act. Subsidies are expected to be approximately $2 million for each of the years from 2019 through 2023 and approximately $6 million in total for 2024 through 2028. |
These future benefit payments to beneficiaries include payments from both funded and unfunded plans.
Funding
Contributions to our pension and retiree medical plans were as follows:
| Pension | Retiree Medical | ||||||||||||||||||||||
| 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | ||||||||||||||||||
| Discretionary (a) | $ | 1,417 | $ | 6 | $ | 459 | $ | 37 | $ | — | $ | — | |||||||||||
| Non-discretionary | 198 | 158 | 200 | 56 | 56 | 36 | |||||||||||||||||
| Total | $ | 1,615 | $ | 164 | $ | 659 | $ | 93 | $ | 56 | $ | 36 |
| (a) | Includes $1.4 billion contribution in 2018 to fund Plan A in the United States. Includes $452 million in 2016 relating to the funding of the group annuity contract purchase from an unrelated insurance company. |
In January 2019, we made discretionary contributions of $150 million to Plan A in the United States. In addition, in 2019, we expect to make non-discretionary contributions of approximately $205 million to our U.S. and international pension benefit plans and approximately $40 million for retiree medical benefits. We regularly evaluate opportunities to reduce risk and volatility associated with our pension and retiree medical plans.
Plan Assets
Our pension plan investment strategy includes the use of actively managed accounts and is reviewed periodically in conjunction with plan liabilities, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. This strategy is also applicable to funds held for the retiree medical plans. Our investment objective includes ensuring that funds are available to meet the plans’ benefit obligations when they become due. Assets contributed to our pension plans are no longer controlled by us, but become the property of our individual pension plans. However, we are indirectly impacted by changes in these plan assets as compared to changes in our projected liabilities. Our overall investment policy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities and real estate to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments, such as futures and forward contracts, to reduce interest rate and foreign currency risks. Futures contracts represent commitments to purchase or sell securities at a future date and at a specified price. Forward contracts consist of currency forwards.
For 2019 and 2018, our expected long-term rate of return on U.S. plan assets is 7.1% and 7.2%, respectively. Our target investment allocations for U.S. plan assets are as follows:
| 2019 | 2018 | ||||
| Fixed income | 47 | % | 47 | % | |
| U.S. equity | 29 | % | 29 | % | |
| International equity | 20 | % | 20 | % | |
| Real estate | 4 | % | 4 | % |
Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodically rebalance our investments.
The expected return on plan assets is based on our investment strategy and our expectations for long-term rates of return by asset class, taking into account volatility and correlation among asset classes and our historical experience. We also review current levels of interest rates and inflation to assess the reasonableness of the long-term rates. We evaluate our expected return assumptions annually to ensure that they are reasonable. To calculate the expected return on plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, such as equity securities, we use a method that recognizes investment gains or losses (the difference between the expected and actual return based on the market-related value of assets) over a five-year period. This has the effect of reducing year-to-year volatility.
Plan assets measured at fair value as of fiscal year-end 2018 and 2017 are categorized consistently by level, and are as follows:
| 2018 | 2017 | ||||||||||||||||||
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Total | |||||||||||||||
| U.S. plan assets (a) | |||||||||||||||||||
| Equity securities, including preferred stock (b) | $ | 5,605 | $ | 5,595 | $ | 10 | $ | — | $ | 6,904 | |||||||||
| Government securities (c) | 1,674 | — | 1,674 | — | 1,365 | ||||||||||||||
| Corporate bonds (c) | 4,145 | — | 4,145 | — | 3,429 | ||||||||||||||
| Mortgage-backed securities (c) | 212 | — | 212 | — | 217 | ||||||||||||||
| Contracts with insurance companies (d) | 9 | — | — | 9 | 8 | ||||||||||||||
| Cash and cash equivalents | 215 | 215 | — | — | 236 | ||||||||||||||
| Sub-total U.S. plan assets | 11,860 | $ | 5,810 | $ | 6,041 | $ | 9 | 12,159 | |||||||||||
| Real estate commingled funds measured at net asset value (e) | 618 | 675 | |||||||||||||||||
| Dividends and interest receivable, net of payables | 65 | 69 | |||||||||||||||||
| Total U.S. plan assets | $ | 12,543 | $ | 12,903 | |||||||||||||||
| International plan assets | |||||||||||||||||||
| Equity securities (b) | $ | 1,651 | $ | 1,621 | $ | 30 | $ | — | $ | 1,928 | |||||||||
| Government securities (c) | 433 | — | 433 | — | 492 | ||||||||||||||
| Corporate bonds (c) | 478 | — | 478 | — | 493 | ||||||||||||||
| Fixed income commingled funds (f) | 356 | 356 | — | — | 383 | ||||||||||||||
| Contracts with insurance companies (d) | 36 | — | — | 36 | 36 | ||||||||||||||
| Cash and cash equivalents | 27 | 27 | — | — | 19 | ||||||||||||||
| Sub-total international plan assets | 2,981 | $ | 2,004 | $ | 941 | $ | 36 | 3,351 | |||||||||||
| Real estate commingled funds measured at net asset value (e) | 102 | 102 | |||||||||||||||||
| Dividends and interest receivable | 7 | 7 | |||||||||||||||||
| Total international plan assets | $ | 3,090 | $ | 3,460 |
| (a) | 2018 and 2017 amounts include $285 million and $321 million, respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. |
| (b) | The equity securities portfolio was invested in U.S. and international common stock and commingled funds, and the preferred stock portfolio in the U.S. was invested in domestic and international corporate preferred stock investments. The common stock is based on quoted prices in active markets. The U.S. commingled funds are based on fair values of the investments owned by these funds that are benchmarked against various U.S. large, mid-cap and small company indices, and includes one large-cap fund that represents 15% and 19% of total U.S. plan assets for 2018 and 2017, respectively. The international commingled funds are based on the fair values of the investments owned by these funds that track various non-U.S. equity indices. The preferred stock investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. |
| (c) | These investments are based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes in active markets. Corporate bonds of U.S.-based companies represent 28% and 23% of total U.S. plan assets for 2018 and 2017, respectively. |
| (d) | Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. The changes in Level 3 amounts were not significant in the years ended December 29, 2018 and December 30, 2017. |
| (e) | The real estate commingled funds include investments in limited partnerships. These funds are based on the net asset value of the appraised value of investments owned by these funds as determined by independent third parties using inputs that are not observable. The majority of the funds are redeemable quarterly subject to availability of cash and have notice periods ranging from 45 to 90 days. |
| (f) | Based on the fair value of the investments owned by these funds that track various government and corporate bond indices. |
Retiree Medical Cost Trend Rates
| 2019 | 2018 | ||||
| Average increase assumed | 6 | % | 6 | % | |
| Ultimate projected increase | 5 | % | 5 | % | |
| Year of ultimate projected increase | 2039 | 2039 |
These assumed health care cost trend rates have an impact on the retiree medical plan expense and liability, however the cap on our share of retiree medical costs limits the impact.
