PepsiCo
Annual Report 2012

Plain-text annual report

Table of Contents Letter to Shareholders 2 10–11 12 Financial Highlights The Breadth of the PepsiCo Portfolio 14 18 Reinforcing Existing Value Drivers Migrating Our Portfolio Towards High-Growth Spaces 22 Accelerating the Benefits of One PepsiCo 24 Aggressively Building New Capabilities 28 Strengthening a Second-to-None Team and Culture 30 Delivering on the Promise of Performance with Purpose PepsiCo Board of Directors PepsiCo Leadership 33 34 35 Financials Dear Fellow Shareholders, Running a company for the long term is like driving a car in a race that has no end. To win a long race, you must take a pit stop every now and then to refresh and refuel your car, tune your engine and take other actions that will make you even faster, stronger and more competi- tive over the long term. That’s what we did in 2012—we refreshed and refueled our growth engine to help drive superior financial returns in the years ahead. We invested significantly behind our brands. We changed the operating model of our company from a loose federation of countries and regions to a more globally integrated one to enable us to build our brands glob- ally, deliver breakthrough innovation to consumers and unleash significant productivity. Simply put, we took actions that we believe set ourselves up for long-term sustainable growth and superior performance. I am delighted to report that our performance in 2012 reflected our operational excellence and was in line with our expectations and guid- ance on every key metric: • • Our organic revenue was up 5 percent;1 Core earnings per share (eps) were $4.10;2 Pictured: Indra K. Nooyi, PepsiCo Chairman and Chief Executive Officer 2 2012 PEPSICO ANNUAL REPORT • • We delivered +$1 billion savings in the first year of our productiv- ity program and remain on track to deliver $3 billion by 2015; We achieved a core net return on invested capital3 (roic) of 15 percent and core return on equity3 (roe) of 28 percent; Management operating cash flow,4 excluding certain items, reached $7.4 billion; and $6.5 billion was returned to our shareholders through share repurchases and dividends. • • The actions we took in 2012 were all designed to take us one step further on the transformation journey of our company, which we started in 2007. Back then, we recognized that the market environ- ment was rapidly shifting around us. We realized that in order to stay in front, we would need to make significant changes. We set our- selves a dual challenge—to renew our highly successful company to position it for long-term advantage and growth while continuing to de- liver strong and consistent financial results during the transformation. We have eagerly embraced this challenge and made the required investments. Our journey to date has shown significant results. We have reinforced our existing business while also shifting our portfolio to attractive growth spaces. We have built out the key capabilities we need to compete in the future. We have raised our capacity to drive continuous productivity. We have strengthened our talent pool across the organiza- tion, and, by no means least, we have embedded our vision of Performance with Purpose into all of our actions and practices. That is what we have achieved so far, and it is considerable. We are an exciting company with a strong foundation and track record. But as I look forward into 2013 and beyond, it is clear that we still have further to go on our journey. Our transformation must continue. The Environment in Which We Operate Over the past several years, a number of forces have combined to radically reshape the external environment in which the food and beverage industry operates. These changes have had a major impact on where and how companies must compete to survive and thrive. Global macroeconomic growth has slowed significantly, and the outlook remains mixed, particularly in developed markets. Global economic power is becoming more distributed, with the East becoming a larger player in the world. The demographic equa- tion in the West is shifting, with an increasing share of consumption in the hands of boomers, women and smaller households, and rapid growth of diverse ethnic and immigrant com- munities across countries. Intensifying consumer and govern- ment focus on health and wellness is changing the relative growth trajectory of our categories and products. Consumers are clearly changing their habits, preferences and consumption patterns. Food safety and security are now front and center in the minds of govern- ments and consumers, increasing the need for robust systems within companies to ensure ingredient and product traceability. Sustained commodity price increases and volatility have challenged company cost structures. Meanwhile, there is a strong and growing environmental consciousness emerging in societies around the world as the focus on water use, waste disposal (espe- cially of plastic) and energy use by industry receives additional scrutiny. Lastly, the global retail environ- ment is transforming. In emerg- ing and developing markets, the growth of organized modern trade is beginning to slowly replace tradi- tional mom and pop stores, and in developed markets, new discount channels like hard discounters and dollar stores are rapidly growing. Additionally, online retailing is beginning to make inroads into our categories while social media amplifies positive messages and rumors in the blink of an eye. The combination of these shifts has put considerable pressure on the 1 2 3 4 Organic results are non-GAAP financial measures that exclude certain items. See page 60 for a reconciliation to the most directly comparable financial measure in accordance with GAAP. Core results are non-GAAP financial measures that exclude certain items. See page 58 for a reconciliation to the most directly comparable financial measure in accordance with GAAP. Core results are non-GAAP financial measures that exclude certain items. See pages 106-107 for reconciliations to the most directly comparable financial measures in accordance with GAAP. Represents a non-GAAP financial measure that excludes certain items. See page 67 for a reconciliation to the most directly comparable financial measure in accordance with GAAP. 5 percent1 in 2012. 5%Organic revenue was up $4.10 $1B Core earnings per share (eps) were $4.102 in 2012. +$1 billion in savings delivered in the first year of our productivity program and remain on track to deliver $3 billion by 2015. 28%Achieved a core net return on invested capital3 (roic) of 15 percent and core return on equity3 (roe) of 28 percent. Management operating cash flow4, excluding certain items, reached $7.4 billion. $7.4B $6.5B $6.5 billion was returned to shareholders through share repurchases and dividends. 2012 PEPSICO ANNUAL REPORT 3 food and beverage industry. The growth outlook in some developed markets and categories has slowed significantly, while emerging and developing markets require new skills for success. Traditional ap- proaches and legacy capabilities are no longer sufficient to compete in these spaces. But these changes also have given rise to unparalleled opportunities for PepsiCo. For one, the convenience trend is accelerating around the world, driving the growth of our catego- ries. The strong outlook in emerging and developing markets for all our products and the demand for Good- for-You products and categories in key markets also present major growth opportunities. Other potential new areas of expansion for us are premium-priced products, products for aging populations and value offer- ings for those with lower incomes. As a global company with positions in every key market in the world, PepsiCo’s sheer scale as well as product and geographic diversity give us the ability to power through country-specific trends and still deliver superior returns. Our iconic brands are trusted in every country to deliver a quality product that meets the highest global safety standards. Our track record of ethi- cal performance and quality prod- ucts provides comfort to consumers and governments the world over. Our Transformation Back in 2007, we recognized the rapidly changing environment and realized we needed new capabilities to compete. We made the required investments to preemptively transform ourselves to capitalize on these opportunities and position the 4 2012 PEPSICO ANNUAL REPORT company for long-term growth and profitability in this volatile and chal- lenging environment. 1. We Reinforced Our Existing Value Drivers We refocused our efforts on our key global brands and categories in our most important developed markets to drive profitable growth. We are the #1 macrosnack player in many developed markets in the world. Our highly profitable snacks business has a strong stable of much-loved megabrands—Lay’s, Doritos, Cheetos and SunChips—and a structurally advantaged go-to-mar- ket system in many major markets such as the U.S., Canada, the U.K. and Australia, among others. We have been concentrating our insights, marketing and innovation resources behind our powerhouse brands and key markets to successfully grow demand and our share. As a result of our consistent invest- ments over the years, Lay’s is the #1 snack food brand in the world; Lay’s, Doritos and Cheetos are lovemarks in many countries in which they op- erate, and a brand such as Tostitos in the U.S. makes party time come alive. We also have taken crowd- sourcing of ideas to a new and exciting place: Our Lay’s “Do Us A Flavor” campaign engages consum- ers directly through social media to co-create new exciting flavors. Launched in the U.K., this campaign has been extended to 17 markets, including the U.S. in 2012. To date, we have received 19 million flavor ideas from around the world! We also have leveraged social me- dia in our consistently strong Dori- tos “Crash the Super Bowl” cam- paign, which puts fan-developed ads on air during the big game. In 2012, Doritos fan-created ads placed first on the traditional and online Ad Meter ranking. In 2013, a “Crash the Super Bowl” Doritos fan-created ad ranked #1 as “most liked” and “most memorable” in the Nielsen ratings. Most importantly, our goal is to make the best savory snacks in the market. We eliminated the use of partially hydrogenated cooking oils used to make savory snacks in North America, dramatically reduc- ing trans fats. Additionally, we have reduced saturated fat levels and are reducing the sodium content of our savory snacks, and we are dial- ing up baked offerings. Our developed market beverage business remains large and profit- able. Across our major beverage markets, we revamped our invest- ment to strengthen our key global beverage brands, which include Pepsi, Mountain Dew, Sierra Mist, 7UP (outside the U.S.), Starbucks and Lipton. We bought back bottlers in North America and Europe to unlock large, underex- ploited system synergies in these mature carbonated soft drink (CSD) markets. We also have taken the right measures to step up the performance of our North America beverage business, where we are the #1 liquid refreshment beverage (LRB) player in measured chan- nels. We have made major changes to our team, operating model and marketing approach to bet- ter adapt to a new consumer and competitive environment. We are dialing up our support on zero-calo- rie products and offering reduced- calorie CSDs, like Pepsi NEXT, which became a $100 million brand at retail in less than 12 months. In 2012, we continued this transfor- mation by simplifying the business and reinvesting heavily behind our key brands while unlocking new sources of productivity. 2. We Migrated Our Portfolio Towards Attractive, High-Growth Spaces Very early, we recognized the growth prospects in the Good- for-You space. We invested to expand it across multiple markets globally, increasing our presence in the growing tasty nutrition space. We are building from our positions of strength with four of the most important platforms and globally admired and loved brands in nutri- tion—Quaker (grains), Tropicana (fruits and vegetables), Gatorade (sports nutrition for athletes) and Naked Juice (super-premium juices and protein smoothies). We also are working to unlock growth oppor- tunities in new product categories, such as dairy with our business in Russia, our joint venture with Alma- rai in parts of the Middle East and our Müller Quaker Dairy joint ven- ture in the U.S.; hummus and other fresh dips with Sabra and Obela; and baked grains with Stacy’s. We established a Global Nutrition Group to drive innovation and brand development, and are concentrating our investments in high-potential return markets and categories. We had great success in 2012, with more to come. We launched Quaker Real Medleys in the U.S., pairing oatmeal with other whole grains, fruits and nuts in a portable cup and portion-controlled serving, which drove our growth in hot cereal retail sales. Quaker Real Medleys recently won breakfast Product of the Year, the largest consumer-voted award recognizing outstanding innovation. Trop 50 reduced-calorie orange juice continues its terrific retail growth momentum in measured channels. We also introduced Tropi- cana Farmstand, enabling U.S. con- sumers to get a serving of both fruit and vegetables in an eight-ounce glass. And Gatorade delivered inno- vation, with Gatorade Prime Energy Chews fueling athletic performance as well as Gatorade retail sales. Importantly, our efforts to capitalize on the growing consumer demand for convenient nutrition are global. The growth of our Quaker busi- ness is a case in point: Last year, we increased Quaker retail sales in the U.K. with the success of Oats so Simple, grew Quaker volume in China and India with breakfast foods customized for local tastes, and leveraged Quaker’s expertise in Rus- sia by launching oats under our local Chudo brand. From 2002 to 2012, our nutrition business revenue has grown sub- stantially and in 2012 represented 20 percent of our company. Emerging and developing markets represent another very attractive high-growth opportunity for PepsiCo. Economic growth is lifting consumers’ income levels and driving urban lifestyles. More women are entering the workforce. This, in turn, is increasing the demand for convenient foods and beverages, providing tailwinds to our categories. Over the past six years, we have invested aggres- sively to bolster our presence in these markets. Our investments included: Important acquisitions, such as Lebedyansky and the Wimm-Bill- Dann juice and dairy business in Russia, Mabel cookies and Lucky snacks in Brazil, and Dilexis cookies in Argentina, to name a few. Strategic partnerships to improve scale and performance, such as Tingyi in China, which makes us part of the leading beverage system in the largest growth market; the con- solidation of our bottling system in Mexico under a new joint venture to increase our scale and step up our capabilities; the strategic partner- ship for dairy and juice with Almarai, Saudi Arabia’s largest food producer; and the fortified water joint venture with Tata in India to serve the value consumer. Organic investments to sustain and improve share, through stepped-up marketplace spend- ing on media, racks, or routes in countries such as Mexico, Brazil, Russia and China. In addition, we established the Global Value Innova- tion Center in India to significantly reduce the cost of our marketplace equipment (e.g., coolers and foun- tain dispensers) to enable us to in- crease our investments in emerging markets in an affordable way. The early results are very promising. Our targeted investments have helped us build advantaged positions in these markets: We are the #1 food and beverage business in Russia, #1 in India and #1 in the Middle East, plus #2 in Mexico and in the top 5 in Brazil, Turkey and many smaller emerging markets, such as Vietnam, the Philippines and Thailand. Looking back to 2006, emerging and developing markets accounted 2012 PEPSICO ANNUAL REPORT 5 for 24 percent of our net revenue; in 2012, they represented 35 percent of our net revenue. And over the long term, we are look- ing to grow our business in these markets at high single digits to low double digits. 