FINANCIAL REVIEW

Our discussion and analysis is an integral part of understanding our financial results. Also refer to Basis of Presentation and Our Divisions in the Notes to the Condensed Consolidated Financial Statements. Tabular dollars are presented 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. Percentage changes are based on unrounded amounts.

Our Critical Accounting Policies

Sales Incentives and Advertising and Marketing Costs

We offer sales incentives and discounts through various programs to customers and consumers. These incentives are accounted for as a reduction of revenue. Certain sales incentives are recognized at the time of sale while other incentives, such as bottler funding and customer volume rebates, are recognized during the year incurred, generally in proportion to revenue, based on annual targets. Anticipated payments are estimated based on 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 recognized during the year incurred, generally in proportion to revenue.

Income Taxes

In determining our quarterly provision for income taxes, we use an estimated annual effective tax rate which is based on our expected annual income, statutory tax rates and tax planning opportunities available to us in the various jurisdictions in which we operate. Subsequent recognition, derecognition and measurement of a tax position taken in a previous period are separately recognized in the quarter in which they occur.

Recent Accounting Pronouncements

In February 2007, the FASB issued SFAS 159 which permits entities to choose to measure many financial instruments and certain other items at fair value. We adopted SFAS 159 as of the beginning of our 2008 fiscal year and our adoption did not impact our financial statements.

In December 2007, the FASB issued SFAS 141R and SFAS 160 to improve, simplify, and converge internationally the accounting for business combinations and the reporting of noncontrolling interests in consolidated financial statements. The provisions of SFAS 141R and SFAS 160 are effective as of the beginning of our 2009 fiscal year. We are currently evaluating the impact of adopting SFAS 141R and SFAS 160 on our financial statements.

In March 2008, the FASB issued SFAS 161 which amends and expands the disclosure requirements of SFAS 133 to provide an enhanced understanding of an entity's use of derivative instruments, how they are accounted for under SFAS 133 and their effect on the entity's financial position, financial performance and cash flows. The provisions of SFAS 161 are effective as of the beginning of our 2009 fiscal year. We are currently evaluating the impact of adopting SFAS 161 on our financial statements.

Our Business Risks

We discuss expectations regarding our future performance, such as our business outlook, in our annual and quarterly reports, press releases, and other written and oral statements. These "forward-looking statements" are based on currently available information, operating plans and projections about future events and trends. They are inherently uncertain, and investors must recognize that events could turn out to be significantly different from our expectations. We undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise.

Our operations outside of the United States generate approximately half of our net revenue. As a result, we are exposed to foreign currency risks, including unforeseen economic changes and political unrest. During the 12 weeks, net favorable foreign currency contributed 3 percentage points to net revenue growth, primarily due to the appreciation in the euro, Mexican peso and Brazilian real. During the 36 weeks, net favorable foreign currency contributed 3 percentage points to net revenue growth, primarily due to appreciation in the euro, Brazilian real, Canadian dollar and Mexican peso. Currency declines which are not offset could adversely impact our future results.

In the second and third quarters of 2008, we entered into additional derivative contracts to further reduce our exposure to price fluctuations in our raw material and energy costs. Derivatives used to hedge commodity price risks that do not qualify for hedge accounting are marked to market each period and related gains and losses are reflected in our income statement.

Our open commodity derivative contracts that do not qualify for hedge accounting had a face value of $682 million at September 6, 2008 and $199 million at September 8, 2007. In addition, during 2008, we entered into other instruments, such as options, to manage our future commodity costs. The open derivative contracts that do not qualify for hedge accounting resulted in net losses of $159 million and $106 million in the 12 and 36 weeks ended September 6, 2008, respectively, and net losses of $27 million and $15 million in the 12 and 36 weeks ended September 8, 2007, respectively.

We expect to be able to continue to reduce the impact of volatility in our raw material and energy costs through our hedging strategies and ongoing productivity initiatives. See Fair Value in the Notes to the Condensed Consolidated Financial Statements for the fair value of our commodity contracts as of September 6, 2008.