Savings Plan
Certain U.S. employees are eligible to participate in a 401(k) savings plan, which is a voluntary defined contribution plan. The plan is designed to help employees accumulate savings for retirement, and we make Company matching contributions for certain employees on a portion of eligible pay based on years of service.
Certain U.S. salaried employees, who are not eligible to participate in a defined benefit pension plan, are also eligible to receive an employer contribution to the 401(k) savings plan based on age and years of service regardless of employee contribution.
In 2018, 2017 and 2016, our total Company contributions were $180 million, $176 million and $164 million, respectively.
For additional unaudited information on our pension and retiree medical plans and related accounting policies and assumptions, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Note 8 — Debt Obligations
The following table summarizes the Company’s debt obligations:
| 2018(a) | 2017(a) | ||||||
| Short-term debt obligations (b) | |||||||
| Current maturities of long-term debt | $ | 3,953 | $ | 4,020 | |||
| Commercial paper (1.3%) | — | 1,385 | |||||
| Other borrowings (6.0% and 4.7%) | 73 | 80 | |||||
| $ | 4,026 | $ | 5,485 | ||||
| Long-term debt obligations (b) | |||||||
| Notes due 2018 (2.4%) | $ | — | $ | 4,016 | |||
| Notes due 2019 (3.1% and 2.1%) | 3,948 | 3,933 | |||||
| Notes due 2020 (3.9% and 3.1%) | 3,784 | 3,792 | |||||
| Notes due 2021 (3.1% and 2.4%) | 3,257 | 3,300 | |||||
| Notes due 2022 (2.8% and 2.6%) | 3,802 | 3,853 | |||||
| Notes due 2023 (2.9% and 2.4%) | 1,270 | 1,257 | |||||
| Notes due 2024-2047 (3.7% and 3.8%) | 16,161 | 17,634 | |||||
| Other, due 2018-2026 (1.3% and 1.3%) | 26 | 31 | |||||
| 32,248 | 37,816 | ||||||
| Less: current maturities of long-term debt obligations | (3,953 | ) | (4,020 | ) | |||
| Total | $ | 28,295 | $ | 33,796 |
| (a) | Amounts are shown net of unamortized net discounts of $119 million and $155 million for 2018 and 2017, respectively. |
| (b) | The interest rates presented reflect weighted-average effective interest rates at year-end. Certain of our fixed rate indebtedness have been swapped to floating rates through the use of interest rate derivative instruments. See Note 9 for additional information regarding our interest rate derivative instruments. |
As of December 29, 2018, our international debt of $62 million was related to borrowings from external parties including various lines of credit. These lines of credit are subject to normal banking terms and conditions and are fully committed at least to the extent of our borrowings.
In 2018, we completed a cash tender offer for certain notes issued by PepsiCo and predecessors to a PepsiCo subsidiary for $1.6 billion in cash to redeem the following amounts:
| Interest Rate | Maturity Date | Amount Tendered | |||||
| 7.290 | % | September 2026 | $ | 11 | |||
| 7.440 | % | September 2026 | $ | 4 | |||
| 7.000 | % | March 2029 | $ | 357 | |||
| 5.500 | % | May 2035 | $ | 138 | |||
| 4.875 | % | November 2040 | $ | 410 | |||
| 5.500 | % | January 2040 | $ | 408 |
We also completed an exchange offer for certain notes issued by predecessors to a PepsiCo subsidiary for the following newly issued PepsiCo notes. These notes were issued in an aggregate principal amount equal to the exchanged notes:
| Interest Rate | Maturity Date | Amount | |||||
| 7.290 | % | September 2026 | $ | 88 | |||
| 7.440 | % | September 2026 | $ | 21 | |||
| 7.000 | % | March 2029 | $ | 516 | |||
| 5.500 | % | May 2035 | $ | 107 |
As a result of the above transactions, we recorded a pre-tax charge of $253 million ($191 million after-tax or $0.13 per share) to interest expense, primarily representing the tender price paid over the carrying value of the tendered notes. See further unaudited information in “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
In 2018, we entered into a new five-year unsecured revolving credit agreement (Five-Year Credit Agreement) which expires on June 4, 2023. The Five-Year Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion. Additionally, we may, once a year, request renewal of the agreement for an additional one-year period.
Also in 2018, we entered into a new 364-day unsecured revolving credit agreement (364-Day Credit Agreement) which expires on June 3, 2019. The 364-Day Credit Agreement enables us and our borrowing subsidiaries to borrow up to $3.75 billion, subject to customary terms and conditions. We may request that commitments under this agreement be increased up to $4.5 billion. We may request renewal of this facility for an additional 364-day period or convert any amounts outstanding into a term loan for a period of up to one year, which would mature no later than the anniversary of the then effective termination date. The Five-Year Credit Agreement and the 364-Day Credit Agreement together replaced our $3.75 billion five-year credit agreement and our $3.75 billion 364-day credit agreement, both dated as of June 5, 2017. Funds borrowed under the Five-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes. Subject to certain conditions, we may borrow, prepay and reborrow amounts under these agreements. As of December 29, 2018, there were no outstanding borrowings under the Five-Year Credit Agreement or the 364-Day Credit Agreement.