3. We Accelerated the Benefits of One PepsiCo PepsiCo’s strength lies in the fact that our portfolio is diverse, but related. The convenient snack and beverage businesses have high levels of coincidence of purchase and consumption and very high velocities at the shelf. We believe this portfolio complementarity pro- vides a natural hedge, allowing us to manage through individual category issues and still deliver good returns. Our portfolio provides us three ad- ditional major benefits. experiences, allowing us to build a world-class workforce. We “lift and shift” best practices across the value chain. For exam- ple, the expertise we have devel- oped in increasing yields while conserving water helps us get more crop per drop in our agricul- tural operations throughout the world, be it potatoes or corn for our snacks, or fruits and vegetables for our juice business. vice message to Chinese consum- ers—Go home to your families for Chinese New Year. This film gar- nered more than 700 million views in China alone. All these activities increased co- incidence of purchases between beverages and snacks and our healthy breakfast bundles, and in 2012, made us the second-largest growth contributor in all measured U.S. retail channels combined. Because of the high coincidence of consumption of our products, we have developed a common con- sumer demand framework under- pinned by a global database, giving us proprietary insights into food and beverage occasions. This guides our innovation actions at the global and local level. Foodservice customers are also beginning to benefit from the power of PepsiCo’s portfolio: Taco Bell in the U.S. is a case in point. For more than 45 years, we have been their beverage partner of choice. Mountain Dew “Baja Blast,” a flavor developed exclusively for Taco Bell, has been a best-selling traffic driver in its system since launch. In 2012, building on this beverage relation- ship, we partnered with Taco Bell to introduce Doritos Locos Tacos, a taco with a shell made from real Nacho Cheese Doritos that has be- come the restaurant’s biggest suc- cess in its 50-year history. In nine months alone, Taco Bell sold more than 325 million Doritos Locos Tacos—one of the most successful new products in the foodservice industry in 2012. In 2013, we expect to continue building on this suc- cess, with the launch of Cool Ranch Doritos Locos Tacos. More impor- tantly, we are innovating now on the beverage front with the launch of Mountain Dew “Baja Blast Freeze.” The pairing of the Doritos and Mountain Dew brands is a natural: In the U.S. convenience channel, Doritos is the number one salty snack, while Mountain Dew is the number one single-serve carbon- ated soft drink. First, cost leverage: We are an important customer to key vendors in the food and beverage space. We have preferred partner status with many of them, which allows us to strategically make use of each other’s supply chains and develop- ment efforts to meaningfully reduce our input costs while accessing their best talent and advanced thinking. Third, commercial benefits: As the second-largest food and bever- age business in the world and the largest in the U.S., we are traffic generators and therefore viewed as a critical growth driver by retail- ers. Just in the U.S., we have nine of the top 40 trademarks at retail, more than any other food and bev- erage company. Additionally, inside PepsiCo, across businesses, we share infrastructure including corporate functions, mas- ter data and back office processing, further lowering our costs. Second, capability sharing: Over the past few years, we have harmo- nized many of our processes, mak- ing it easier to move talent across the company—both businesses and geographies. We are able to attract world-class talent and give them a truly diverse, but related set of Retailers benefit from our in-store promotions that leverage power- ful properties such as the National Football League, Major League Baseball and the National Hockey League in the U.S.; talented soc- cer players like Lionel Messi, who appeared in both Pepsi and Lay’s commercial activities globally; as well as through mini-films like the “Bring Happiness Home” Chinese New Year production that brought together Lay’s, Tropicana and Pepsi to deliver an emotional public ser- 6 2012 PEPSICO ANNUAL REPORT An example of a market where we truly leverage the cost, capability and commercial benefits from our broad portfolio is Russia. Our business is operated as an integrated whole, with shared offices, infrastructure, talent, supply chain and go-to-mar- ket systems. We are an extremely efficient and effective leader in the food and beverage business in that country—lowering our costs signifi- cantly and expanding the reach of our products several fold. We believe our whole is worth more than the sum of our parts. It is our Power of One. 4. We Are Aggressively Building New Capabilities PepsiCo has historically been man- aged as a loose federation of coun- tries and regions. This organizational structure fostered an entrepreneur- ial culture in the company, not nec- essarily a culture of global efficiency. Starting in 2010 and accelerating in 2012, we began to modify our global operating model, balancing independence and scale, to become a globally networked company. Our in-country and regional teams are empowered to serve their markets, but through global groups and func- tions, we are harmonizing our efforts across the world around brand build- ing, innovation and the management of our supply chain. Our new model already has begun to yield results. Our global cat- egory groups are guiding regions to rationalize their brand portfolios and focus the bulk of our spending behind 12 global brands. We are continuing to increase the caliber of our global marketing talent and implementing global campaigns for our iconic global brands, beginning with “Live for Now,” the first-ever global positioning campaign for brand Pepsi. In 2012, “Live for Now” engaged millions of consum- ers through music, sports, social media and other consumer touch points. In December, we announced a unique creative collaboration with 17-time Grammy Award win- ning singer Beyoncé to work with us on creating content to engage Pepsi consumers around the world. Our brand equity scores are steadily improving, and we are just getting started. Our innovation efforts also have im- proved substantially. Back in 2007, we invested to rebuild our R&D ca- pability in the company. We brought in outstanding talent and created new long-term research capabilities. We increased our investment be- hind natural sweeteners, disruptive processes, packaging and nutrition platforms. We are also teaching our people how to leverage R&D in intelligent ways to create platforms for growth rather than just one-off line extensions. We also have taken other major actions to drive innovation. In 2012, for the first time in PepsiCo, we created a design capability in the company. Our goal is to use design in the early stages of innovation ef- forts to create memorable products and experiences for our consumers. We also have put in place a com- mon stage-gate process to facilitate data-driven decision making. We created the capability to lift and shift ideas across the various countries within PepsiCo. Examples include the launch of Lay’s “Do Us A Flavor Campaign” in the U.S. after its suc- cess in Europe, Asia, South America and Africa; our continued expansion in the cookie and biscuits category in Brazil, Argentina, the Middle East and the Philippines, building on the strengths of our Gamesa-Quaker business in Mexico; and the success of Quaker Yogurt Bars in the U.S. after their development in Canada. Thanks to all these initiatives, at the end of 2012, innovation from prod- ucts launched in the past three years accounted for approximately eight percent of our net revenue. Going forward, we intend to con- tinue to leverage R&D to help us develop more breakthrough innova- tion that delivers true incremental growth and is sustainable. To draw from creative expertise in every corner of the world, in 2012 we opened new R&D centers in Shang- hai, China; Hamburg, Germany; and Monterrey, Mexico. Our global supply chain group has been working on best practice trans- fer across our enterprise, bringing in breakthrough thinking from external sources to lower our costs and cre- ate more capacity and flexibility in our supply chain. We are rigorously analyzing, auditing and benchmarking the performance of our facilities and using what we learn to strengthen our manufacturing, distribution and go-to-market capabilities around the globe. Our environmental sustain- ability agenda, which includes water, energy and packaging reductions, has helped us decrease our costs while conserving natural resources. All of these actions, plus scores of others, have enabled us to double our historic productivity run rate starting in 2012, leading to a $3 bil- lion cost take-out over three years. We have reduced our cash conver- 2012 PEPSICO ANNUAL REPORT 7 sion cycle by nine days in 2012 and also found ways to reduce our net capital spending from 5.5 percent of net revenue in 2010 to 4 percent of net revenue in 2012, which is consistent with our long-term capi- tal spending target of less than or equal to 5 percent of net revenue. Going forward, we are well on our way to harmonizing our global pro- cesses, master data and IT systems to increase visibility across the company, ensure compliance with all our initiatives, easily measure our progress and speed up decision making. We intend to be one of the most efficient food and beverage companies in the world. 5. We Are Building a Second-to- None Team and Culture In recent years, with our transfor- mation actions, we truly have asked a lot of all our associates. It is their passion, resilience and talent that have made our progress possible. To nurture and grow our associates, enabling them to lead PepsiCo into the future, we have implemented award-winning talent and leader- ship development initiatives. We also have been recruiting executives from outside our industry to infuse fresh thinking and bring new capa- bilities to our team. I’m especially proud of the work we have done as a company to build a strong team of current and future female leaders. As we continue to focus on developing world-class talent and teams, PepsiCo was recognized in 2012 by the Great Place to Work Institute, which ranked us as one of the “World’s Best Multinational Workplaces.” In addition, Chief Executive magazine ranked PepsiCo as one of the “Best Companies for Leaders” in 2012. 8 2012 PEPSICO ANNUAL REPORT One area that deserves mention is the great courage and humanity demonstrated by our associates. In 2012, whether it was in response to Hurricane Sandy in the U.S., the flooding in the Philippines, political unrest and transition in Egypt or other country-specific events, our teams have demonstrated an unwavering commitment to our consumers, customers and com- munities while delivering our performance goals. There are countless stories, and I wish I could tell them all in tribute, because I am truly proud of our associates and humbled to be their leader. 6. We Are Delivering on the Promise of Performance with Purpose There is a great deal of activity in PepsiCo today, all focused on delivering sustained value. We have seen what happens when corporate executives chase short- term rewards to the exclusion of the long term. No company can see itself as simply an engine for short-term growth and nothing more. A company operates under a license from society. Its products are regulated by public authorities. The work of modern business encompasses partnerships with the public and non-profit sectors. We were one of the first contempo- rary companies to recognize the im- portant interdependence between corporations and society when we articulated our Performance with Purpose direction back in 2007. Performance with Purpose is our goal to deliver sustained financial performance by providing a wide range of foods and beverages from treats to healthy eats; finding inno- vative ways to minimize our impact on the environment and lower our costs through energy and water conservation, as well as reduced use of packaging material; provid- ing a safe and inclusive workplace for our employees globally; and by respecting, supporting and investing in the local communities in which we operate. The progress we have made over the last six years—and in 2012 in particular—is heartening indeed. We continued to grow our Good-for- You offerings, demonstrated leader- ship in water conservation that was recognized with the Stockholm Industry Water Award and the U.S. Water Prize, and reduced our Lost Time Injury Rate by 32 percent in 2012. These are but a few examples of the progress we have made, progress that has led to our selec- tion as one of the “World’s Most Ad- mired Companies” by Fortune, one of its most respected by Barron’s and one of its most ethical by Ethisphere. 2013 and Beyond: Our Transformation Journey Continues I am proud of what we have achieved in the last several years. We anticipated many of the envi- ronmental changes early on and uniquely and necessarily trans- formed ourselves while still deliver- ing strong results. We have accom- plished a great deal and are on the right track. We have clear and decisive plans to continue to reshape the business while delivering results. Our key initiatives have not changed. We will continue to drive profitable growth in our developed markets while continuing to migrate our portfo- lio toward attractive high-growth spaces. We will work to fully realize the benefits of our complemen- tary categories, capitalize on our strengthened and new capabilities, make every penny a prisoner, fur- ther invest to develop the skills of our associates, and most important- ly, accelerate our work consistent with Performance with Purpose. Our current plans reaffirm our commitment to achieving out- standing results while we continue our necessary and expansive trans- formation journey. This journey will not be easy, but important work never is. So, as we navigate our car around the track, I believe we are very well positioned to run a great race, in support of our shareholders today and for the next generation. Recently, PepsiCo was referred to as a company with great charac- ter. I am sure it is because we have endured and thrived in challenging times. I hope it is also because we have demonstrated the courage to look beyond the immediate and our commitment to managing the company for sustainable long-term performance, respecting and acting on the interdependence of corpora- tions and the societies in which we operate. This is the very essence of Perfor- mance with Purpose. I believe it is important now more than ever. Billion Dollar Brands PepsiCo has 22 brands that each generated $1 billion or more in 2012 in estimated annual retail sales: 1 3 2 4 3 Indra K. Nooyi PepsiCo Chairman and Chief Executive Officer 1 G Series, G2, Propel 2 Outside the U.S. 3 PepsiCo/Unilever partnership 4 PepsiCo/Starbucks partnership 2012 PEPSICO ANNUAL REPORT 9 Financial Highlights Mix of Net Revenue Net Revenues Food 51% 49% Beverage U.S. 51% 49% Outside U.S. 10% 20% 37% 33% Division Operating Profit 7% 13% 28% 52% PepsiCo AMEA PepsiCo Europe PepsiCo Americas Beverages PepsiCo Americas Foods 10% 20% 33% 37% PepsiCo AMEA PepsiCo Europe PepsiCo Americas Beverages PepsiCo Americas Foods 7% 13% 28% 52% Cumulative Total Shareholder Return Return on PepsiCo stock investment (including dividends) and the S&P 500® PepsiCo, Inc. S&P 500® 250 200 150 100 50 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 (MAR) 12/00 12/01 12/02 12/03 12/04 12/05 12/06 12/07 12/08 12/09 12/10 12/11 12/12 3/131 PepsiCo, Inc. $100 $99 $87 $98 $111 $128 $139 $172 $127 $146 $161 $169 $180 $201 S&P 500® $100 $88 $69 $88 $98 $103 $119 $126 $79 $100 $115 $118 $136 $146 *The return for PepsiCo and the S&P 500 indices are calculated through March 1, 2013. 1 As of March 1, 2013. 10 2012 PEPSICO ANNUAL REPORT PepsiCo, Inc. and Subsidiaries (In millions except per share data; all per share amounts assume dilution) Summary of Operations 2012 2011 Chg (a) Core net revenue (b) $65,492 $65,881 Core division operating profit (c) $10,844 $11,329 Core total operating profit (d) $9,682 $10,368 Core net income attributable to PepsiCo (e) $6,454 $7,035 Core earnings per share attributable to PepsiCo (e) $4.10 $4.40 -1% -4% -7% -8% -7% Other Data Management operating cash flow, excluding certain items (f) $7,387 $6,145 20% Net cash provided by operating activities $8,479 $8,944 -5% Capital spending $2,714 $3,339 -19% Common share repurchases $3,219 $2,489 29% Dividends paid Long-term debt $3,305 $3,157 5% $23,544 $20,568 14% (a) (b) (c) (d) (e) (f) Percentage changes are based on unrounded amounts. In 2011, excludes the impact of an extra reporting week. See page 106 “Reconciliation of GAAP and Non-GAAP Information” for a reconciliation to the most directly comparable financial measure in accordance with GAAP. Excludes corporate unallocated expenses, merger and integration charges and restructuring and impairment charges in both years. In 2012, also excludes restructuring and other charges related to the transaction with Tingyi. In 2011, also excludes certain inventory fair value adjustments in connection with our Wimm-Bill-Dann (WBD) and bottling acquisitions and the impact of an extra reporting week. See page 106 “Reconciliation of GAAP and Non-GAAP Information” for a reconciliation to the most directly comparable financial measure in accordance with GAAP. Excludes merger and integration charges, restructuring and impairment charges and the net mark- to-market impact of our commodity hedges in both years. In 2012, also excludes restructuring and other charges related to the transaction with Tingyi and a pension lump sum settlement charge. In 2011, also excludes certain inventory fair value adjustments in connection with our WBD and bottling acquisitions and the impact of an extra reporting week. See page 106 “Reconciliation of GAAP and Non-GAAP Information” for a reconciliation to the most directly comparable financial measure in accordance with GAAP. Excludes merger and integration charges, restructuring and impairment charges and the net mark- to-market impact of our commodity hedges in both years. In 2012, also excludes restructuring and other charges related to the transaction with Tingyi, a pension lump sum settlement charge and tax benefit related to tax court decision. In 2011, also excludes certain inventory fair value adjustments in connection with our WBD and bottling acquisitions and the impact of an extra reporting week. See pages 58 and 106 “Results of Operations – Consolidated Review” in Management’s Discussion and Analysis and “Reconciliation of GAAP and Non-GAAP Information” for reconciliations to the most directly comparable financial measures in accordance with GAAP. Includes the impact of net capital spending, and excludes discretionary pension and retiree medical payments, merger and integration payments, restructuring payments and capital expenditures related to the integration of our bottlers in both years. In 2012, also excludes capital expenditures related to the Productivity Plan and payments for restructuring and other charges related to the transaction with Tingyi. See also “Our Liquidity and Capital Resources” in Management’s Discussion and Analysis. See page 107 “Reconciliation of GAAP and Non-GAAP Information” for a reconciliation to the most directly comparable financial measure in accordance with GAAP. “Theactions wetookin 2012wereall designedto takeusonestep furtheronthe transformation journeyofour company.” Indra K. Nooyi PepsiCo Chairman and Chief Executive Officer 2012 PEPSICO ANNUAL REPORT 11 Fun-for-You Our Fun-for-You portfolio includes treats that are beloved the world over as well as offerings that are regional favorites. Better-for-You Among the foods and beverages in our Better-for-You portfolio are snacks baked with lower fat content, snacks with whole grains, and beverages with fewer or zero calories and less added sugar. Good-for-You Our growing Good-for-You portfolio is comprised of nutritious foods and beverages that include fruits, vegetables, whole grains, low-fat dairy, nuts, seeds and key nutrients with levels of sodium, sugar and saturated fat in line with global dietary requirements. Also included are offerings that provide a functional benefit, such as addressing the performance needs of athletes. 