Cautionary statements included in Item 1A. in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 and in our revised Management's Discussion and Analysis included in Exhibit 99.1 to our Current Report on Form 8-K filed with the Securities and Exchange Commission (SEC) on April 7, 2008 should be considered when evaluating our trends and future 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. Additionally, "acquisitions" reflect all mergers and acquisitions activity, including the impact of acquisitions, divestitures and changes in ownership or control in consolidated subsidiaries and non-consolidated equity investees.

Items Affecting Comparability

The year-over-year comparisons of our financial results are affected by the
following items:



                                               12 Weeks Ended           36 Weeks Ended
                                             9/6/08      9/8/07       9/6/08      9/8/07
     Operating profit
     Mark-to-market net losses               $  (176 )   $   (29 )   $   (119 )         -
     Net income
     Mark-to-market net losses               $  (112 )   $   (19 )   $    (76 )         -
     Tax benefits                                  -     $   115            -     $   115
     Net income per common share - diluted
     Mark-to-market net losses               $ (0.07 )   $ (0.01 )   $  (0.05 )         -
     Tax benefits                                  -     $  0.07            -     $  0.07

Mark-to-Market Net Losses

In the 12 and 36 weeks ended September 6, 2008, we recognized $176 million and $119 million, respectively, of mark-to-market net losses on commodity hedges in corporate unallocated expenses. In the 12 weeks ended September 8, 2007, we recognized $29 million of mark-to-market net losses on commodity hedges in corporate unallocated expenses. In the 36 weeks ended September 8, 2007, the impact of commodity hedges in corporate unallocated expenses was nominal. We centrally manage commodity derivatives on behalf of our divisions. Certain of these commodity derivatives do not qualify for hedge accounting treatment and are marked to market with the resulting gains and losses recognized in corporate unallocated expenses. These gains and losses are subsequently reflected in division results when the divisions take delivery of the underlying commodity.

Tax Benefits

In 2007, we recognized $115 million of non-cash tax benefits related to the favorable resolution of certain foreign tax matters.

Subsequent Event

On October 14, 2008, we announced our Productivity for Growth program. The program includes actions in all segments of the business that we believe will simplify the organization for more effective and timely decision-making, increase cost competitiveness across the supply chain, and upgrade and streamline our product portfolio. Globally, approximately 3,300 positions will be eliminated in connection with the productivity program, of which about 40% relate to the closing of up to six plants and other capacity rationalization actions, which will be announced by the end of the year. As a result of the program, we expect to incur a pre-tax charge of approximately $550 million to $600 million in the fourth quarter of 2008, comprised of approximately $275 million of severance and other employee-related costs; approximately $200 million for asset impairments (substantially all non-cash) resulting from plant closures and related actions; and approximately $100 million for other costs. We expect that approximately $325 million to $375 million of this charge will result in cash expenditures during the fourth quarter of 2008 and into 2009. We currently expect to complete the productivity program during the first quarter of 2009.

Volume

Since our divisions each use different measures of physical unit volume, a common servings metric is necessary to reflect our consolidated physical unit volume. For the 12 weeks, total servings increased 2%, with worldwide beverages growing 3% and worldwide snacks growing 2%. For the 36 weeks, total servings increased 4%, with worldwide beverages growing 4% and worldwide snacks growing 3%.

We discuss volume for our beverage businesses on a bottler case sales (BCS) basis in which all beverage volume is converted to an 8-ounce-case metric. A portion of our volume is sold by our bottlers, and that portion is based on our bottlers' sales to retailers and independent distributors. The remainder of our volume is based on our shipments to retailers and independent distributors. BCS is reported to us by our bottlers on a monthly basis. Our third quarter beverage volume includes bottler sales for June, July and August. Concentrate shipments and equivalents (CSE) represent our physical beverage volume shipments to bottlers, retailers and independent distributors, and is the measure upon which our revenue is based.