In 2016, we paid $2.5 billion to redeem all of our outstanding 7.900% senior notes due 2018 and 5.125% senior notes due 2019 for the principal amounts of $1.5 billion and $750 million, respectively, and terminated certain interest rate swaps. As a result, we recorded a pre-tax charge of $233 million ($156 million after-tax or $0.11 per share) to interest expense, primarily representing the premium paid in accordance with the
“make-whole” redemption provisions. See further unaudited information in “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
See “Our Liquidity and Capital Resources” in Management’s Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our borrowings and long-term contractual commitments.
Note 9 — Financial Instruments
Derivatives and Hedging
We are exposed to market risks arising from adverse changes in:
| • | commodity prices, affecting the cost of our raw materials and energy; |
| • | foreign exchange rates and currency restrictions; and |
| • | interest rates. |
In the normal course of business, we manage commodity price, foreign exchange and interest rate risks through a variety of strategies, including productivity initiatives, global purchasing programs and hedging. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportunities or efficiencies, including the use of derivatives. Our global purchasing programs include fixed-price contracts and purchase orders and pricing agreements.
Our hedging strategies include the use of derivatives and, in the case of our net investment hedges, debt instruments. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. Cash flows from derivatives used to manage commodity price, foreign exchange or interest rate risks are classified as operating activities in the cash flow statement. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. See “Our Business Risks” in Management’s Discussion and Analysis of Financial Condition and Results of Operations for further unaudited information on our business risks.
We do not use derivative instruments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, including reviewing netting agreements, if any, and a review of credit ratings, credit default swap rates and potential nonperformance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are creditworthy in order to reduce our concentration of credit risk.
Commodity Prices
We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price contracts and purchase orders, pricing agreements and derivative instruments, which primarily include swaps and futures. In addition, risk to our supply of certain raw materials is mitigated through purchases from multiple geographies and suppliers. We use derivatives, with terms of no more than three years, to economically hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for energy, agricultural products and metals. Ineffectiveness for those derivatives that qualify for hedge accounting treatment was not material for all periods presented. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting treatment are marked to market each period with the resulting gains and losses recorded in corporate unallocated expenses as either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. These gains and losses are
subsequently reflected in division results when the divisions recognize the cost of the underlying commodity in operating profit.
Our commodity derivatives had a total notional value of $1.1 billion as of December 29, 2018 and $0.9 billion as of December 30, 2017.
Foreign Exchange
Our operations outside of the United States generated 43% of our net revenue in 2018, with Mexico, Russia, Canada, the United Kingdom and Brazil comprising approximately 20% of our net revenue in 2018. As a result, we are exposed to foreign exchange risks in the international markets in which our products are made, manufactured, distributed or sold.
Additionally, we are exposed to foreign exchange risk from net investments in foreign subsidiaries, foreign currency purchases and foreign currency assets and liabilities created in the normal course of business. We manage this risk through sourcing purchases from local suppliers, negotiating contracts in local currencies with foreign suppliers and through the use of derivatives, primarily forward contracts with terms of no more than two years. Exchange rate gains or losses related to foreign currency transactions are recognized as transaction gains or losses on our income statement as incurred. We also use net investment hedges to partially offset the effects of foreign currency on our investments in certain of our foreign subsidiaries.
Our foreign currency derivatives had a total notional value of $2.0 billion as of December 29, 2018 and $1.6 billion as of December 30, 2017. The total notional amount of our debt instruments designated as net investment hedges was $0.9 billion as of December 29, 2018 and $1.5 billion as of December 30, 2017. Ineffectiveness for derivatives and non-derivatives that qualify for hedge accounting treatment was not material for all periods presented. For foreign currency derivatives that do not qualify for hedge accounting treatment, all gains and losses were offset by changes in the underlying hedged items, resulting in no material net impact on earnings.
Interest Rates
We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We use various interest rate derivative instruments including, but not limited to, interest rate swaps, cross-currency interest rate swaps, Treasury locks and swap locks to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. Certain of our fixed rate indebtedness have been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency interest rate swaps match the principal, interest payment and maturity date of the related debt. Our Treasury locks and swap locks are entered into to protect against unfavorable interest rate changes relating to forecasted debt transactions.
Our interest rate derivatives had a total notional value of $10.5 billion as of December 29, 2018 and $14.2 billion as of December 30, 2017. Ineffectiveness for derivatives that qualify for cash flow hedge accounting treatment was not material for all periods presented.
As of December 29, 2018, approximately 29% of total debt, after the impact of the related interest rate derivative instruments, was subject to variable rates, compared to approximately 43% as of December 30, 2017.
Available-for-Sale Securities
Investments in debt securities are classified as available-for-sale. All highly liquid investments with original maturities of three months or less are classified as cash equivalents. Our investments in available-for-sale
debt securities are reported at fair value. Unrealized gains and losses related to changes in the fair value of available-for-sale debt securities are recognized in accumulated other comprehensive loss within common shareholders’ equity. Unrealized gains and losses on our investments in debt securities as of December 29, 2018 and December 30, 2017 were not material. Changes in the fair value of available-for-sale debt securities impact net income only when such securities are sold or an other-than-temporary impairment is recognized. We regularly review our investment portfolio to determine if any debt security is other-than-temporarily impaired. In making this judgment, we evaluate, among other things, the duration and extent to which the fair value of a debt security is less than its cost; the financial condition of the issuer and any changes thereto; and our intent to sell, or whether we will more likely than not be required to sell, the debt security before recovery of its amortized cost basis. Our assessment of whether a debt security is other-than-temporarily impaired could change in the future due to new developments or changes in assumptions related to any particular debt security. We recorded no other-than-temporary impairment charges on our available-for-sale debt securities for the years ended December 29, 2018, December 30, 2017 and December 31, 2016.