12 2012 PEPSICO ANNUAL REPORT 2012 PEPSICO ANNUAL REPORT 13 Reinforcing Existing Value Drivers Snacks We are a leading global snacks company, with much-loved brands that include Lay’s, Doritos, Cheetos and SunChips. In many key developed markets, including the U.S., Canada, the U.K. and Australia, we are the #1 macrosnack player. In the U.S., for example, we have 7 of the top 10 product offerings in macrosnacks. To grow our snacks business, we have been concentrating our insights, marketing and innovation resources behind our powerhouse brands and key markets. We also have expanded our snacks portfo- lio, providing our consumers with reduced-sodium and baked options. WalkErS Walkers, one of the U.K.’s most beloved trademarks, offers a range of popular snacks, including Walkers potato crisps, the category leader in the market. Sales of Walkers Crinkles (pictured below) have grown rapidly since their launch in 2011, exceeding growth targets. We are extremely proud that our Walkers business was named “Branded Supplier of the Year” at the U.K.’s Grocer Gold Awards. The judging panel for the awards, which recognize strong perfor- mance and outstanding customer service, included key PepsiCo retail customers. 14 2012 PEPSICO ANNUAL REPORT Our Banner Sun portfolio includes Lay’s, the #1 snack food brand in the world. With bold and unique flavors, Doritos is the world’s leading corn snack. A cheesy crunch to lighten up the day, Cheetos is the global leader in its category. SunChips are tasty multigrain snacks that provide 18 grams of whole grains in a one ounce bag. 2012 PEPSICO ANNUAL REPORT 15 Brand Pepsi enables consumers to make the most of the moment and embrace their individuality with choices that include Pepsi, Pepsi NEXT, Pepsi MAX and Diet Pepsi. Sierra Mist, our delicious lemon-lime carbonated soft drink in the U.S., is among our 22 billion-dollar brands. How We DEW: Mountain Dew is the #1 flavored carbonated soft drink in measured channels in the U.S. 16 2012 PEPSICO ANNUAL REPORT Crafted with premium Starbucks coffee beans, the Starbucks ready-to-drink beverage portfolio1 delivered double-digit retail sales growth in 2012. Beverages PepsiCo is the leader in Liquid Re- freshment Beverages in measured channels in North America. Our North American beverage business is large and profitable. It includes refreshing, great-tasting offerings that hold the #1 or #2 positions in most major categories. Our portfolio also is tremendously diverse. For more than two de- cades, we have been increasing the number of choices we offer con- sumers, adding ready-to-drink teas and coffee drinks, isotonics and other noncarbonated beverages. Importantly, we offer low- or zero-calorie and smaller-portioned options, such as 8 ounce cans (pictured below), for almost every drink we make. To further help our consumers manage calories, we are keenly focused on innovation. In 2012, we launched Pepsi NEXT, a game-changer in the cola category. It delivers real cola taste with 60 percent less sugar than Pepsi-Cola. In less than 12 months, Pepsi NEXT achieved more than $100 million in retail sales. Lipton ready-to-drink tea2, the category leader in the 2 2, the category leader in the Lipton ready-to-drink tea2, the category leader in the Lipton ready-to-drink tea U.S., is refreshing consumers and growing in markets around the world. 1 PepsiCo/Starbucks partnership. 2 PepsiCo/Unilever partnership. 2012 PEPSICO ANNUAL REPORT 17 Migrating Our Portfolio Towards High-Growth Spaces NEW GrOWTh PlaTfOrmS The acquisition of Wimm-Bill-Dann in 2011 and the launch of our Müller Quaker Dairy joint venture in the U.S. in 2012 provide us with new platforms in value-added dairy. We’re excited about the strong growth prospects of this category. New value-added dairy offerings in 2012 included Chudo drinkable yogurt in Russia and Müller Greek Corner yogurt in the U.S. (both pictured below). Our Nutrition Portfolio We continue to build our portfolio in fruits and vegetables, grains, dairy and sports nutrition, strategi- cally positioning PepsiCo to meet growing consumer demand for tasty and convenient nutrition. Our leading brands include Tropicana, Quaker, Gatorade and Naked Juice. Our efforts to grow in the nutri- tion space are global, as illustrated by the progress of our Quaker business. Last year, we increased Quaker retail sales in the U.K. with the success of Oats So Simple, grew Quaker volume in China and India with breakfast foods custom- ized for local tastes, and lever- aged Quaker’s expertise in Russia by launching oats under our local Chudo brand. 18 2012 PEPSICO ANNUAL REPORT Quaker, the most trusted “masterbrand” in its breakfast and snacking categories in the U.S., grew volume in markets around the globe. Tropicana innovation includes premium packaging, Tropicana Farmstand in the U.S. and the 2013 launch of Trop 50 in the U.K. Gatorade, the clear leader in the sports Gatorade, the clear leader in the sports nutrition category, is poised to continue its global expansion in 2013. Naked Juice is one of our strongest growth performers and in 2012, grew net revenue 21 percent over 2011. 2012 PEPSICO ANNUAL REPORT 19 Emerging & Developing markets Over the past five years, we have deliberately invested for growth in emerging and developing markets. We are now the #1 food and beverage business in Russia, India and the Middle East. We are the #2 food and beverage business in Mexico, where we have a strong position in macrosnacks and have increased the scale of our Mexican beverage business under a new joint venture. We are also among the top 5 food and beverage busi- nesses in Brazil, Turkey and many other markets. PErCENTaGE Of NET rEvENuE frOm EmErGiNG & DEvElOPiNG markETS 24% 35% 2006 2012 In 2006, emerging and developing markets accounted for 24 percent of PepsiCo net revenue; in 2012, they represented 35 percent. 20 2012 PEPSICO ANNUAL REPORT laTiN amEriCa Our Latin America foods business delivered double-digit organic reve- nue growth1 in 2012. We grew volume in cookies and biscuits in markets such as Argentina, where we launched Toddy cookies, and Brazil, where we acquired the Mabel brand in 2011. Our Sabritas brand in Mexico helped deliver volume growth in the savory category. Our beverage business in Latin America also delivered growth, with the rising popular- ity of brands such as H2Oh! Our innovation in Latin America included the launch of a Quaker oats-based beverage in Mexico and Brazil. ruSSia We continue to build on our leading position in Russia, with global brands such as Lay’s, Pepsi and 7UP. Our strong local brands include Chudo (dairy and grains), Fruktovy Sad (juices and juice drinks) and Hrusteam (bread snacks). 1 Organic results are non-GAAP financial measures that exclude certain items. See page 60 for a reconcili- ation to the most directly comparable financial measure in accordance with GAAP. ChiNa China is projected to become the world’s largest beverage market by 2015. Our strategic beverage alliance with Tingyi gives us a competi- tive advantage in this market. Our iconic beverage brands, including Pepsi, Mirinda, Gatorade and Tropicana, are now brought to Chinese consumers through the PepsiCo-Tingyi beverage system. Last year, we reached consumers in innovative ways when we made Bring Happiness Home, a video to celebrate the Chinese New Year. It was viewed by more than 700 million people. The video featured Pepsi, Lay’s and Tropicana, with each brand having its own story, and all the stories weaving together as a family reunited for the holiday… to bring happiness home. Watch the 2012 Bring Happiness Home video at www.PepsiCo.com/BHH Innovation, including Oats for Rice and Cereal Powder Drink, helped grow volume for our Quaker business in China in 2012. 2012 PEPSICO ANNUAL REPORT 21 Accelerating the Benefits of One PepsiCo ONE PEPSiCO iN ruSSia In Russia, our snack, beverage, juice and dairy businesses are actively working together to increase the impact of our portfolio in the market. The benefits derived from their continued integration are seen in the top- and bottom- line growth delivered by our Russia business in 2012. Our juice business in Russia leads the market with brands such as Fruktovy Sad (pictured below). PepsiCo Strengths In 2012, we continued our focus on accelerating the benefits of One PepsiCo, leveraging our strong po- sitions in both foods and beverages to become a more efficient and effective company. Having a common supply chain and sharing infrastructure has enabled us to decrease costs. The expertise we have developed in “lifting and shifting” best practices has helped us to improve our performance in how we make, move and go to market with our foods and bever- ages. Our broad portfolio continues to attract world-class talent. Above all, being an integrated food and beverage company enables us to better serve our consumers and retail customers. We provide unique value to them through pro- grams, promotions and merchan- dizing across our categories, often with partners such as the National Football League and Major League Baseball. 22 2012 PEPSICO ANNUAL REPORT “DoritosLocosTacos, thebiggestnew productlaunchin TacoBellhistory, wouldnothavebeen possiblewithoutthe strongpartnership wehavewith PepsiCo.” GregCreed ChiefExecutiveOfficer,TacoBell In 2012, we partnered with Taco Bell to introduce Doritos Locos Tacos, the restaurant’s biggest suc- cess in its 50-year history. In nine months alone, Taco Bell sold 325 million Doritos Locos Tacos. We are building on this success with Cool Ranch-flavored Doritos Locos Tacos and the launch of Mountain Dew Baja Blast Freeze. The pairing of the Doritos and Mountain Dew brands is a powerful demonstra- tion of One PepsiCo: In the U.S. convenience channel, Doritos is the number one salty snack, while Moun- tain Dew is the number one single-serve carbonated soft drink. 2012 PEPSICO ANNUAL REPORT 23 Aggressively Building New Capabilities “DO uS a flavOr” Our “Do Us A Flavor” contest— which invites consumers to submit flavor ideas—began in the U.K. and has since been lifted and shifted to 17 markets, including Australia, Egypt, Poland, India, South Africa and Saudi Arabia. In 2012, to mark the 75th anniversary of Lay’s, we launched the “Do Us A Flavor” cam- paign in the U.S., receiving nearly 4 million fan submissions in response. Brand Building In 2012, we significantly stepped up our advertising and marketing investments, with a focus on 12 megabrands: in beverages, Pepsi, Mountain Dew, Sierra Mist (in the U.S.) and 7UP (outside the U.S.), Lipton ready-to-drink teas and Mirinda; in snacks, Lay’s, Doritos, Cheetos and SunChips; and in our nutrition business, Quaker, Tropicana and Gatorade. We launched bold new brand positioning with our global Pepsi “Live for Now” campaign and fresh Tropicana messaging in North America and Europe; upped our game in digital marketing with the Lipton Brisk Star Wars game app for mobile phones; and placed first on the Ad Meter rankings for Super Bowl XLVI with Doritos fan-created commercials. 24 2012 PEPSICO ANNUAL REPORT In 2012, Pepsi’s first global campaign, “Live for Now,” engaged millions of consumers through music, sports, social media and other consumer touch points. In December, we announced a unique creative collaboration with 17-time Grammy Award winning singer Beyoncé to work with us on engaging content for Pepsi consumers. As we launch “Live for Now” around the world, we are customizing it for our local markets, while staying true to the brand position of living in the moment. In the Middle East, the campaign is called “Yalla Now” and in India, “Oh Yes Abhi.” 2012 PEPSICO ANNUAL REPORT 25 Good-for-You innovation Better-for-You innovation un-for-You fun-for-You innovation innovation Accelerating innovation is a key pri- ority for PepsiCo. We have invested in Research & Development and built new capabilities to help us de- velop breakthrough innovation that delivers sustainable incremental growth. Innovation from products launched in the past three years accounted for approximately eight percent of our net revenue in 2012. 26 2012 PEPSICO ANNUAL REPORT mEETiNG CONSumEr DEmaND Innovation enables us to meet growing consumer demand for tasty and convenient nutrition with Good-for-You choices such as Quaker Real Medleys, Gatorade Prime Energy Chews for athletes, Tropicana Farmstand and Chudo Kasha cereal (in Russia). Through innovation, we provide Better-for- You choices with reduced sugar, salt and saturated fat, without compromising on taste. Better- for-You choices launched in 2012 included Pepsi NEXT, Lay’s Forno (in Saudi Arabia) and Starbucks Refreshers. Innovation also means new Fun-for-You tastes, textures and experiences, with offerings such as Doritos JACKED and Walkers Deep Ridged (in the U.K. and Ireland). SHANGHAI research & Development In the last five years, we have transformed the R&D organization at PepsiCo to create a global network, develop strong core research capabilities and build deep scientific skills. Our R&D team includes experts from a wide range of scientific disciplines who help keep PepsiCo on the leading edge of our industry. The team is focused on delivering science- backed innovation to meet consumer needs and grow our businesses. HAMBURG MONTERREY GlOBal CENTErS PepsiCo’s new food and beverage innovation center in Shanghai will serve as a hub for new product, packaging and equipment inno- vation for PepsiCo’s businesses throughout Asia and, more broadly, will partner with PepsiCo’s R&D centers globally. Our new R&D center in Hamburg, Germany will play a leading role in our global research and innovation focused on fruits and vegetables. In 2013, we will inaugurate our Global Baking Innovation and Nutri- tion Center. Located in Monterrey, Mexico, it will focus on baked snacks innovation that can be adapted globally. 2012 PEPSICO ANNUAL REPORT 27 Strengthening a Second-to-None Team and Culture Celebrating Diversity, fostering inclusion As a company doing business in more than 200 countries and terri- tories, diversity and inclusion have never been more vital to our suc- cess. Being as diverse as our con- sumers enables us to understand, firsthand, how to meet their needs. A safe and inclusive workplace that values different perspectives builds employee engagement, fosters creativity and fuels innova- tion. The vignettes below offer but a few examples of how PepsiCo both supports and benefits from diversity and inclusion. are women exceeds 50 percent. Tailored programs enable progress: In Saudi Arabia, we have construct- ed workplaces that respect local customs while enabling women to work and advance. Our Saudi team includes 25 women hired in 2011 and 2012 in both management and front-line roles. TAkING A STAND fOR EqUALITy As a global company, PepsiCo works in countries with a broad array of laws and regulations. Regardless of where we oper- ate, PepsiCo takes great care to respect the diversity, talents and abilities of all. GROWING THE NUMBER Of WOMEN LEADERS We are committed to increasing the number of women leaders within PepsiCo through recruiting and development initiatives around the world. In our Asia, Middle East and Africa sector, for example, the percentage of newly hired or promoted executives who At PepsiCo, we define diversity as all the unique characteristics that make up each of us: personal- ity, lifestyle, thought processes, work experience, ethnicity, race, color, religion, gender, gender identity, sexual orientation, marital status, age, national origin, disability, veteran status, or other differences. 28 2012 PEPSICO ANNUAL REPORT RECRUITING VETERANS TO OUR COMPANy Our efforts to recruit U.S. military veterans to PepsiCo have earned us a place on the G.I. Jobs ranking of Top 100 Military Friendly Employers. Only the top two percent of thou- sands of eligible companies make the Top 100 ranking. On the 2013 list, PepsiCo is the only food and beverage company in the top 50. CREATING OPPORTUNITIES fOR DIffERENTLy-ABLED PEOPLE Our PepsiCo Mexico Foods as well as our Middle East business exem- plify how PepsiCo creates opportu- nities for differently-abled people. Both of these businesses have developed strong track records for hiring and developing the talents of people with hearing impairments. The accomplishments of these associates are a source of pride for our entire company. SUPPORTING OUR LOCAL COMMUNITIES We believe we have a responsibility to the communities where we op- erate. Our U.K. team, for example, partners with a charity called Magic Breakfast to help alleviate hunger. Thanks to this partnership, which is supported by our Quaker and Tropicana businesses, about 6,000 children in the U.K. begin their day with a nutritious breakfast. honoring Our associates Every day, PepsiCo associates show their passion for the busi- ness. During challenging times, our associates have demonstrated great courage. When Hurricane Sandy brought terrible devastation to the Eastern U.S., teams of PepsiCo associates worked tire- lessly to help communities in New York and New Jersey. In the Philip- pines, when heavy monsoon rains and a typhoon caused flooding in Manila, our associates took action, providing aid to those in need. And through political unrest and transition, our associates in Egypt safely kept our business on track. With their unwavering dedication to our consumers, customers and communities, our PepsiCo associates around the world are second to none. We thank and salute them. “In2012, PepsiCowas listedamong theTop25 ‘World’sBest Multinational Workplaces’ bytheGreat PlacetoWork Institute.” A PepsiCo advertisement, used as part of our recruiting efforts, features women associates in our Asia, Middle East and Africa sector: (left to right) Stephanie Lewis (nutrition manager), Shaima Al Awadhi (commercial man- agement trainee) and Khushnuma Panthaki (communications coordinator). 