Consolidated Results

Total Net Revenue and Operating Profit



                                             12 Weeks Ended                           36 Weeks Ended
                                    9/6/08        9/8/07       Change        9/6/08        9/8/07       Change
Total net revenue                  $ 11,244      $ 10,171          11 %     $ 30,522      $ 27,128          13 %

Operating profit
FLNA                               $    785      $    742           6 %     $  2,153      $  2,034           6 %
QFNA                                    134           126           7 %          422           399           6 %
LAF                                     225           185          22 %          646           501          29 %
PAB                                     662           741         (11 )%       1,847         1,943          (5 )%
UKEU                                    279           238          17 %          643           544          18 %
MEAA                                    227           192          18 %          599           498          20 %
Corporate - impact of
mark-to-market on commodity
hedges                                 (176 )         (29 )       499 %         (119 )           -           -
Corporate - other                      (152 )        (133 )        16 %         (469 )        (479 )        (2 )%

Total operating profit             $  1,984      $  2,062          (4 )%    $  5,722      $  5,440           5 %


Total operating profit margin          17.6 %        20.3 %      (2.7 )         18.7 %        20.1 %      (1.4 )

See Results of Operations - Division Review for a tabular presentation and discussion of key drivers of net revenue.

12 Weeks

Total operating profit decreased 4% and margin decreased 2.7 percentage points. The unfavorable mark-to-market impact of our commodity hedges reduced operating profit performance by 7 percentage points and reduced margin by 1.4 percentage points. The leverage from the revenue growth was partially offset by the impact of higher commodity costs. The favorable impact of foreign currency contributed 2 percentage points to operating profit performance and the favorable impact of acquisitions contributed 1 percentage point.

Other corporate unallocated expenses increased 16%, reflecting foreign transaction losses of $10 million compared to net gains of $7 million in the prior year. Higher costs associated with our ongoing business transformation initiative and increased research and development costs were offset by the favorable impact of certain employee-related items.

36 Weeks

Total operating profit increased 5% and margin decreased 1.4 percentage points. The unfavorable mark-to-market impact of our commodity hedges reduced operating profit growth by 2 percentage points and reduced margin by 0.4 percentage points. Leverage from the revenue growth was offset by the impact of higher commodity costs. The impact of foreign currency contributed 2 percentage points to operating profit growth and the impact of acquisitions contributed 1 percentage point.

Other corporate unallocated expenses decreased 2%. Lower deferred compensation costs and the favorable impact of certain other employee-related items were partially offset by higher costs associated with our ongoing business transformation initiative, increased research and development costs and foreign transaction losses. The decrease in deferred compensation costs is offset (as a reduction to interest income) by losses on investments used to economically hedge these costs.

Other Consolidated Results



                                                   12 Weeks Ended                          36 Weeks Ended
                                         9/6/08       9/8/07        Change        9/6/08       9/8/07       Change
Bottling equity income                   $   201      $   218            (7 )%    $   439      $   465         (5.5 )%
Interest expense, net                    $   (59 )    $   (36 )    $    (23 )     $  (152 )    $   (71 )    $   (81 )
Tax rate                                    25.9 %       22.3 %                      26.4 %       24.7 %
Net income                               $ 1,576      $ 1,743           (10 )%    $ 4,423      $ 4,396            1 %
Net income per common share - diluted    $  0.99      $  1.06            (6 )%    $  2.74      $  2.64            4 %

12 Weeks

Bottling equity income decreased 7%, primarily reflecting lower pre-tax gains on our sales of PBG and PAS stock in the current year.

Net interest expense increased $23 million, primarily reflecting higher average debt balances, partially offset by the impact of lower average rates on our debt.

The tax rate increased 3.6 percentage points compared to the prior year, primarily due to $115 million of tax benefits recognized in the prior year related to the favorable resolution of certain foreign tax matters.

Net income decreased 10% and the related net income per share decreased 6%. The unfavorable mark-to-market impact of our commodity hedges and the absence of the tax benefits recognized in the prior year reduced both net income performance and related net income per share by 12 percentage points. Net income per share was favorably impacted by our share repurchases.