In 2017, we recorded a pre-tax gain of $95 million ($85 million after-tax or $0.06 per share), net of discount and fees, associated with the sale of our minority stake in Britvic. The gain on the sale of this equity investment was recorded in our ESSA segment in selling, general and administrative expenses. See Note 2 for additional information on investments in certain equity securities.
KSF Beverage Holding Co., Ltd.
During 2016, we concluded that the decline in estimated fair value of our 5% indirect equity interest in KSFB was other than temporary based on significant negative economic trends in China and changes in assumptions associated with KSFB’s future financial performance arising from the disclosure by KSFB’s parent company, Tingyi, regarding the operating results of its beverage business. As a result, we recorded a pre- and after-tax impairment charge of $373 million ($0.26 per share) in 2016 in the AMENA segment. This charge was recorded in selling, general and administrative expenses on our income statement and reduced the value of our 5% indirect equity interest in KSFB to its estimated fair value. The estimated fair value was derived using both an income and market approach, and is considered a non-recurring Level 3 measurement within the fair value hierarchy. The carrying value of the investment in KSFB was $166 million as of December 29, 2018 and December 30, 2017. We continue to monitor the impact of economic and other developments on the remaining value of our investment in KSFB.
See further unaudited information in “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Fair Value Measurements
The fair values of our financial assets and liabilities as of December 29, 2018 and December 30, 2017 are categorized as follows:
| 2018 | 2017 | ||||||||||||||||
| Fair Value Hierarchy Levels(a) | Assets(a) | Liabilities(a) | Assets(a) | Liabilities(a) | |||||||||||||
| Available-for-sale debt securities (b) | 2 | $ | 3,658 | $ | — | $ | 14,510 | $ | — | ||||||||
| Short-term investments (c) | 1 | $ | 196 | $ | — | $ | 228 | $ | — | ||||||||
| Prepaid forward contracts (d) | 2 | $ | 22 | $ | — | $ | 27 | $ | — | ||||||||
| Deferred compensation (e) | 2 | $ | — | $ | 450 | $ | — | $ | 503 | ||||||||
| Derivatives designated as fair value hedging instruments: | |||||||||||||||||
| Interest rate (f) | 2 | $ | 1 | $ | 108 | $ | 24 | $ | 130 | ||||||||
| Derivatives designated as cash flow hedging instruments: | |||||||||||||||||
| Foreign exchange (g) | 2 | $ | 44 | $ | 14 | $ | 15 | $ | 31 | ||||||||
| Interest rate (g) | 2 | — | 323 | — | 213 | ||||||||||||
| Commodity (h) | 1 | — | 1 | — | 2 | ||||||||||||
| Commodity (i) | 2 | — | 3 | 2 | — | ||||||||||||
| $ | 44 | $ | 341 | $ | 17 | $ | 246 | ||||||||||
| Derivatives not designated as hedging instruments: | |||||||||||||||||
| Foreign exchange (g) | 2 | $ | 3 | $ | 10 | $ | 10 | $ | 3 | ||||||||
| Commodity (h) | 1 | 2 | 17 | — | 19 | ||||||||||||
| Commodity (i) | 2 | 5 | 92 | 85 | 12 | ||||||||||||
| $ | 10 | $ | 119 | $ | 95 | $ | 34 | ||||||||||
| Total derivatives at fair value (j) | $ | 55 | $ | 568 | $ | 136 | $ | 410 | |||||||||
| Total | $ | 3,931 | $ | 1,018 | $ | 14,901 | $ | 913 |
| (a) | Fair value hierarchy levels are defined in Note 7. Unless otherwise noted, financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. |
| (b) | Based on quoted broker prices or other significant inputs derived from or corroborated by observable market data. As of December 29, 2018, these debt securities were primarily classified as cash equivalents. As of December 30, 2017, $5.8 billion and $8.7 billion of debt securities were classified as cash equivalents and short-term investments, respectively. The decrease primarily reflects net maturities and sales of debt securities with maturities greater than three months. Refer to the cash flow statement and “Our Liquidity and Capital Resources” in Management’s Discussion and Analysis of Financial Condition and Results of Operations for further discussion on use of these proceeds. |
| (c) | Based on the price of index funds. These investments are classified as short-term investments and are used to manage a portion of market risk arising from our deferred compensation liability. |
| (d) | Based primarily on the price of our common stock. |
| (e) | Based on the fair value of investments corresponding to employees’ investment elections. |
| (f) | Based on LIBOR forward rates. |
| (g) | Based on recently reported market transactions of spot and forward rates. |
| (h) | Based on quoted contract prices on futures exchange markets. |
| (i) | Based on recently reported market transactions of swap arrangements. |
| (j) | Derivative assets and liabilities are presented on a gross basis on our balance sheet. Amounts subject to enforceable master netting arrangements or similar agreements which are not offset on the balance sheet as of December 29, 2018 and December 30, 2017 were not material. Collateral received or posted against any of our asset or liability positions were not material. Collateral posted is classified as restricted cash. See Note 13 for further information. |
The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to their short-term maturity. The fair value of our debt obligations as of December 29, 2018 and
December 30, 2017 was $32 billion and $41 billion, respectively, based upon prices of similar instruments in the marketplace, which are considered Level 2 inputs.