2012 PEPSICO ANNUAL REPORT 29 Delivering on the Promise of Performance with Purpose Our Promise Performance with Purpose under- pins our goal to deliver long-term, sustainable financial performance. It guides our strategy and opera- tions, with a focus on Human Sus- tainability, Environmental Sustain- ability and Talent Sustainability. human Sustainability Human Sustainability means pro- viding a wide range of foods and beverages, from treats to healthy eats. Our efforts to increase choices for our consumers include reducing levels of fat, sodium and added sugar in many of our treats. At the same time, we have expanded our portfolio to provide consumers with convenient foods and beverages that support their daily nutrition requirements. We have made significant progress in expanding our portfolio: In the U.S., for example, low- or zero- calorie beverages, active hydration offerings and juices collectively comprised 49 percent of our 2012 beverage volume. Environmental Sustainability Environmental Sustainability means finding innovative ways to cut costs and minimize our impact on the environment through en- ergy and water conservation and reduction of packaging volume. Last year, we announced that we achieved our water reduction goal to improve global operational water-use efficiency by 20 percent per unit of production four years ahead of schedule. We also met our goal to provide access to safe water to three million people in 2012—three years ahead of plan— through the efforts of the PepsiCo Foundation. In recognition of our comprehensive approach to water stewardship, including our efforts throughout our business opera- tions, our work in the communities 30 2012 PEPSICO ANNUAL REPORT where we operate, and our con- tinued leadership on the issue, PepsiCo was honored with the prestigious 2012 Stockholm Indus- try Water Award. To help guide our agricultural operations, we developed and are piloting a leading framework for sustainable agriculture that engages growers, helps measure on-farm progress and leverages our scale to share best practices for improvement. At the end of last year, Frito-Lay North America had nearly 200 electric trucks deployed in the U.S.; the business has the largest commercial fleet of all-electric delivery trucks in the country. Through 2012, we exceeded by more than 20 percent our goal to reduce the packaging weight of our products by 350 million pounds over the last five years, primarily in our beverage bottles. Talent Sustainability Talent Sustainability means invest- ing in our associates to help them succeed; providing a safe and inclusive workplace globally; and respecting, supporting and invest- ing in the local communities where we operate. In all of our markets, we are devel- oping the talent of associates, pre- paring them to lead PepsiCo into the future. Through PepsiCo Uni- versity and online courses offered by our global functions, more than 8,000 of our associates completed more than 11,500 courses in 2012. The professional development we offer our associates enables them to develop the skills, capabilities and mindsets needed to drive sus- tainable financial performance and value creation. We also have been recognized ex- ternally for our leadership in using social media sites, such as LinkedIn and Twitter, to recruit great talent to our company. And in Health and Safety, we de- creased our Lost Time Injury Rate by 32 percent compared to 2011. 49%Low- or zero-calorie beverages, active hydration offerings and juices collectively comprised 49 percent of our 2012 U.S. beverage volume. 20%We achieved our goal—four years ahead of schedule—to improve global operational water-use efficiency by 20 percent per unit of production by 2015, compared to a 2006 baseline. We have reduced the packaging weight of our products by more than 350 million pounds over the last five years. 350 350 350 MILLION MILLION 32%In 2012, we decreased our Lost Time Injury Rate by 32 percent compared to 2011. 2012 PEPSICO ANNUAL REPORT 31 The Stockholm International Water Institute awarded PepsiCo the 2012 Stockholm Industry Water Award. 32 2012 PEPSICO ANNUAL REPORT PepsiCo Board of Directors Shown in photo, left to right: Victor J. Dzau, M.D. Chancellor for Health Affairs, Duke University; President and Chief Executive Officer, Duke University Health System 67. Elected 2005. Ian M. Cook Chairman, President and Chief Executive Officer, Colgate-Palmolive Company 60. Elected 2008. Sharon Percy Rockefeller President and Chief Executive Officer, WETA Public Stations 68. Elected 1986. Daniel Vasella, M.D. Former Chairman and Chief Executive Officer, Novartis AG 59. Elected 2002. James J. Schiro Former Chief Executive Officer, Zurich Financial Services 67. Elected 2003. Indra k. Nooyi Chairman and Chief Executive Officer, PepsiCo 57. Elected 2001. Dina Dublon Former Executive Vice President and Chief Financial Officer, JPMorgan Chase & Co. 59. Elected 2005. Ray L. Hunt Chairman, President and Chief Executive Officer, Hunt Consolidated, Inc. 69. Elected 1996. Shona L. Brown Senior Advisor, Google Inc. 47. Elected 2009. George W. Buckley Chairman, Arle Capital LLP 66. Elected 2012. Lloyd G. Trotter Managing Partner, GenNx360 Capital Partners 67. Elected 2008. Alberto Weisser Chairman and Chief Executive Officer, Bunge Limited 57. Elected 2011. Alberto Ibargüen President and Chief Executive Officer, John S. and James L. Knight Foundation 69. Elected 2005. 2012 PEPSICO ANNUAL REPORT 33 PepsiCo Leadership PepsiCo Executive Officers1 Zein Abdalla President, PepsiCo Saad Abdul-Latif Chief Executive Officer, PepsiCo Asia, Middle East and Africa Albert P. Carey Chief Executive Officer, PepsiCo Americas Beverages Brian C. Cornell Chief Executive Officer, PepsiCo Americas Foods Marie T. Gallagher Senior Vice President and Controller, PepsiCo Thomas R. Greco Executive Vice President, PepsiCo; President, Frito-Lay North America Enderson Guimaraes Chief Executive Officer, PepsiCo Europe Hugh f. Johnston Executive Vice President and Chief Financial Officer, PepsiCo Mehmood khan Executive Vice President, PepsiCo Chief Scientific Officer, Global Research and Development Indra k. Nooyi Chairman and Chief Executive Officer, PepsiCo Larry Thompson Executive Vice President, Government Affairs, General Counsel and Corporate Secretary Cynthia M. Trudell Executive Vice President, Human Resources and Chief Human Resources Officer, PepsiCo Shown in photo, left to right: Albert Carey, Zein Abdalla, Mehmood Khan, Brian Cornell, James Wilkinson, Saad Abdul-Latif, Cynthia Trudell, Larry Thompson, Hugh Johnston, Enderson Guimaraes, and Indra Nooyi 1 PepsiCo Executive Officers subject to Section 16 of the Securities Exchange Act of 1934 of March 8, 2013. 34 2012 PEPSICO ANNUAL REPORT Financials Management’s Discussion and Analysis Our Business Executive Overview Our Operations Our Customers Our Distribution Network Our Competition Other Relationships Our Business Risks Our Critical Accounting Policies Revenue Recognition Goodwill and Other Intangible Assets Income Tax Expense and Accruals Pension and Retiree Medical Plans Our Financial Results Items Affecting Comparability Results of Operations —  Consolidated Review Results of Operations —  Division Review Frito-Lay North America Quaker Foods North America Latin America Foods PepsiCo Americas Beverages Europe Asia, Middle East and Africa Our Liquidity and Capital Resources Consolidated Statement of Income Consolidated Statement of Comprehensive Income Consolidated Statement of Cash Flows 36 37 39 39 39 40 40 49 50 51 52 54 56 59 60 61 62 63 64 65 66 68 69 70 Note 4 Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Note 2 Our Significant Accounting Policies Note 3 Restructuring, Impairment and Integration Charges Property, Plant and Equipment and Intangible Assets Income Taxes Stock-Based Compensation Note 5 Note 6 Note 7 Pension, Retiree Medical and Savings Plans Note 8 Related Party Transactions Note 9 Debt Obligations and Commitments Note 10 Financial Instruments Note 11 Net Income Attributable to PepsiCo per Common Share Note 12 Preferred Stock Note 13 Accumulated Other Comprehensive Loss Attributable to PepsiCo Note 14 Supplemental Financial Information Note 15 Acquisitions and Divestitures Management’s Responsibility for Financial Reporting Management’s Report on Internal Control Over Financial Reporting Report of Independent Registered Public Accounting Firm Selected Financial Data Reconciliation of GAAP and Non-GAAP Information Consolidated Balance Sheet 72 Glossary Consolidated Statement of Equity 73 74 78 80 81 84 85 87 93 93 95 97 98 98 98 99 100 101 102 103 105 108 2012 PEPSICO ANNUAL REPORT 35 Management’s Discussion and Analysis Our discussion and analysis is an integral part of our consoli- dated financial statements and is provided as an addition to, and should be read in connection with, our consolidated finan- cial statements and the accompanying notes. Definitions of key terms can be found in the glossary beginning on page 108. 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 Business Executive Overview We are a leading global food and beverage company with brands that are respected household names throughout the world. Through our operations, authorized bottlers, contract manufacturers and other partners, we make, market, sell and distribute a wide variety of convenient and enjoyable foods and beverages, serving customers and consumers in more than 200 countries and territories. Our management monitors a variety of key indicators to evaluate our business results and financial condition. These indicators include market share, volume, net revenue, oper- ating profit, management operating cash flow, earnings per share and return on invested capital. During 2012 we undertook a number of significant initia- tives that we believe will position us for future success. These initiatives included increasing investment in our iconic global brands; stepping up our innovation program and launching new products like Pepsi Next; and implementing a multi-year productivity program that resulted in over $1 billion in savings last year alone. We successfully completed these initiatives while returning $6.5 billion to shareholders through repur- chases and dividends during 2012. As we look to 2013 and beyond, we are focused on position- ing our Company for long-term advantage and growth while continuing to deliver strong and consistent financial results. Our business strategies are designed to address key chal- lenges facing our industry, including increasing consumer and government focus on health and wellness, demographic shifts and retail trade consolidation, and macroeconomic uncer- tainty and commodity price volatility. We believe that many of these challenges create new opportunities for growth for our Company. For example, we expect that the acceleration of the convenience trend will drive continued growth in the demand for convenient foods and beverages worldwide. In addition, the favorable outlook in emerging and developing markets creates opportunities for growth in all of our products in those markets. We believe that there are also potential new 36 2012 PEPSICO ANNUAL REPORT categories of expansion for us in the global food and beverage marketplace, such as Good-for-You and premium priced prod- ucts, products for aging populations and value offerings. In order to address these challenges and capitalize on these opportunities, we plan to do the following: Reinforce our existing value drivers. We will continue to refocus our efforts on key global brands and categories in our most important developed markets to drive profitable growth. We believe that concentrating our insights, marketing and innovation resources behind our most significant brands in key markets will enable us to reinforce our existing competitive advantages resulting from our go-to- market systems and strong brands, particularly with respect to snacks, and continue to grow demand and market share. Migrate our portfolio towards attractive high growth categories and markets. We plan to build on our existing efforts in the Good-for-You space to continue to grow our nutrition business by growing our most admired existing nutrition brands, including Quaker, Tropicana and Gatorade. Our efforts to capitalize on the grow- ing consumer demand for convenient nutrition are global. We are also working to unlock opportunities in new product categories through our dairy business in Russia and our Müller Quaker Dairy joint venture in the United States, our Sabra dips joint venture and our Stacy’s baked grain snack business. We believe emerging and developing markets represent another very attractive high growth space for PepsiCo. Economic growth in these markets is lifting consumer income levels and driving urban lifestyles, which is in turn increas- ing demand for convenient foods and beverages. We expect to continue to invest aggressively for advantaged growth in emerging and developing markets, such as through tuck-in acquisitions like Mabel cookies in Brazil and through strate- gic partnerships to improve scale and performance such as our partnership with Tingyi (Cayman Islands) Holding Corp. (Tingyi) in China. Accelerate the benefits of “Power of One.” We are focused on continuing to drive cost savings and other productivity enhancements derived from our complemen- tary food and beverage portfolio, which benefit both our top and bottom line. For example, we realize significant benefits from our cost scale across our portfolio. We also capture productivity benefits by applying a common set of best-in- class processes, technologies and best practices across our businesses around the globe. In addition, the complementary nature of our categories allows us to drive commercial activi- ties across food and beverage to accelerate our growth within particular markets. Harmonize internal processes and aggressively build out new capabilities. To be successful in an increasingly competitive environment, we must effectively implement our global operating model and aggressively build out new capabilities. We are leveraging the expertise of our marketing and innovation teams across the Company. We plan to increase the use of global marketing campaigns for our iconic global brands, such as the “Live for Now” campaign for Pepsi to create a more consistent brand experience for consumers around the world. We also expect to continue to increase our investment behind sweeteners and other research and development initiatives. In addition, we are investing in packaging and other innovations, includ- ing through the creation of a new design group. Other global processes, such as master data and information technology systems, are also being harmonized to increase efficiency across the Company and speed decision-making. Build and retain top talent. Our continued growth and our ability to effectively respond to a rapidly changing environment requires us to develop and retain talented associates. To address this need, we have implemented award-winning talent and leadership initiatives and plan to continue to recruit from outside our industry to infuse fresh thinking and bring complementary capabilities to our team. Deliver on the promise of Performance with Purpose. Performance with Purpose is our vision to succeed in the long term by creating sustained value. PepsiCo was again recog- nized for its leadership in this area in 2012 by earning a place on the prestigious Dow Jones Sustainability World Index for the sixth consecutive year and on the North America Index for the seventh consecutive year. We plan to continue delivering on this vision by offering a wide range of product choices, finding innovative ways to cut costs and minimize our impact on the environment, providing a safe and inclusive workplace and respecting and investing in the communities in which we operate. Management’s Discussion and Analysis Our Operations We are organized into four business units, as follows: 1) PepsiCo Americas Foods, which includes Frito-Lay North America (FLNA), Quaker Foods North America (QFNA) and all of our Latin American food and snack businesses (LAF); 2) PepsiCo Americas Beverages (PAB), which includes all of our North American and Latin American bever- age businesses; 3) PepsiCo Europe, which includes all beverage, food and snack businesses in Europe and South Africa; and 4) PepsiCo Asia, Middle East and Africa (AMEA), which includes all beverage, food and snack businesses in AMEA, excluding South Africa. Our four business units are comprised of six reportable seg- ments (also referred to as divisions), as follows: • FLNA, • QFNA, • LAF, • PAB, • Europe, and • AMEA. See Note  1 to our consolidated financial statements for financial information about our divisions and geographic areas. Frito-Lay North America Either independently or in conjunction with third-party part- ners, FLNA makes, markets, sells and distributes branded snack foods. These foods include Lay’s potato chips, Doritos tortilla chips, Cheetos cheese flavored snacks, Tostitos tortilla chips, branded dips, Ruffles potato chips, Fritos corn chips and Santitas tortilla chips. FLNA’s branded products are sold to independent distributors and retailers. In addition, FLNA’s joint venture with Strauss Group makes, markets, sells and distributes Sabra refrigerated dips and spreads. Quaker Foods North America Either independently or in conjunction with third-party part- ners, QFNA makes, markets, sells and distributes cereals, rice, pasta, dairy and other branded products. QFNA’s products include Quaker oatmeal, Aunt Jemima mixes and syrups, Quaker Chewy granola bars, Quaker grits, Cap’n Crunch cereal, Life cereal, Quaker rice cakes, Rice-A-Roni side dishes, Near East side dishes and Pasta Roni side dishes. These branded products are sold to independent distributors and retailers. 