36 Weeks

Bottling equity income decreased 5.5%, reflecting lower pre-tax gains on our sales of PBG and PAS stock in the current year and our reduced ownership levels in PBG and PAS in 2008.

Net interest expense increased $81 million, primarily reflecting higher average debt balances, partially offset by the impact of lower average rates on our debt.

The tax rate increased 1.7 percentage points compared to the prior year, primarily due to $115 million of tax benefits recognized in the prior year related to the favorable resolution of certain foreign tax matters.

Net income increased 1% and the related net income per share increased 4%. These increases primarily reflect our operating profit growth. The unfavorable mark-to-market impact of our commodity hedges and the absence of the tax benefits recognized in the prior year reduced both net income performance and related net income per share by 4 percentage points. Net income per share was also favorably impacted by our share repurchases.

Results of Operations - Division Review

The results and discussions below are based on how our Chief Executive Officer monitors the performance of our divisions. For additional information on our divisions, see Our Divisions in the Notes to the Condensed Consolidated Financial Statements.

Net Revenue
12 Weeks Ended                 FLNA         QFNA           LAF          PAB          UKEU            MEAA         Total
September 6, 2008             $ 3,057      $   391       $ 1,544      $ 2,923       $ 1,783         $ 1,546      $ 11,244
September 8, 2007             $ 2,800      $   411       $ 1,252      $ 2,926       $ 1,519         $ 1,263      $ 10,171
% Impact of:
Volume(a)                           1 %         (9 )%          - %         (4 )%          - %(d)         10 %           - %(d)
Effective net pricing(b)            8            3            11            3             5               7             6
Foreign exchange                    -            -             9            1             8               4             3
Acquisitions                        -            -             4            -             4               1             1

% Change(c)                         9 %         (5 )%         23 %          - %          17 %            22 %          11 %


Net Revenue
36 Weeks Ended                 FLNA         QFNA           LAF          PAB          UKEU            MEAA         Total
September 6, 2008             $ 8,737      $ 1,292       $ 4,038      $ 8,163       $ 4,421         $ 3,871      $ 30,522
September 8, 2007             $ 8,076      $ 1,264       $ 3,041      $ 8,001       $ 3,655         $ 3,091      $ 27,128
% Impact of:
Volume(a)                           1 %         (2 )%          1 %         (3 )%          4 %            13 %           1 %
Effective net pricing(b)            6            3            10            4             4               5             5
Foreign exchange                    1            1             8            1             9               6             3
Acquisitions                        -            -            14            -             4               2             2

% Change(c)                         8 %          2 %          33 %          2 %          21 %            25 %          13 %

(a) Excludes the impact of acquisitions and divestitures. In certain instances, volume growth varies from the amounts disclosed in the following divisional discussions due to non-consolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE. Our net revenue excludes non-consolidated joint venture volume, and, for our beverage businesses, is based on CSE.

(b) 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.

(c) Amounts may not sum due to rounding.

(d) Includes unfavorable impact of a reporting calendar change in Spain and Portugal.

Frito-Lay North America



                               12 Weeks Ended       %        36 Weeks Ended       %
                              9/6/08    9/8/07    Change    9/6/08    9/8/07    Change
          Net revenue        $  3,057   $ 2,800        9   $  8,737   $ 8,076        8
          Operating profit   $    785   $   742        6   $  2,153   $ 2,034        6

12 Weeks

Net revenue grew 9% and pound volume grew 1.5%. The volume growth reflects mid-single-digit growth in trademark Tostitos, high-single-digit growth in trademark Ruffles as well as mid-single-digit growth in trademark Cheetos and dips. These volume gains were largely offset by a high-single-digit decline in trademark Lay's, reflecting pricing actions and potato shortages. Net revenue growth was largely driven by positive effective net pricing.

Operating profit grew 6%, driven by the net revenue growth. This growth was partially offset by higher commodity costs, primarily cooking oil and fuel.

Smart Spot eligible products represented approximately 14% of net revenue. These products grew in the low-single-digit range, while the balance of the portfolio experienced double-digit revenue growth.