Losses/(gains) on our hedging instruments are categorized as follows:
| Fair Value/Non- designated Hedges | Cash Flow and Net Investment Hedges | ||||||||||||||||||||||
| Losses/(Gains) Recognized in Income Statement(a) | Losses/(Gains) Recognized in Accumulated Other Comprehensive Loss | Losses/(Gains) Reclassified from Accumulated Other Comprehensive Loss into Income Statement(b) | |||||||||||||||||||||
| 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | ||||||||||||||||||
| Foreign exchange | $ | 9 | $ | (15 | ) | $ | (52 | ) | $ | 62 | $ | (8 | ) | $ | 10 | ||||||||
| Interest rate | 53 | 101 | 110 | (195 | ) | 119 | (184 | ) | |||||||||||||||
| Commodity | 117 | (48 | ) | 3 | 3 | — | 3 | ||||||||||||||||
| Net investment | — | — | (77 | ) | 157 | — | — | ||||||||||||||||
| Total | $ | 179 | $ | 38 | $ | (16 | ) | $ | 27 | $ | 111 | $ | (171 | ) |
| (a) | Foreign exchange derivative losses/gains are primarily included in selling, general and administrative expenses. Interest rate derivative losses/gains are primarily from fair value hedges and are included in interest expense. These losses/gains are substantially offset by decreases/increases in the value of the underlying debt, which are also included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. |
| (b) | Foreign exchange derivative losses/gains are primarily included in cost of sales. Interest rate derivative losses/gains are included in interest expense. Commodity derivative losses/gains are included in either cost of sales or selling, general and administrative expenses, depending on the underlying commodity. |
Based on current market conditions, we expect to reclassify net gains of $5 million related to our cash flow hedges from accumulated other comprehensive loss into net income during the next 12 months.
Note 10 — Net Income Attributable to PepsiCo per Common Share
The computations of basic and diluted net income attributable to PepsiCo per common share are as follows:
| 2018 | 2017 | 2016 | ||||||||||||||||||
| Income | Shares(a) | Income | Shares(a) | Income | Shares(a) | |||||||||||||||
| Net income attributable to PepsiCo | $ | 12,515 | $ | 4,857 | $ | 6,329 | ||||||||||||||
| Preferred shares: | ||||||||||||||||||||
| Dividends | — | — | (1 | ) | ||||||||||||||||
| Redemption premium | (2 | ) | (4 | ) | (5 | ) | ||||||||||||||
| Net income available for PepsiCo common shareholders | $ | 12,513 | 1,415 | $ | 4,853 | 1,425 | $ | 6,323 | 1,439 | |||||||||||
| Basic net income attributable to PepsiCo per common share | $ | 8.84 | $ | 3.40 | $ | 4.39 | ||||||||||||||
| Net income available for PepsiCo common shareholders | $ | 12,513 | 1,415 | $ | 4,853 | 1,425 | $ | 6,323 | 1,439 | |||||||||||
| Dilutive securities: | ||||||||||||||||||||
| Stock options, RSUs, PSUs, PEPunits and Other | — | 10 | — | 12 | 1 | 12 | ||||||||||||||
| Employee stock ownership plan (ESOP) convertible preferred stock | 2 | — | 4 | 1 | 5 | 1 | ||||||||||||||
| Diluted | $ | 12,515 | 1,425 | $ | 4,857 | 1,438 | $ | 6,329 | 1,452 | |||||||||||
| Diluted net income attributable to PepsiCo per common share | $ | 8.78 | $ | 3.38 | $ | 4.36 |
| (a) | Weighted-average common shares outstanding (in millions). |
Out-of-the-money options excluded from the calculation of diluted earnings per common share are as follows:
| 2018 | 2017 | 2016 | |||||||||
| Out-of-the-money options (a) | 0.7 | 0.4 | 0.7 | ||||||||
| Average exercise price per option | $ | 109.83 | $ | 110.12 | $ | 99.98 |
| (a) | In millions. |
Note 11 — Preferred Stock
In connection with our merger with The Quaker Oats Company (Quaker) in 2001, shares of our convertible preferred stock were authorized and issued to an ESOP fund established by Quaker. Quaker made the final award to its ESOP in June 2001.
In 2018, all of the outstanding shares of our convertible preferred stock were converted into an aggregate of 550,102 shares of our common stock at the conversion ratio set forth in Exhibit A to our amended and restated articles of incorporation. As a result, there are no shares of our convertible preferred stock outstanding as of December 29, 2018 and our convertible preferred stock is retired for accounting purposes.
As of December 30, 2017, there were 3 million shares of convertible preferred stock authorized, 803,953 preferred shares issued and 114,753 shares outstanding. The outstanding preferred shares had a fair value of $68 million as of December 30, 2017.
Activities of our preferred stock are included in the equity statement.
Note 12 — Accumulated Other Comprehensive Loss Attributable to PepsiCo
The changes in the balances of each component of accumulated other comprehensive loss attributable to PepsiCo are as follows:
| Currency Translation Adjustment | Cash Flow Hedges | Pension and Retiree Medical | Available-For-Sale Securities | Other | Accumulated Other Comprehensive Loss Attributable to PepsiCo | ||||||||||||||||||
| Balance as of December 26, 2015 (a) | $ | (11,080 | ) | $ | 37 | $ | (2,329 | ) | $ | 88 | $ | (35 | ) | $ | (13,319 | ) | |||||||
| Other comprehensive (loss)/income before reclassifications | (313 | ) | (74 | ) | (750 | ) | (43 | ) | — | (1,180 | ) | ||||||||||||
| Amounts reclassified from accumulated other comprehensive loss | — | 150 | 407 | — | — | 557 | |||||||||||||||||
| Net other comprehensive (loss)/income | (313 | ) | 76 | (343 | ) | (43 | ) | — | (623 | ) | |||||||||||||
| Tax amounts | 7 | (30 | ) | 27 | 19 | — | 23 | ||||||||||||||||
| Balance as of December 31, 2016 (a) | (11,386 | ) | 83 | (2,645 | ) | 64 | (35 | ) | (13,919 | ) | |||||||||||||
| Other comprehensive (loss)/income before reclassifications (b) | 1,049 | 130 | (375 | ) | 25 | — | 829 | ||||||||||||||||
| Amounts reclassified from accumulated other comprehensive loss | — | (171 | ) | 158 | (99 | ) | — | (112 | ) | ||||||||||||||
| Net other comprehensive (loss)/income | 1,049 | (41 | ) | (217 | ) | (74 | ) | — | 717 | ||||||||||||||
| Tax amounts | 60 | 5 | 58 | 6 | 16 | 145 | |||||||||||||||||
| Balance as of December 30, 2017 (a) | (10,277 | ) | 47 | (2,804 | ) | (4 | ) | (19 | ) | (13,057 | ) | ||||||||||||
| Other comprehensive (loss)/income before reclassifications (c) | (1,664 | ) | (61 | ) | (813 | ) | 6 | — | (2,532 | ) | |||||||||||||