2012 PEPSICO ANNUAL REPORT 37 Management’s Discussion and Analysis Latin America Foods Either independently or in conjunction with third-party part- ners, LAF makes, markets, sells and distributes a number of snack food brands including Marias Gamesa, Cheetos, Doritos, Ruffles, Emperador, Saladitas, Elma Chips, Rosquinhas Mabel, Sabritas and Tostitos, as well as many Quaker-branded cereals and snacks. These branded products are sold to independent distributors and retailers. PepsiCo Americas Beverages Either independently or in conjunction with third-party part- ners, PAB makes, markets, sells and distributes beverage concentrates, fountain syrups and finished goods under vari- ous beverage brands including Pepsi, Mountain Dew, Gatorade, Diet Pepsi, Aquafina, 7UP (outside the U.S.), Diet Mountain Dew, Tropicana Pure Premium, Sierra Mist and Mirinda. PAB also, either independently or in conjunction with third-party partners, makes, markets and sells ready-to-drink tea and coffee products through joint ventures with Unilever (under the Lipton brand name) and Starbucks. Further, PAB manufac- tures and distributes certain brands licensed from Dr Pepper Snapple Group, Inc. (DPSG), including Dr  Pepper and Crush, and certain juice brands licensed from Dole Food Company, Inc. PAB operates its own bottling plants and distribution facilities and sells branded finished goods directly to inde- pendent distributors and retailers. PAB also sells concentrate and finished goods for our brands to authorized independent bottlers, who in turn also sell our brands as finished goods to independent distributors and retailers in certain markets. PAB’s volume reflects sales to its independent distributors and retailers, as well as the sales of beverages bearing our trademarks that bottlers have reported as sold to independent distributors and retailers. Bottler case sales (BCS) and con- centrate 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 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 quanti- fies the sell-through of our products at the consumer level. See Note  15 to our consolidated financial statements for additional information about our acquisitions of The Pepsi Bottling Group (PBG) and PepsiAmericas, Inc. (PAS) in 2010. Europe Either independently or in conjunction with third-party part- ners, Europe makes, markets, sells and distributes a number of leading snack foods including Lay’s, Walkers, Doritos, Cheetos and Ruffles, as well as many Quaker-branded cereals and snacks, through consolidated businesses as well as through noncontrolled affiliates. Europe also, either independently or in conjunction with third-party partners, makes, markets, sells and distributes beverage concentrates, fountain syrups and finished goods under various beverage brands includ- ing Pepsi, Pepsi Max, 7UP, Diet Pepsi and Tropicana. These branded products are sold to authorized bottlers, independent distributors and retailers. In certain markets, however, Europe operates its own bottling plants and distribution facilities. Europe also, either independently or in conjunction with third- party partners, makes, markets and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). In addition, Europe makes, markets, sells and distributes a number of leading dairy prod- ucts including Domik v Derevne, Chudo and Agusha. Europe reports two measures of volume. Snacks volume 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. Beverage volume reflects Company-owned or authorized bottler sales of beverages bearing Company-owned or licensed trade- marks to independent distributors and retailers (see PepsiCo Americas Beverages above). In 2011, we acquired Wimm-Bill- Dann Foods OJSC (WBD), Russia’s leading branded food and beverage company. WBD’s portfolio of products is included within Europe’s snacks or beverage reporting, depending on product type. See Note  15 to our consolidated financial statements for additional information about our acquisitions of WBD in 2011 and PBG and PAS in 2010. Asia, Middle East and Africa Either independently or in conjunction with third-party part- ners, AMEA makes, markets, sells and distributes a number of leading snack food brands including Lay’s, Chipsy, Kurkure, Doritos, Cheetos and Smith’s through consolidated businesses as well as through noncontrolled affiliates. Further, either independently or in conjunction with third-party partners, AMEA makes, markets and sells many Quaker-branded cereals and snacks. AMEA also makes, markets, sells and distributes beverage concentrates, fountain syrups and finished goods under various beverage brands including Pepsi, Mirinda, 7UP, Mountain Dew, Aquafina and Tropicana. These branded prod- ucts are sold to authorized bottlers, independent distributors and retailers. However, in certain markets, AMEA operates its own bottling plants and distribution facilities. AMEA also, either independently or in conjunction with third-party part- ners, makes, markets and sells ready-to-drink tea products through an international joint venture with Unilever (under the Lipton brand name). Further, AMEA licenses co-branded juice products to third-party partners through a strategic alliance 38 2012 PEPSICO ANNUAL REPORT with Tingyi under the House of Tropicana brand name. AMEA reports two measures of volume (see Europe above). See Note  15 to our consolidated financial statements for additional information about our transaction with Tingyi in 2012. Our Distribution Network Our products are brought to market through direct-store- delivery (DSD), customer warehouse and distributor networks. The distribution system used depends on customer needs, product characteristics and local trade practices. Management’s Discussion and Analysis Our Customers Our primary customers include wholesale distributors, food- service distributors, grocery stores, convenience stores, mass merchandisers, membership stores and authorized indepen- dent bottlers. We normally grant our independent bottlers exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographic area. These arrangements provide us with the right to charge our independent bottlers for concentrate, finished goods and Aquafina royalties and specify the manufacturing process required for product quality. Since we do not sell directly to the consumer, we rely on and provide financial incentives to our customers to assist in the distribution and promotion of our products. For our inde- pendent distributors and retailers, these incentives include volume-based rebates, product placement fees, promotions and displays. For our independent bottlers, these incentives are referred to as bottler funding and are negotiated annually with each bottler to support a variety of trade and consumer programs, such as consumer incentives, advertising support, new product support, and vending and cooler equipment placement. Consumer incentives include coupons, pricing discounts and promotions, and other promotional offers. Advertising support is directed at advertising programs and supporting independent bottler media. New product support includes targeted consumer and retailer incentives and direct marketplace support, such as point-of-purchase materials, product placement fees, media and advertising. Vending and cooler equipment placement programs support the acquisition and placement of vending machines and cooler equipment. The nature and type of programs vary annually. Retail consolidation and the current economic environment continue to increase the importance of major customers. In 2012, sales to Wal-Mart Stores, Inc. (Wal-Mart) including Sam’s Club (Sam’s), represented approximately 11% of our total net revenue. Our top five retail customers represented approximately 30% of our 2012 North American (United States and Canada) net revenue, with Wal-Mart (including Sam’s) representing approximately 17%. These percentages include concentrate sales to our independent bottlers which were used in finished goods sold by them to these retailers. Direct-Store-Delivery We, our independent bottlers and our distributors operate DSD systems that deliver snacks and beverages directly to retail stores where the products are merchandised by our employees or our bottlers. DSD enables us to merchandise with maximum visibility and appeal. DSD is especially well- suited to products that are restocked often and respond to in-store promotion and merchandising. Customer Warehouse Some of our products are delivered from our manufacturing plants and warehouses to customer warehouses and retail stores. These less costly systems generally work best for prod- ucts that are less fragile and perishable, have lower turnover, and are less likely to be impulse purchases. Distributor Networks We distribute many of our products through third-party dis- tributors. Third-party distributors are particularly effective when greater distribution reach can be achieved by including a wide range of products on the delivery vehicles. For exam- ple, our foodservice and vending business distributes snacks, foods and beverages to restaurants, businesses, schools and stadiums through third-party foodservice and vending dis- tributors and operators. Our Competition Our businesses operate in highly competitive markets. Our beverage, snack and food brands compete against global, regional, local and private label manufacturers and other value competitors. In many countries in which we do business, The Coca-Cola Company is our primary beverage competitor. Other food and beverage competitors include, but are not lim- ited to, Nestlé S.A., Danone, DPSG, Kellogg Company, General Mills, Inc. and Mondelēz International, Inc. In many markets, we compete against numerous regional and local companies. Many of our snack and food brands hold significant lead- ership positions in the snack and food industry worldwide. However, The Coca-Cola Company has significant CSD share advantage in many markets outside the United States. Our beverage, snack and food brands compete on the basis of price, quality, product variety and distribution. Success in this competitive environment is dependent on effective pro- motion of existing products, the introduction of new products 2012 PEPSICO ANNUAL REPORT 39 Management’s Discussion and Analysis and the effectiveness of our advertising campaigns, marketing programs, product packaging, pricing, increased efficiency in production techniques and brand and trademark development and protection. We believe that the strength of our brands, innovation and marketing, coupled with the quality of our products and flexibility of our distribution network, allows us to compete effectively. Other Relationships Certain members of our Board of Directors also serve on the boards of certain vendors and customers. Those Board members do not participate in our vendor selection and nego- tiations 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 incremen- tal compensation for their Board services. Our Business Risks Forward-Looking Statements This Annual Report contains statements reflecting our views about our future performance that constitute “forward- looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). Statements that constitute forward-looking statements within the meaning of the Reform Act are generally identified through the inclusion of words such as “believe,” “expect,” “intend,” “estimate,” “project,” “anticipate,” “will” or similar statements or variations of such words and other similar expressions. All statements addressing our future operating performance, and statements addressing events and developments that we expect or anticipate will occur in the future, are forward- looking statements within the meaning of the Reform Act. These forward-looking statements are based on currently available information, operating plans and projections about future events and trends. They inherently involve risks and uncertainties that could cause actual results to differ materially from those predicted in any such forward-looking statements. Investors are cautioned not to place undue reliance on any such forward-looking statements, which speak only as of the date they are made. We undertake no obligation to update any forward-looking statement, whether as a result of new information, future events or otherwise. The discussion of risks below and elsewhere in this report is by no means all inclusive but is designed to highlight what we believe are important factors to consider when evaluating our future performance. 40 2012 PEPSICO ANNUAL REPORT Demand for our products may be adversely affected by changes in consumer preferences and tastes or if we are unable to innovate or market our products effectively. We are a global food and beverage company operating in highly competitive categories and rely on continued demand for our products. To generate revenues and profits, we must sell products that appeal to our customers and to consum- ers. Any significant changes in consumer preferences or any inability on our part to anticipate or react to such changes could result in reduced demand for our products and erosion of our competitive and financial position. Our success depends on: our ability to anticipate and respond to shifts in consumer trends, including increased demand for products that meet the needs of consumers who are increasingly concerned with health and wellness; our product quality; our ability to extend our portfolio of convenient foods in growing markets; our abil- ity to develop new products that are responsive to consumer preferences, including our Fun-for-You, Better-for-You and Good-for-You products; and our ability to respond to competi- tive product and pricing pressures. For example, our growth rate may be adversely affected if we are unable to maintain or grow our current share of the liquid refreshment beverage market in North America, or our current share of the snack market globally, or if demand for our products does not grow in emerging and developing markets. In general, changes in product category consumption or consumer demographics could result in reduced demand for our products. Consumer preferences may shift due to a vari- ety of factors, including the aging of the general population; consumer concerns regarding the health effects of ingredi- ents such as sodium, sugar or other product ingredients or attributes; changes in social trends that impact travel, vacation or leisure activity patterns; changes in weather patterns or seasonal consumption cycles; negative publicity (whether or not valid) resulting from regulatory action or litigation against us or other companies in our industry; a downturn in eco- nomic conditions; or taxes that would increase the cost of our products to consumers. Any of these changes may reduce consumers’ willingness to purchase our products. See also “Changes in the legal and regulatory environment could limit our business activities, increase our operating costs, reduce demand for our products or result in litigation.”, “Our finan- cial performance could suffer if we are unable to compete effectively.”, “Unfavorable economic conditions may have an adverse impact on our business results or financial condition.” and “Any damage to our reputation could have a material adverse effect on our business, financial condition and results of operations.” Our continued success is also dependent on our product innovation, including maintaining a robust pipeline of new products and improving the quality of existing products, Management’s Discussion and Analysis and the effectiveness of our product packaging, advertising campaigns and marketing programs, including our ability to successfully adapt to a rapidly changing media environment, such as through use of social media and online advertising campaigns and marketing programs. Although we devote significant resources to the actions mentioned above, there can be no assurance as to our continued ability to develop and launch successful new products or variants of existing products or to effectively execute advertising campaigns and marketing programs. In addition, both the launch and ongoing success of new products and advertising campaigns are inher- ently uncertain, especially as to their appeal to consumers. Our failure to make the right strategic investments to drive innova- tion or successfully launch new products or variants of existing products could decrease demand for our existing products by negatively affecting consumer perception of existing brands, as well as result in inventory write-offs and other costs. Changes in the legal and regulatory environment could limit our business activities, increase our operating costs, reduce demand for our products or result in litigation. The conduct of our businesses, including the production, stor- age, distribution, sale, advertising, marketing, labeling, health and safety practices, transportation and use of many of our products, are subject to various laws and regulations adminis- tered by federal, state and local governmental agencies in the United States, as well as to laws and regulations administered by government entities and agencies outside the United States in markets in which our products are made, manufactured or sold, including in emerging and developing markets where legal and regulatory systems may be less developed. These laws and regulations and interpretations thereof may change, sometimes dramatically, as a result of political, economic or social events. Such changes may include changes in: food and drug laws; laws related to product labeling, advertising and marketing practices; laws regarding the import of ingredients used in our products; laws regarding the import or export of our products; laws and programs aimed at reducing ingre- dients present in certain of our products, including sodium, saturated fat and added sugar; regulatory actions targeting the snack food or beverage industries such as restrictions on the sale of snack and beverage products in publicly regu- lated venues or restrictions on the use of the Supplemental Nutrition Assistance Program to purchase certain snacks or beverages; increased regulatory scrutiny of, and increased litigation involving, product claims and concerns regarding the effects on health of ingredients in, or attributes of, cer- tain of our products, including without limitation those found in energy drinks; state consumer protection laws; taxation requirements, including taxes that would increase the cost of our products to consumers; competition laws; employment laws; privacy laws; laws regulating the price we may charge for our products; laws regulating access to and use of water or utilities; and environmental laws, including laws relating to the regulation of water rights and treatment. New laws, regula- tions or governmental policy and their related interpretations, or changes in any of the foregoing, may alter the environment in which we do business and, therefore, may impact our results or increase our costs or liabilities. Governmental entities or agencies in jurisdictions where we operate may also impose new labeling, product or production requirements, or other restrictions. Studies are underway by third parties to assess the health implications of consump- tion of certain ingredients present in some of our products, including sugar, artificial sweeteners, as well as substances such as acrylamide that are naturally formed in a wide variety of foods when they are cooked (whether commercially or at home), including french fries, potato chips, cereal, bread and coffee. Certain of these studies of acrylamide found that it is probable that acrylamide causes cancer in laboratory animals when consumed in extraordinary amounts. If consumer con- cerns about the health implications of consumption of certain ingredients present in some of our products, including sugar, artificial sweeteners, or acrylamide increase as a result of these studies, other new scientific evidence, or for any other reason, whether or not valid, demand for our products could decline and we could be subject to lawsuits or new regulations that could affect sales of our products, any of which could have an adverse effect on our business, financial condition or results of operations. We are also subject to Proposition 65 in California, a law which requires that a specific warning appear on any product sold in California that contains a substance listed by that State as having been found to cause cancer or birth defects. If we were required to add warning labels to any of our products or place warnings in certain locations where our products are sold, sales of those products could suffer not only in those locations but elsewhere. In many jurisdictions, compliance with competition laws is of special importance to us due to our competitive position in those jurisdictions. Regulatory authorities under whose laws we operate may also have enforcement powers that can sub- ject us to actions such as product recall, seizure of products or other sanctions, which could have an adverse effect on our sales or damage our reputation. Although we have policies and procedures in place that are designed to promote legal and regulatory compliance, our employees or suppliers could take actions that violate these policies and procedures or applicable laws or regulations. Violations of these laws or regulations could subject us to criminal or civil enforcement actions which could have a material adverse effect on our business. 