36 Weeks

Net revenue grew 8% and pound volume grew 2%. The volume growth reflects high-single-digit growth in trademark Cheetos and Ruffles as well as mid-single-digit growth in dips, partially offset by a mid-single-digit decline in trademark Lay's. Net revenue growth also benefited from positive effective net pricing. Favorable Canadian exchange rates contributed 1 percentage point to net revenue growth.

Operating profit grew 6%, reflecting the net revenue growth. This growth was partially offset by higher commodity costs, primarily cooking oil and fuel. Favorable Canadian exchange rates contributed nearly 1 percentage point to the operating profit growth.

Smart Spot eligible products represented approximately 15% of net revenue. These products grew in the low-single-digit range, while the balance of the portfolio experienced high-single-digit revenue growth.

Quaker Foods North America



                              12 Weeks Ended        %          36 Weeks Ended       %
                             9/6/08     9/8/07    Change      9/6/08    9/8/07    Change
         Net revenue        $    391    $   411       (5 )   $  1,292   $ 1,264        2
         Operating profit   $    134    $   126        7     $    422   $   399        6

12 Weeks

Net revenue declined 5% and volume decreased 9%, reflecting the negative impact of the Cedar Rapids flood that occurred at the end of the second quarter. The volume decrease reflects a double-digit decline in ready-to-eat cereals, a high-single-digit decline in Quaker Oatmeal and a low-single-digit decline in Aunt Jemima syrup and mix, partially offset by high-single-digit growth in Rice-A-Roni. The net revenue decline reflects the volume decline partially offset by favorable effective net pricing, due primarily to price increases taken last year and in the first half of 2008.

Operating profit increased 7%. The net impact of the flood on operating profit reflects our business disruption insurance recovery. Favorable effective net pricing and lower advertising and marketing costs were partially offset by increased commodity costs.

Smart Spot eligible products represented over half of the net revenue and declined in the high-single-digit range. The balance of the portfolio declined in the low-single-digit range.

36 weeks

Net revenue increased 2% and volume decreased 2%, reflecting the negative impact of the Cedar Rapids flood. The volume decrease reflects a high-single-digit decline in ready-to-eat cereals and a low-single-digit decline in Quaker Oatmeal. The net revenue growth benefited from favorable effective net pricing due primarily to price increases taken last year and in the first half of 2008. Favorable Canadian exchange rates contributed 1 percentage point to net revenue growth.

Operating profit increased 6%, reflecting the net revenue growth and lower advertising and marketing costs, partially offset by increased commodity costs. The net impact of the flood on operating profit reflects our business disruption insurance recovery, net of the costs incurred to cover the insurance deductible.

Smart Spot eligible products represented over half of net revenue and experienced a low-single-digit net revenue decline. The balance of the portfolio grew in the mid-single-digit range.

Latin America Foods



                               12 Weeks Ended       %        36 Weeks Ended       %
                              9/6/08    9/8/07    Change    9/6/08    9/8/07    Change
          Net revenue        $  1,544   $ 1,252       23   $  4,038   $ 3,041       33
          Operating profit   $    225   $   185       22   $    646   $   501       29

12 Weeks

Snacks volume grew 3%, primarily reflecting an acquisition in Brazil in the fourth quarter of 2007. A mid-single-digit decline at Sabritas in Mexico, largely resulting from weight-outs, was partially offset by double-digit growth in several smaller markets. Additionally, Gamesa in Mexico grew at a low-single-digit rate. The acquisition in Brazil contributed 3.5 percentage points to the volume growth.

Net revenue grew 23%, reflecting favorable effective net pricing. Foreign currency contributed 9 percentage points and acquisitions contributed nearly 4 percentage points to the net revenue growth.

Operating profit grew 22%, driven by the net revenue growth, offset by increased commodity costs. An insurance recovery gain contributed 8 percentage points to the operating profit growth. Foreign currency contributed 10 percentage points and acquisitions contributed nearly 3 percentage points to the operating profit growth.

36 Weeks

. . .