| Amounts reclassified from accumulated other comprehensive loss | 44 | 111 | 218 | — | — | 373 | |||||||||||||||||
| Net other comprehensive (loss)/income | (1,620 | ) | 50 | (595 | ) | 6 | — | (2,159 | ) | ||||||||||||||
| Tax amounts | (21 | ) | (10 | ) | 128 | — | — | 97 | |||||||||||||||
| Balance as of December 29, 2018 (a) | $ | (11,918 | ) | $ | 87 | $ | (3,271 | ) | $ | 2 | $ | (19 | ) | $ | (15,119 | ) |
| (a) | Pension and retiree medical amounts are net of taxes of $1,253 million as of December 26, 2015, $1,280 million as of December 31, 2016, $1,338 million as of December 30, 2017 and $1,466 million as of December 29, 2018. |
| (b) | Currency translation adjustment primarily reflects the appreciation of the euro, Russian ruble, Pound sterling and Canadian dollar. |
| (c) | Currency translation adjustment primarily reflects the depreciation of the Russian ruble, Canadian dollar, Pound sterling and Brazilian real. |
The following table summarizes the reclassifications from accumulated other comprehensive loss to the income statement:
| Amount Reclassified from Accumulated Other Comprehensive Loss | Affected Line Item in the Income Statement | ||||||||||||
| 2018 | 2017 | 2016 | |||||||||||
| Currency translation: | |||||||||||||
| Divestitures | $ | 44 | $ | — | $ | — | Selling, general and administrative expenses | ||||||
| Cash flow hedges: | |||||||||||||
| Foreign exchange contracts | $ | (1 | ) | $ | — | $ | 2 | Net revenue | |||||
| Foreign exchange contracts | (7 | ) | 10 | (46 | ) | Cost of sales | |||||||
| Interest rate derivatives | 119 | (184 | ) | 187 | Interest expense | ||||||||
| Commodity contracts | 3 | 4 | 3 | Cost of sales | |||||||||
| Commodity contracts | (3 | ) | (1 | ) | 4 | Selling, general and administrative expenses | |||||||
| Net losses/(gains) before tax | 111 | (171 | ) | 150 | |||||||||
| Tax amounts | (27 | ) | 64 | (63 | ) | ||||||||
| Net losses/(gains) after tax | $ | 84 | $ | (107 | ) | $ | 87 | ||||||
| Pension and retiree medical items: | |||||||||||||
| Amortization of net prior service credit | $ | (17 | ) | $ | (24 | ) | $ | (39 | ) | Other pension and retiree medical benefits income/(expense) | |||
| Amortization of net losses | 216 | 167 | 209 | Other pension and retiree medical benefits income/(expense) | |||||||||
| Settlement/curtailment | 19 | 15 | 237 | Other pension and retiree medical benefits income/(expense) | |||||||||
| Net losses before tax | 218 | 158 | 407 | ||||||||||
| Tax amounts | (45 | ) | (44 | ) | (144 | ) | |||||||
| Net losses after tax | $ | 173 | $ | 114 | $ | 263 | |||||||
| Available-for-sale securities: | |||||||||||||
| Sale of Britvic securities | $ | — | $ | (99 | ) | $ | — | Selling, general and administrative expenses | |||||
| Tax amount | — | 10 | — | ||||||||||
| Net gain after tax | $ | — | $ | (89 | ) | $ | — | ||||||
| Total net losses/(gains) reclassified for the year, net of tax | $ | 301 | $ | (82 | ) | $ | 350 |
Note 13 — Restricted Cash
The following table provides a reconciliation of cash and cash equivalents and restricted cash as reported within the balance sheet to the same items as reported in the cash flow statement.
| 2018 | 2017 | ||||||
| Cash and cash equivalents | $ | 8,721 | $ | 10,610 | |||
| Restricted cash (a) | 1,997 | — | |||||
| Restricted cash included in other assets (b) | 51 | 47 | |||||
| Total cash and cash equivalents and restricted cash | $ | 10,769 | $ | 10,657 |
| (a) | Represents consideration held by our paying agent in connection with our acquisition of SodaStream. |
| (b) | Restricted cash included in other assets primarily relates to collateral posted against our derivative asset or liability positions. |
Note 14 — Acquisitions and Divestitures
Acquisition of SodaStream International Ltd.
On December 5, 2018, we acquired all of the outstanding shares of SodaStream, a manufacturer and distributor of sparkling water makers, for $144.00 per share in cash, in a transaction valued at approximately $3.3 billion. The total consideration transferred was approximately $3.3 billion (or $3.2 billion, net of cash and cash equivalents acquired), including $2.0 billion of consideration held by our paying agent in connection with this acquisition and reported as restricted cash as of December 29, 2018.
We accounted for the transaction as a business combination. We recognized and measured the identifiable assets acquired and liabilities assumed at their estimated fair values on the date of acquisition. The preliminary estimates of the fair value of the identifiable assets acquired and liabilities assumed in SodaStream as of the acquisition date include goodwill and other intangible assets of $3.0 billion and property, plant and equipment of $0.2 billion, all of which are recorded in our ESSA segment. The preliminary estimates of the fair value of identifiable assets acquired and liabilities assumed are subject to revisions, which may result in adjustments to the preliminary values discussed above as valuations are finalized. We expect to finalize these amounts as soon as possible, but no later than the end of 2019.
Under the guidance on accounting for business combinations, merger and integration costs are not included as components of consideration transferred but are accounted for as expenses in the period in which the costs are incurred. In 2018, we incurred merger and integration charges of $75 million ($0.05 per share), including $57 million in our ESSA segment and $18 million in corporate unallocated expenses. These charges include closing costs, advisory fees and employee-related costs and were recorded in selling, general and administrative expenses. See “Item 6. Selected Financial Data” and “Items Affecting Comparability” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Refranchising in Thailand
In 2018, we refranchised our beverage business in Thailand by selling a controlling interest in our Thailand bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $144 million ($126 million after-tax or $0.09 per share) in selling, general and administrative expenses in our AMENA segment as a result of this transaction.