2012 PEPSICO ANNUAL REPORT 41 Management’s Discussion and Analysis In addition, we and our subsidiaries are party to a variety of legal and environmental remediation obligations arising in the normal course of business, as well as environmental reme- diation, product liability, toxic tort and related indemnification proceedings in connection with certain historical activities and contractual obligations of businesses acquired by our subsid- iaries. Due to regulatory complexities, uncertainties inherent in litigation and the risk of unidentified contaminants on current and former properties of ours and our subsidiaries, the poten- tial exists for remediation, liability and indemnification costs to differ materially from the costs we have estimated. We cannot guarantee that our costs in relation to these matters will not exceed our established liabilities or otherwise have an adverse effect on our results of operations. See “Our financial perfor- mance could be adversely affected if we are unable to grow our business in emerging and developing markets or as a result of unstable political conditions, civil unrest or other develop- ments and risks in the markets where our products are sold.” Our financial performance could suffer if we are unable to compete effectively. The food, snack and beverage industries in which we operate are highly competitive. We compete with major international food, snack and beverage companies that, like us, operate in multiple geographic areas, as well as regional, local and private label manufacturers and other value competitors. We com- pete with other large companies in each of the food, snack and beverage categories, including Nestlé S.A., Danone, Mondelēz International, Kellogg Company, General Mills and DPSG. In many countries where we do business, including the United States, our primary beverage competitor is The Coca-Cola Company. We compete on the basis of brand recognition, taste, price, quality, product variety, distribution, marketing and promotional activity, convenience, service and the ability to identify and satisfy consumer preferences. If we are unable to compete effectively, we may be unable to grow or maintain sales or gross margins in the global market or in various local markets. This may have a material adverse impact on our revenues and profit margins. See also “Unfavorable economic conditions may have an adverse impact on our business results or financial condition.” Our financial performance could be adversely affected if we are unable to grow our business in emerging and developing markets or as a result of unstable political conditions, civil unrest or other developments and risks in the markets where our products are sold. Our operations outside of the United States, particularly in Russia, Mexico, Canada and the United Kingdom, contribute significantly to our revenue and profitability, and we believe that our emerging and developing markets, particularly China, 42 2012 PEPSICO ANNUAL REPORT India, Brazil and the Africa and Middle East regions, pres- ent important future growth opportunities for us. However, there can be no assurance that our existing products, vari- ants of our existing products or new products that we make, manufacture, market or sell will be accepted or successful in any particular emerging or developing market, due to local or global competition, product price, cultural differences or oth- erwise. If we are unable to expand our businesses in emerging and developing markets, or achieve the return on capital we expect as a result of our investments, particularly in Russia, as a result of economic and political conditions, increased competition, reduced demand for our products, an inability to acquire or form strategic business alliances or to make neces- sary infrastructure investments or for any other reason, our financial performance could be adversely affected. Unstable economic or political conditions, civil unrest or other develop- ments and risks in the markets where our products are sold, including in Europe, Venezuela, Mexico, the Middle East and Egypt, could also have an adverse impact on our business results or financial condition. Factors that could adversely affect our business results in these markets include: foreign ownership restrictions; nationalization of our assets; regula- tions on the transfer of funds to and from foreign countries, which, from time to time, result in significant cash balances in foreign countries such as Venezuela, and on the repatriation of funds; currency hyperinflation, devaluation or fluctuation, such as the devaluation of the Venezuelan bolivar; the lack of well-established or reliable legal systems; and increased costs of business due to compliance with complex foreign and United States laws and regulations that apply to our interna- tional operations, including the Foreign Corrupt Practices Act and the U.K. Bribery Act, and adverse consequences, such as the assessment of fines or penalties, for failing to comply with these laws and regulations. In addition, disruption in these markets due to political instability or civil unrest could result in a decline in consumer purchasing power, thereby reducing demand for our products. See “Demand for our products may be adversely affected by changes in consumer prefer- ences and tastes or if we are unable to innovate or market our products effectively.”, “Changes in the legal and regulatory environment could limit our business activities, increase our operating costs, reduce demand for our products or result in litigation.”, “Our financial performance could suffer if we are unable to compete effectively.”, “Disruption of our supply chain could have an adverse impact on our business, financial condi- tion and results of operations.” and “Failure to successfully complete or integrate acquisitions and joint ventures into our existing operations, or to complete or manage divestitures or refranchising, could have an adverse impact on our business, financial condition and results of operations.” Management’s Discussion and Analysis Unfavorable economic conditions may have an adverse impact on our business results or financial condition. Many of the countries in which we operate, including the United States and several of the members of the European Union, have experienced and continue to experience unfavorable economic conditions. Our business or financial results may be adversely impacted by these unfavorable economic conditions, including: adverse changes in interest rates, tax laws or tax rates; volatile commodity markets and inflation; contraction in the availability of credit in the marketplace due to legislation or other economic conditions such as the European sovereign debt crisis, which may potentially impair our ability to access the capital markets on terms commercially acceptable to us or at all; the effects of government initiatives to manage eco- nomic conditions; reduced demand for our products resulting from a slow-down in the general global economy or a shift in consumer preferences for economic reasons or otherwise to regional, local or private label products or other economy products, or to less profitable channels; impairment of assets; or a decrease in the fair value of pension or post-retirement assets that could increase future employee benefit costs and/ or funding requirements of our pension or post-retirement plans. In addition, we cannot predict how current or worsen- ing economic conditions will affect our critical customers, suppliers and distributors and any negative impact on our critical customers, suppliers or distributors may also have an adverse impact on our business results or financial condition. In addition, some of the major financial institutions with which we execute transactions, including U.S. and non-U.S. com- mercial banks, insurance companies, investment banks and other financial institutions, may be exposed to a ratings down- grade, bankruptcy, liquidity, default or similar risks as a result of unfavorable economic conditions. A ratings downgrade, bankruptcy, receivership, default or similar event involving a major financial institution may limit the availability of credit or willingness of financial institutions to extend credit on terms commercially acceptable to us or at all or, with respect to finan- cial institutions who are parties to our financing arrangements, leave us with reduced borrowing capacity or unhedged against certain currencies or price risk associated with forecasted pur- chases of raw materials which could have an adverse impact on our business results or financial condition. Our operating results may be adversely affected by increased costs, disruption of supply or shortages of raw materials and other supplies. We and our business partners use various raw materials and other supplies in our business. The principal ingredients we use include apple, orange and pineapple juice and other juice concentrates, aspartame, corn, corn sweeteners, flavorings, flour, grapefruit and other fruits, oats, oranges, potatoes, raw milk, rice, seasonings, sucralose, sugar, vegetable and essential oils and wheat. Our key packaging materials include plastic resins, including polyethylene terephthalate (PET) and polypropylene resin used for plastic beverage bottles and film packaging used for snack foods, aluminum used for cans, glass bottles, closures, cardboard and paperboard cartons. Fuel and natural gas are also important commodities for us due to their use in our facilities and in the trucks delivering our products. Some of these raw materials and supplies are sourced inter- nationally and some are available from a limited number of suppliers or are in shortest supply when seasonal demand is at its peak. We are exposed to the market risks arising from adverse changes in commodity prices, affecting the cost of our raw materials and energy, including fuel. The raw materials and energy which we use for the production of our products are largely commodities that are subject to price volatility and fluctuations in availability caused by changes in global supply and demand, weather conditions, agricultural uncertainty or governmental incentives and controls. We purchase these materials and energy mainly in the open market. If commodity price changes result in unexpected increases in raw materials and energy costs, we may not be able to increase our prices to offset these increased costs without suffering reduced volume, revenue and operating results. In addition, we use derivatives to hedge price risk associated with forecasted purchases of certain raw materials and energy, including fuel. Certain of these derivatives that do not qualify for hedge accounting treatment can result in increased volatility in our net earnings in any given period due to changes in the spot prices of the underlying commodities. See also “Changes in the legal and regulatory environment could limit our business activities, increase our operating costs, reduce demand for our products or result in litigation.”, “Unfavorable economic conditions may have an adverse impact on our business results or financial condition.”, “Climate change, or legal, regulatory or market measures to address climate change, may negatively affect our business and operations.”, “Market Risks” and Note 1 to our consolidated financial statements. Failure to realize anticipated benefits from our productivity plan or global operating model could have an adverse impact on our business, financial condition and results of operations. We are implementing a strategic plan that we believe will position our business for future success and growth, to allow us to achieve a lower cost structure and operate efficiently in the highly competitive food, snack and beverage industries. In order to capitalize on our cost reduction efforts, it will be necessary to make certain investments in our business, which may be limited due to capital constraints. In addition, it is criti- cal that we have the appropriate personnel in place to continue 2012 PEPSICO ANNUAL REPORT 43 Management’s Discussion and Analysis to lead and execute our plan. Our future success and earnings growth depends in part on our ability to reduce costs and improve efficiencies. If we are unable to successfully imple- ment our productivity plan or fail to implement it as timely as we anticipate, our business, financial condition and results of operations could be adversely impacted. In addition, we have launched a global operating model to improve efficiency, decision making, innovation and brand management across the global PepsiCo organization. If we are unable to implement this model effectively, it may have a negative impact on our ability to deliver sustained or breakthrough innovation or to otherwise compete effectively. Disruption of our supply chain could have an adverse impact on our business, financial condition and results of operations. Our ability, and that of our suppliers, third-party business partners, including our independent bottlers, contract manu- facturers, joint venture partners, independent distributors and retailers, to make, manufacture, distribute and sell prod- ucts is critical to our success. Damage or disruption to our or their manufacturing or transportation and distribution capa- bilities due to any of the following could impair our ability to make, manufacture, transport, distribute or sell our prod- ucts: adverse weather conditions or natural disaster, such as a hurricane, earthquake or flooding; government action; fire; terrorism; the outbreak or escalation of armed hostilities; pan- demic; industrial accidents or other occupational health and safety issues; strikes and other labor disputes; or other reasons beyond our control or the control of our suppliers and busi- ness partners. Failure to take adequate steps to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, could adversely affect our business, financial condition and results of operations, as well as require additional resources to restore our supply chain. Any damage to our reputation could have a material adverse effect on our business, financial condition and results of operations. Maintaining a good reputation globally is critical to selling our branded products. Product contamination or tampering, the failure to maintain high standards for product quality, safety and integrity, including with respect to raw materials and ingredients obtained from suppliers, or allegations of product quality issues, mislabeling or contamination, even if untrue, may reduce demand for our products or cause production and delivery disruptions. If any of our products becomes unfit for consumption, causes injury or is mislabeled, we may have to engage in a product recall and/or be subject to liability. A widespread product recall or a significant product liability issue could cause our products to be unavailable for a period of time, which could further reduce consumer demand and brand equity. In addition, we operate globally, which requires us to comply with numerous local regulations, including, without lim- itation, anti-corruption laws and competition laws. In the event that our employees, bottlers or agents engage in improper activities abroad, we may be subject to enforcement actions, litigation, loss of sales or other consequences which may cause us to suffer damage to our reputation in the United States and abroad. Our reputation could also be adversely impacted by any of the following, or by adverse publicity (whether or not valid) relating thereto: the failure to maintain high ethical, social and environmental standards for all of our operations and activi- ties; the failure to achieve our goals with respect to sodium, saturated fat and added sugar reduction or the development of our global nutrition business; health concerns about our prod- ucts or particular ingredients in our products; our research and development efforts; our environmental impact, including use of agricultural materials, packaging, energy use and waste management; the practices of our bottlers with respect to any of the foregoing; or our responses to any of the foregoing. In addition, water is a limited resource in many parts of the world and demand for water continues to increase. Our reputation could be damaged if we or others in our industry do not act, or are perceived not to act, responsibly with respect to water use. Failure to comply with local