Refranchising in Czech Republic, Hungary, and Slovakia
In 2018, we refranchised our entire beverage bottling operations and snack distribution operations in CHS (included within our ESSA segment). We recorded a pre-tax gain of $58 million ($46 million after-tax or $0.03 per share) in selling, general and administrative expenses in our ESSA segment as a result of this transaction.
Refranchising in Jordan
In 2017, we refranchised our beverage business in Jordan by selling a controlling interest in our Jordan bottling operations to form a joint venture, where we now have an equity method investment. We recorded a pre-tax gain of $140 million ($107 million after-tax or $0.07 per share) in selling, general and administrative expenses in our AMENA segment as a result of this transaction.
Note 15 — Supplemental Financial Information
Balance Sheet
| 2018 | 2017 | 2016 | |||||||||
| Accounts and notes receivable | |||||||||||
| Trade receivables | $ | 6,079 | $ | 5,956 | |||||||
| Other receivables | 1,164 | 1,197 | |||||||||
| 7,243 | 7,153 | ||||||||||
| Allowance, beginning of year | 129 | 134 | $ | 130 | |||||||
| Net amounts charged to expense | 16 | 26 | 37 | ||||||||
| Deductions (a) | (33 | ) | (35 | ) | (30 | ) | |||||
| Other (b) | (11 | ) | 4 | (3 | ) | ||||||
| Allowance, end of year | 101 | 129 | $ | 134 | |||||||
| Net receivables | $ | 7,142 | $ | 7,024 | |||||||
| Inventories (c) | |||||||||||
| Raw materials and packaging | $ | 1,312 | $ | 1,344 | |||||||
| Work-in-process | 178 | 167 | |||||||||
| Finished goods | 1,638 | 1,436 | |||||||||
| $ | 3,128 | $ | 2,947 | ||||||||
| Other assets | |||||||||||
| Noncurrent notes and accounts receivable | $ | 86 | $ | 59 | |||||||
| Deferred marketplace spending | 112 | 134 | |||||||||
| Pension plans (d) | 269 | 374 | |||||||||
| Other | 293 | 346 | |||||||||
| $ | 760 | $ | 913 | ||||||||
| Accounts payable and other current liabilities | |||||||||||
| Accounts payable | $ | 7,213 | $ | 6,727 | |||||||
| Accrued marketplace spending | 2,541 | 2,390 | |||||||||
| Accrued compensation and benefits | 1,755 | 1,785 | |||||||||
| Dividends payable | 1,329 | 1,161 | |||||||||
| SodaStream consideration payable | 1,997 | — | |||||||||
| Other current liabilities | 3,277 | 2,954 | |||||||||
| $ | 18,112 | $ | 15,017 |
| (a) | Includes accounts written off. |
| (b) | Includes adjustments related primarily to currency translation and other adjustments. |
| (c) | Approximately 5% of the inventory cost in 2018 and 2017 were computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. |
| (d) | See Note 7 for additional information regarding our pension plans. |
Statement of Cash Flows
| 2018 | 2017 | 2016 | |||||||||
| Interest paid (a) | $ | 1,388 | $ | 1,123 | $ | 1,102 | |||||
| Income taxes paid, net of refunds (b) | $ | 1,203 | $ | 1,962 | $ | 1,393 |
| (a) | In 2018 and 2016, excludes the premiums paid in accordance with the debt transactions discussed in Note 8. |
| (b) | In 2018, includes tax payments of $115 million related to the TCJ Act. |
Lease Information
| 2018 | 2017 | 2016 | |||||||||
| Rent expense | $ | 771 | $ | 742 | $ | 701 |
Minimum lease payments under non-cancelable operating leases by period
| Operating Lease Payments | |||
| 2019 | $ | 459 | |
| 2020 | 406 | ||
| 2021 | 294 | ||
| 2022 | 210 | ||
| 2023 | 161 | ||
| 2024 and beyond | 310 | ||
| Total minimum operating lease payments | $ | 1,840 |
Management’s Responsibility for Financial Reporting
To Our Shareholders:
At PepsiCo, our actions – the actions of all our associates – are governed by our Global Code of Conduct. This Code is clearly aligned with our stated values – a commitment to deliver sustained growth through empowered people acting with responsibility and building trust. Both the Code and our core values enable us to operate with integrity – both within the letter and the spirit of the law. Our Code of Conduct is reinforced consistently at all levels and in all countries. We have maintained strong governance policies and practices for many years.
The management of PepsiCo is responsible for the objectivity and integrity of our consolidated financial statements. The Audit Committee of the Board of Directors has engaged independent registered public accounting firm, KPMG LLP, to audit our consolidated financial statements, and they have expressed an unqualified opinion.
We are committed to providing timely, accurate and understandable information to investors. Our commitment encompasses the following:
Maintaining strong controls over financial reporting. Our system of internal control is based on the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in their report titled Internal Control – Integrated Framework (2013). The system is designed to provide reasonable assurance that transactions are executed as authorized and accurately recorded; that assets are safeguarded; and that accounting records are sufficiently reliable to permit the preparation of financial statements that conform in all material respects with accounting principles generally accepted in the United States. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the specified time periods. We monitor these internal controls through self-assessments and an ongoing program of internal audits. Our internal controls are reinforced through our Global Code of Conduct, which sets forth our commitment to conduct business with integrity, and within both the letter and the spirit of the law.
Exerting rigorous oversight of the business. We continuously review our business results and strategies. This encompasses financial discipline in our strategic and daily business decisions. Our Executive Committee is actively involved – from understanding strategies and alternatives to reviewing key initiatives and financial performance. The intent is to ensure we remain objective in our assessments, constructively challenge our approach to potential business opportunities and issues, and monitor results and controls.