laws and regulations, to maintain an effective system of internal controls or to provide accurate and timely financial information could also hurt our reputa- tion. Furthermore, the rising popularity of social networking and other consumer-oriented technologies has increased the speed and accessibility of information dissemination, and, as a result, negative or inaccurate posts or comments on such sites may also generate adverse publicity that could damage our reputation. Damage to our reputation or loss of consumer con- fidence in our products for any of these or other reasons could result in decreased demand for our products and could have a material adverse effect on our business, financial condition and results of operations, as well as require additional resources to rebuild our reputation. See also “Changes in the legal and regulatory environment could limit our business activities, increase our operating costs, reduce demand for our products or result in litigation.” Failure to successfully complete or integrate acquisitions and joint ventures into our existing operations, or to complete or manage divestitures or refranchisings, could have an adverse impact on our business, financial condition and results of operations. We regularly evaluate potential acquisitions, joint ventures, divestitures and refranchisings. Potential issues associated 44 2012 PEPSICO ANNUAL REPORT Management’s Discussion and Analysis with these activities could include, among other things, our ability to realize the full extent of the benefits or cost savings that we expect to realize as a result of the completion of an acquisition, divestiture or refranchising, or the formation of a joint venture, within the anticipated time frame, or at all; receipt of necessary consents, clearances and approvals in connection with an acquisition, joint venture, divestiture  or refranchising; and diversion of management’s attention from base strategies and objectives. With respect to acquisitions, the following also pose potential risks: our ability to suc- cessfully combine our businesses with the business of the acquired company, including integrating the manufacturing, distribution, sales and administrative support activities and information technology systems between our Company and the acquired company and successfully operating in new cat- egories; motivating, recruiting and retaining executives and key employees; conforming standards, controls (including internal control over financial reporting), procedures and poli- cies, business cultures and compensation structures between our Company and the acquired company; consolidating and streamlining corporate and administrative infrastructures; consolidating sales and marketing operations; retaining exist- ing customers and attracting new customers; identifying and eliminating redundant and underperforming operations and assets; coordinating geographically dispersed organiza- tions; and managing tax costs or inefficiencies associated with integrating our operations following completion of the acquisitions. With respect to joint ventures, we share owner- ship and management responsibility of a company with one or more parties who may or may not have the same goals, strategies, priorities or resources as we do and joint ventures are intended to be operated for the benefit of all co-owners, rather than for our exclusive benefit. In addition, acquisitions and joint ventures outside of the United States increase our exposure to risks associated with operations outside of the United States, including fluctuations in exchange rates and compliance with the Foreign Corrupt Practices Act and other anti-corruption and anti-bribery laws, and laws and regula- tions outside the United States. With respect to divestitures and refranchisings, we may not be able to complete such transactions on terms commercially favorable to us or at all. In addition, as divestitures and refranchisings may reduce our direct control over certain aspects of our business, any failure to maintain good relations with divested or refranchised busi- nesses in our supply or sales chain may adversely impact sales or business performance. If an acquisition or joint venture is not successfully completed or integrated into our existing operations, or if a divestiture or refranchising is not success- fully completed or managed, our business, financial condition and results of operations could be adversely impacted. If we are unable to hire or retain key employees or a highly skilled and diverse workforce, it could have a negative impact on our business. Our continued growth requires us to hire, retain and develop our leadership bench and a highly skilled and diverse work- force. We compete to hire new employees and then must train them and develop their skills and competencies. Any unplanned turnover or our failure to develop an adequate suc- cession plan to backfill current leadership positions, including our Chief Executive Officer, or to hire and retain a diverse workforce could deplete our institutional knowledge base and erode our competitive advantage. In addition, our operating results could be adversely affected by increased costs due to increased competition for employees, higher employee turn- over or increased employee benefit costs. Trade consolidation or the loss of any key customer could adversely affect our financial performance. We must maintain mutually beneficial relationships with our key customers, including Wal-Mart, as well as other retailers, to effectively compete. The loss of any of our key customers, including Wal-Mart, could have an adverse effect on our finan- cial performance. In addition, our industry has been affected by increasing concentration of retail ownership, particularly in the United States and Europe, which may impact our abil- ity to compete as such retailers may demand lower pricing and increased promotional programs. Further, should larger retailers increase utilization of their own distribution net- works and private label brands, the competitive advantages we derive from our go-to-market systems and brand equity may be eroded. Failure to appropriately respond to any such actions or to offer effective sales incentives and marketing programs to our customers could reduce our ability to secure adequate shelf space at our retailers and adversely affect our financial performance. Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings. Our objective is to maintain credit ratings that provide us with ready access to global capital and credit markets. Any down- grade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, 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 experi- enced historically, and therefore require us to rely more heavily on more expensive types of debt financing. Our borrowing costs and access to the commercial paper market could also 2012 PEPSICO ANNUAL REPORT 45 Management’s Discussion and Analysis be adversely affected if a credit rating agency announces that our ratings are under review for a potential downgrade. If we are not able to build and sustain proper information technology infrastructure, successfully implement our ongoing business transformation initiative or outsource certain functions effectively, our business could suffer. We depend on information technology as an enabler to improve the effectiveness of our operations, to interface with our customers, to maintain financial accuracy and effi- ciency, to comply with regulatory financial reporting, legal and tax requirements, and for digital marketing activities and electronic communication among our locations around the world and between our personnel and the personnel of our independent bottlers, contract manufacturers, joint ventures, suppliers or other third-party partners. If we do not allocate and effectively manage the resources necessary to build and sustain the proper information technology infrastructure, we could be subject to transaction errors, processing inefficien- cies, the loss of customers, business disruptions, the loss of or damage to intellectual property, or the loss of sensitive or confidential data through security breach or otherwise. We have embarked on multi-year business transformation initiatives to migrate certain of our financial processing sys- tems to enterprise-wide systems solutions. There can be no certainty that these initiatives will deliver the expected ben- efits. The failure to deliver our goals may impact our ability to process transactions accurately and efficiently and remain in step with the changing needs of the trade, which could result in the loss of customers. In addition, the failure to either deliver the applications on time, or anticipate the necessary readiness and training needs, could lead to business disruption and loss of customers and revenue. In addition, we have outsourced certain information tech- nology support services and administrative functions, such as payroll processing and benefit plan administration, to third- party service providers and may outsource other functions in the future to achieve cost savings and efficiencies. If the service providers that we outsource these functions to do not perform or do not perform effectively, we may not be able to achieve the expected cost savings and may have to incur addi- tional costs to correct errors made by such service providers. Depending on the function involved, such errors may also lead to business disruption, processing inefficiencies, the loss of or damage to intellectual property through security breach, the loss of sensitive data through security breach or otherwise, liti- gation or remediation costs and could have a negative impact on employee morale. Our information systems could also be penetrated by out- side parties intent on extracting confidential information, corrupting information or disrupting business processes. Such unauthorized access could disrupt our business and could result in the loss of assets, litigation, remediation costs, damage to our reputation and loss of revenue resulting from unauthorized use of confidential information or failure to retain or attract customers following such an event. Fluctuations in exchange rates may have an adverse impact on our business results or financial condition. We hold assets and incur liabilities, earn revenues and pay expenses in a variety of currencies other than the U.S. dollar. Because our consolidated financial statements are presented in U.S. dollars, the financial statements of our subsidiaries outside the United States are translated into U.S. dollars. Our operations outside of the U.S. generate a significant portion of our net revenue. Fluctuations in exchange rates may therefore adversely impact our business results or financial condition. See also “Market Risks” and Note 1 to our consolidated finan- cial statements. Climate change, or legal, regulatory or market measures to address climate change, may negatively affect our business and operations. There is concern that carbon dioxide and other greenhouse gases in the atmosphere may have an adverse impact on global temperatures, weather patterns and the frequency and sever- ity of extreme weather and natural disasters. In the event that such climate change has a negative effect on agricultural productivity, we may be subject to decreased availability or less favorable pricing for certain commodities that are neces- sary for our products, such as sugar cane, corn, wheat, rice, oats, potatoes and various fruits. We may also be subjected to decreased availability or less favorable pricing for water as a result of such change, which could impact our manufacturing and distribution operations. In addition, natural disasters and extreme weather conditions may disrupt the productivity of our facilities or the operation of our supply chain. The increas- ing concern over climate change also may result in more regional, federal and/or global legal and regulatory require- ments to reduce or mitigate the effects of greenhouse gases. In the event that such regulation is more aggressive than the sustainability measures that we are currently undertaking to monitor our emissions and improve our energy efficiency, we may experience significant increases in our costs of opera- tion and delivery. In particular, increasing regulation of fuel emissions could substantially increase the cost of energy, including fuel, required to operate our facilities or transport 46 2012 PEPSICO ANNUAL REPORT Management’s Discussion and Analysis and distribute our products, thereby substantially increasing the distribution and supply chain costs associated with our products. As a result, climate change could negatively affect our business and operations. See also “Changes in the legal and regulatory environment could limit our business activities, increase our operating costs, reduce demand for our products or result in litigation.”, “Our operating results may be adversely affected by increased costs, disruption of supply or shortages of raw materials and other supplies.” and “Disruption of our supply chain could have an adverse impact on our business, financial condition and results of operations.” A portion of our workforce belongs to unions. Failure to successfully renew collective bargaining agreements, or strikes or work stoppages could cause our business to suffer. Many of our employees are covered by collective bargain- ing agreements. These agreements expire on various dates. Strikes or work stoppages and interruptions could occur if we are unable to renew these agreements on satisfactory terms, which could adversely impact our operating results. The terms and conditions of existing or renegotiated agreements could also increase our costs or otherwise affect our ability to fully implement future operational changes to enhance our efficiency. Our intellectual property rights could be infringed or challenged and reduce the value of our products and brands and have an adverse impact on our business, financial condition and results of operations. We possess intellectual property rights that are important to our business. These intellectual property rights include ingredient formulas, trademarks, copyrights, patents, business processes and other trade secrets which are important to our business and relate to some of our products, their packaging, the processes for their production and the design and opera- tion of various equipment used in our businesses. We protect our intellectual property rights globally through a combina- tion of trademark, copyright, patent and trade secret laws, third-party assignment and nondisclosure agreements and monitoring of third-party misuses of our intellectual property. If we fail to obtain or adequately protect our ingredient formu- las, trademarks, copyrights, patents, business processes and other trade secrets, or if there is a change in law that limits or removes the current legal protections of our intellectual prop- erty, the value of our products and brands could be reduced and there could be an adverse impact on our business, finan- cial condition and results of operations. See also “Changes in the legal and regulatory environment could limit our business activities, increase our operating costs, reduce demand for our products or result in litigation.” Potential liabilities and costs from litigation or legal proceedings could have an adverse impact on our business, financial condition and results of operations. We and our subsidiaries are party to a variety of legal claims and proceedings in the ordinary course of business, includ- ing but not limited to litigation related to our marketing or commercial practices, product labels and environmental and insurance matters. Since litigation is inherently uncertain, there is no guarantee that we will be successful in defending ourselves against such claims or proceedings, or that man- agement’s assessment of the materiality of these matters, including the reserves taken in connection therewith, will be consistent with the ultimate outcome of such claims or proceedings. In the event that management’s assessment of materiality on current claims and proceedings proves inac- curate or litigation that is material arises in the future, there may be a material adverse effect on our consolidated financial statements, results of operations or cash flows. See also “Any damage to our reputation could have a material adverse effect on our business, financial condition and results of operations.” 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 these risks through a variety of strategies, including productivity initia- tives, global purchasing programs and hedging strategies. Ongoing productivity initiatives involve the identification and effective implementation of meaningful cost-saving opportu- nities or efficiencies. Our global purchasing programs include fixed-price purchase orders and pricing agreements. See Note  9 to our consolidated financial statements for further information on our non-cancelable purchasing commitments. Our hedging strategies include the use of derivatives. 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 com- modity, foreign exchange or interest risks are classified as operating activities. We do not use derivative instruments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, including a review of credit ratings, credit default swap rates and potential non- performance of the counterparty. Based on our most recent assessment of our counterparty credit risk, we consider this 2012 PEPSICO ANNUAL REPORT 47 Management’s Discussion and Analysis risk to be low. In addition, we enter into derivative contracts with a variety of financial institutions that we believe are cred- itworthy in order to reduce our concentration of credit risk. See “Unfavorable economic conditions may have an adverse impact on our business results or financial condition.” 