Engaging strong and effective Corporate Governance from our Board of Directors. We have an active, capable and diligent Board that meets the required standards for independence, and we welcome the Board’s oversight as a representative of our shareholders. Our Audit Committee is comprised of independent directors with the financial literacy, knowledge and experience to provide appropriate oversight. We review our critical accounting policies, financial reporting and internal control matters with them and encourage their direct communication with KPMG LLP, with our Internal Auditor and with our General Counsel. We also have a Compliance & Ethics Department, led by our Chief Compliance & Ethics Officer, who coordinates our compliance policies and practices.
Providing investors with financial results that are complete, transparent and understandable. The consolidated financial statements and financial information included in this report are the responsibility of management. This includes preparing the financial statements in accordance with accounting principles generally accepted in the United States, which require estimates based on management’s best judgment.
PepsiCo has a strong history of doing what’s right. We realize that great companies are built on trust, strong ethical standards and principles. Our financial results are delivered from that culture of accountability, and we take responsibility for the quality and accuracy of our financial reporting.
February 15, 2019
| /s/ MARIE T. GALLAGHER | |
| Marie T. Gallagher | |
| Senior Vice President and Controller (Principal Accounting Officer) | |
| /s/ HUGH F. JOHNSTON | |
| Hugh F. Johnston | |
| Vice Chairman, Executive Vice President and Chief Financial Officer | |
| /s/ RAMON L. LAGUARTA | |
| Ramon L. Laguarta | |
| Chairman of the Board of Directors and Chief Executive Officer |
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
PepsiCo, Inc.:
Opinions on the Consolidated Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying Consolidated Balance Sheets of PepsiCo, Inc. and Subsidiaries (the “Company”) as of December 29, 2018 and December 30, 2017, and the related Consolidated Statements of Income, Comprehensive Income, Cash Flows, and Equity for each of the fiscal years in the three-year period ended December 29, 2018 and the related notes (collectively, the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of December 29, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 29, 2018 and December 30, 2017, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December 29, 2018, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 29, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As permitted by SEC guidance, the scope of management’s assessment of the effectiveness of internal control over financial reporting as of December 29, 2018 excluded SodaStream International Ltd. and its subsidiaries (“SodaStream”), which the Company acquired in December 2018. SodaStream’s total assets and net revenue represented approximately 5% and 1%, respectively, of the consolidated total assets and net revenue of PepsiCo, Inc. as of and for the year ended December 29, 2018. Our audit of internal control over financial reporting of PepsiCo, Inc. also excluded an evaluation of the internal control over financial reporting of SodaStream.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over
financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
We have served as the Company’s auditor since 1990.
New York, New York
February 15, 2019
GLOSSARY
Acquisitions and divestitures: all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and nonconsolidated equity investees.
Bottler Case Sales (BCS): measure of physical beverage volume shipped to retailers and independent distributors from both PepsiCo and our independent bottlers.
Bottler funding: financial incentives we give to our independent bottlers to assist in the distribution and promotion of our beverage products.
Concentrate Shipments and Equivalents (CSE): measure of our physical beverage volume shipments to independent bottlers, retailers and independent distributors.
Constant currency: financial results assuming constant foreign currency exchange rates used for translation based on the rates in effect for the comparable prior-year period. In order to compute our constant currency results, we multiply or divide, as appropriate, our current year U.S. dollar results by the current year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates.
Consumers: people who eat and drink our products.
CSD: carbonated soft drinks.
Customers: authorized independent bottlers, distributors and retailers.
Derivatives: financial instruments, such as futures, swaps, Treasury locks, cross currency swaps and forward contracts that we use to manage our risk arising from changes in commodity prices, interest rates and foreign exchange rates.
Direct-Store-Delivery (DSD): delivery system used by us and our independent bottlers to deliver snacks and beverages directly to retail stores where our products are merchandised.
Effective net pricing: reflects the year-over-year impact of discrete pricing actions, sales incentive activities and mix resulting from selling varying products in different package sizes and in different countries.
Free cash flow: net cash provided by operating activities less capital spending plus sales of property, plant and equipment.
Hedge accounting: treatment for qualifying hedges that allows fluctuations in a hedging instrument’s fair value to offset corresponding fluctuations in the hedged item in the same reporting period. Hedge accounting is allowed only in cases where the hedging relationship between the hedging instruments and hedged items is highly effective, and only prospectively from the date a hedging relationship is formally documented.
Independent bottlers: customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographical area.
Mark-to-market net gain or loss: change in market value for commodity derivative contracts that we purchase to mitigate the volatility in costs of energy and raw materials that we consume. The market value is determined based on prices on national exchanges and recently reported transactions in the marketplace.
Organic: a measure that adjusts for impacts of acquisitions, divestitures and other structural changes, and foreign exchange translation. In excluding the impact of foreign exchange translation, we assume constant foreign exchange rates used for translation based on the rates in effect for the comparable prior-year period. See the definition of “Constant currency” for additional information. Our 2018 reported results reflect the accounting policy election taken in conjunction with the adoption of the revenue recognition guidance to exclude from net revenue and cost of sales all sales, use, value-added and certain excise taxes assessed by governmental authorities on revenue-producing transactions not already excluded. Our 2018 organic revenue growth excludes the impact of these taxes previously recognized in net revenue. In addition, our fiscal 2016 reported results included an extra week of results. Our 2017 organic revenue growth excludes the impact of the 53rd reporting week from our 2016 results.
Servings: common metric reflecting our consolidated physical unit volume. Our divisions’ physical unit measures are converted into servings based on U.S. Food and Drug Administration guidelines for single-serving sizes of our products.
Total marketplace spending: includes sales incentives and discounts offered through various programs to our customers, consumers or independent bottlers, as well as advertising and other marketing activities.
Transaction gains and losses: the impact on our consolidated financial statements of exchange rate changes arising from specific transactions.
Translation adjustment: the impact of converting our foreign affiliates’ financial statements into U.S. dollars for the purpose of consolidating our financial statements.
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