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  10 to 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. Commodity Prices We expect to be able to reduce the impact of volatility in our raw material and energy costs through our hedging strate- gies and ongoing sourcing initiatives. We use derivatives, with terms of no more than three years, to economically hedge price fluctuations related to a portion of our anticipated com- modity purchases, primarily for agricultural products, metals and energy. Our open commodity derivative contracts that qualify for hedge accounting had a face value of $507  million as of December  29, 2012 and $598  million as of December  31, 2011. At the end of 2012, 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 2012 by $49 million. Our open commodity derivative contracts that do not qual- ify for hedge accounting had a face value of $853 million as of December 29, 2012 and $630 million as of December 31, 2011. At the end of 2012, the potential change in fair value of commodity derivative instruments, assuming a 10% decrease in the underlying commodity price, would have increased our net losses in 2012 by $85 million. Foreign Exchange 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 PepsiCo common sharehold- ers’ equity under the caption currency translation adjustment. Our operations outside of the U.S. generate 49% of our net revenue, with Russia, Mexico, Canada, the United Kingdom and Brazil comprising approximately 25% of our net revenue. As a 48 2012 PEPSICO ANNUAL REPORT result, we are exposed to foreign currency risks. During 2012, unfavorable foreign exchange reduced net revenue growth by 2.5  percentage points, primarily due to depreciation of the Russian ruble, euro, Brazilian real and the Mexican peso. Currency declines against the U.S. dollar which are not offset could adversely impact our future results. The results of our Venezuelan businesses have been reported under hyperinflationary accounting since the begin- ning of our  2010 fiscal year, at which time the functional currency of our Venezuelan entities was changed from the boli- var fuerte (bolivar) to the U.S. dollar. As a result of the change to hyperinflationary accounting and the devaluation of the bolivar, we recorded an after-tax net charge of $120 million in 2010. In 2012 and 2011, the majority of our transactions and net monetary assets qualified to be remeasured at the official exchange rate of obtaining U.S. dollars for dividends through the government-operated Foreign Exchange Administration Board (CADIVI) (4.3 bolivars per dollar for 2012 and 2011). In 2012 and 2011, our operations in Venezuela comprised 7% and 8% of our cash and cash equivalents balance, respectively, and generated 1% of our net revenue in 2012 and less than 1% of our net revenue in 2011. Effective February 2013, the Venezuelan government devalued the bolivar by resetting the official exchange rate to 6.3  bolivars per dollar. We expect that the impact of the devaluation on PepsiCo’s 2013 net revenue and operating profit will not be material. The above impact excludes an after-tax net charge of approximately $100 million associated with the remeasurement of bolivar denominated net monetary assets. This after-tax net charge will be reflected in items affecting comparability in our 2013 first quarter Form 10-Q. We continue to use available options to obtain U.S. dollars to meet our operational needs. We are also exposed to foreign currency risk from 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, negotiat- ing 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 recog- nized as transaction gains or losses in our income statement as incurred. Our foreign currency derivatives had a total face value  of $2.8  billion as of December  29, 2012 and $2.3  billion as of  December  31, 2011. At the end of 2012, we estimate that an unfavorable 10% change in the exchange rates would have increased our net unrealized losses by $134 million. For foreign currency derivatives that do not qualify for hedge accounting treatment, all losses and gains were offset by changes in the underlying hedged items, resulting in no net material impact on earnings. Management’s Discussion and Analysis Interest Rates We centrally manage our debt and investment portfolios con- sidering 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 has been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency 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 relat- ing to forecasted debt transactions. The notional amounts of the interest rate derivative instru- ments outstanding as of December 29, 2012 and December 31, 2011 were $8.1 billion and $8.3 billion, respectively. Assuming year-end 2012 variable rate debt and investment levels, a 1-percentage-point increase in interest rates would have increased net interest expense by $9 million in 2012. Risk Management Framework The achievement of our strategic and operating objectives necessarily involves taking risks. Our risk management process is intended to ensure that risks are taken knowingly and pur- posefully. As such, we leverage an integrated risk management framework to identify, assess, prioritize, address, manage, monitor and communicate risks across the Company. This framework includes: • PepsiCo’s Board of Directors, which is responsible for over- seeing the assessment and mitigation of the Company’s top risks, receives updates on key risks throughout the year. The Audit Committee of the Board of Directors helps define PepsiCo’s risk management processes and assists the Board in its oversight of strategic, financial, operating, business, compliance, safety, reputational and other risks facing PepsiCo. The Compensation Committee of the Board of Directors assists the Board in overseeing potential risks that may be associated with the Company’s compensa- tion programs; • The PepsiCo Risk Committee (PRC), comprised of a cross- functional, geographically diverse, senior management group which meets regularly to identify, assess, prioritize and address our key risks; • Division Risk Committees (DRC), comprised of cross- functional senior management teams which meet regularly to identify, assess, prioritize and address division-specific business risks; • PepsiCo’s Risk Management Office, which manages the overall risk management process, provides ongoing guid- ance, tools and analytical support to the PRC and the DRCs, identifies and assesses potential risks and facilitates ongo- ing communication between the parties, as well as with PepsiCo’s Audit Committee and Board of Directors; • PepsiCo Corporate Audit, which evaluates the ongoing effectiveness of our key internal controls through periodic audit and review procedures; and • PepsiCo’s Compliance & Ethics Department, which leads and coordinates our compliance policies and practices. Our Critical Accounting Policies An appreciation of our critical accounting policies is neces- sary to understand our financial results. These policies may require management to make difficult and subjective judg- ments 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 possi- ble 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 peri- ods presented, and have discussed these policies with our Audit Committee. Our critical accounting policies arise in conjunction with the following: • revenue recognition; • goodwill and other intangible assets; • income tax expense and accruals; and • pension and retiree medical plans. Revenue Recognition 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 U.S., and generally within 30 to 90 days inter- nationally, and may allow discounts for early payment. We recognize revenue upon shipment or delivery to our custom- ers based on written sales terms that do not allow for a right of return. However, our policy for DSD and certain chilled prod- ucts 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. Based on our experience 2012 PEPSICO ANNUAL REPORT 49 Management’s Discussion and Analysis with this practice, we have reserved for anticipated damaged and out-of-date products. 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 our other distribution networks, we monitor customer inven- tory levels. As discussed in “Our Customers,” we offer sales incen- tives and discounts through various programs to customers and consumers. Total marketplace spending includes sales incentives, discounts, advertising and other marketing activi- ties. Sales incentives and discounts are primarily accounted for as a reduction of revenue and totaled $34.7  billion in 2012, $34.6  billion in 2011 and $29.1 billion in 2010. Sales incentives and discounts include payments to customers for performing merchandising 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 activi- ties. 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 incen- tive costs are normally insignificant and are recognized in earnings in the period such differences are determined. 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. Payments made to obtain these rights are recognized over the shorter of the economic or contractual life, as a reduction of revenue, and the remain- ing balances of $335  million as of December  29, 2012 and $313 million as of December 31, 2011 are included in current assets and other assets on our balance sheet. For interim reporting, our policy is to allocate our fore- casted 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 and volume, as applicable, to our forecasted annual gross revenue and volume, as applicable. Based on our review of 50 2012 PEPSICO ANNUAL REPORT the forecasts at each interim period, any changes in estimates and the related allocation of sales incentives are recognized in the interim period as they are identified. In addition, we apply a similar allocation methodology for interim reporting purposes for advertising and other marketing activities. See Note 2 to our consolidated financial statements for additional information on our total marketplace spending. Our annual financial statements are not impacted by this interim alloca- tion methodology. 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 in our income statement. Goodwill and Other Intangible Assets We sell products under a number of brand names, many of which were developed by us. The brand development costs are expensed as incurred. We also purchase brands in acqui- sitions. In a business combination, the consideration is first assigned to identifiable assets and liabilities, including brands, 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 fac- tors, 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 perpetual brand criteria are not met, brands are amortized over their expected useful lives, which generally range from five to 40  years. Determining the expected life of a brand requires management judgment and is based on an evalua- tion of a number of factors, including market share, consumer awareness, brand history, future expansion expectations and regulatory restrictions, as well as the macroeconomic environ- ment of the countries in which the brand is sold. Perpetual brands and goodwill are not amortized and are assessed for impairment at least annually. If the carrying amount of a perpetual brand exceeds its fair value, as deter- mined by its discounted cash flows, an impairment loss is recognized in an amount equal to that excess. Goodwill is evaluated using a two-step impairment test at the reporting unit level. A reporting unit can be a division or business within a division. The first step compares the book value of a report- ing unit, including goodwill, with its fair value, as determined by its discounted cash flows. Discounted cash flows are pri- marily based on growth rates for sales and operating profit Management’s Discussion and Analysis which are inputs from our annual long-range planning process. Additionally, they are also impacted by estimates of discount rates, perpetuity growth assumptions and other factors. If the book value of a reporting unit exceeds its fair value, we com- plete the second step to determine the amount of goodwill impairment loss that we should record, if any. In the second step, we determine an implied fair value of the reporting unit’s goodwill by allocating the fair value of the reporting unit to all of the assets and liabilities other than goodwill (including any unrecognized intangible assets). The amount of impairment loss is equal to the excess of the book value of the goodwill over the implied fair value of that goodwill. Amortizable brands are only evaluated for impairment upon a significant change in the operating or macroeconomic envi- ronment. 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. In connection with our acquisitions of PBG and PAS, we reacquired certain franchise rights which provided PBG and PAS with the exclusive and perpetual rights to manufacture and/or distribute beverages for sale in specified territories. In determining the useful life of these reacquired franchise rights, we considered many factors, including the pre-exist- ing perpetual bottling arrangements, the indefinite period expected for the reacquired rights to contribute to our future cash flows, as well as the lack of any factors that would limit the useful life of the reacquired rights to us, including legal, regulatory, contractual, competitive, economic or other fac- tors. Therefore, certain reacquired franchise rights, as well as perpetual brands and goodwill, are not amortized, but instead are tested for impairment at least annually. Certain reacquired and acquired franchise rights are amortized over the remaining contractual period of the contract in which the right was granted. Significant management judgment is necessary to evaluate the impact of operating and macroeconomic changes and to estimate future cash flows. Assumptions used in our impair- ment evaluations, such as forecasted growth rates and our 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 discussed in “Our Business Risks.” We did not recognize any impairment charges for good- will in the years presented. In addition, as of December  29, 2012, we did not have any reporting units that were at risk of failing the first step of the goodwill impairment test. We recognized impairment charges in Europe for other nonamor- tizable intangible assets of $23 million and $14 million in 2012 and 2011, respectively. We did not recognize any impairment charges for other nonamortizable intangible assets in 2010. As of December  29, 2012, we had $31.7  billion of goodwill and other nonamortizable intangible assets, primarily related to the acquisitions of PBG, PAS and WBD. 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 vari- ous 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 may 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. 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 gener- ally 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 in 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 real- ized. 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. In 2012, our annual tax rate was 25.2% compared to 26.8% in 2011, as discussed in “Other Consolidated Results.” The tax rate in 2012 decreased 1.6  percentage points primarily reflecting the tax impact of a favorable tax court decision combined with the pre-payment of Medicare subsidy liabilities, partially offset by the tax impact of the transaction with Tingyi and the lapping of prior year tax benefits related to a portion of our international bottling operations. 2012 PEPSICO ANNUAL REPORT 51 Management’s Discussion and Analysis Pension and Retiree Medical Plans Our pension plans cover certain full-time employees in the U.S. 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 medi- cal) 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. As of February 2012, certain U.S. employees earning a ben- efit under one of our defined benefit pension plans were no longer eligible for Company matching contributions on their 401(k) contributions. In the fourth quarter of 2012, the Company offered certain former employees who have vested benefits in our defined benefit pension plans the option of receiving a one-time lump sum payment equal to the present value of the participant’s pension benefit (payable in cash or rolled over into a qualified retirement plan or Individual Retirement Account (IRA)). See Note 7 to our consolidated financial statements. For information about certain changes to our U.S. pension and retiree medical plans and changes in connection with our acquisitions of PBG and PAS, see Note 7 to our consolidated financial statements. Our Assumptions The determination of pension and retiree medical plan obliga- tions and related expenses 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 liability due to the passage of time (interest cost), and (3) other gains and losses as discussed below, reduced by (4) the expected return on assets for our funded plans. Significant assumptions used to measure our annual pen- sion and retiree medical expense include: Our assumptions reflect our historical experience and management’s best judgment regarding future expectations. Due to the significant management judgment involved, our assumptions could have a material impact on the measure- ment of our pension and retiree medical benefit expenses and obligations. At each measurement date, the discount rates are based on interest rates for high-quality, long-term corporate debt secu- rities with maturities comparable to those of our liabilities. In 2011 and 2010, our U.S. discount rate was determined using the Mercer Pension Discount Yield Curve (Mercer Curve). The Mercer Curve in 2011 and 2010 used a portfolio of high- quality bonds rated Aa or higher by Moody’s. In 2012, due to the downgrade of several global financial institutions by Moody’s, Mercer developed a new curve, the Above Mean Curve, which we used to determine the discount rate for our U.S. pension and retiree medical plans. These curves included 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. The expected return on pension plan assets is based on our pension plan 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 histori- cal 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. Our pension plan invest- ment strategy includes the use of actively managed securities and is reviewed periodically in conjunction with plan liabilities, an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. Our investment objective is to ensure that funds are available to meet the plans’ benefit obligations when they become due. Our overall investment strategy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments which are primarily used to reduce risk. Our expected long-term rate of return on U.S. plan assets is 7.8%. • the interest rate used to determine the present value of Our target investment allocations are as follows: liabilities (discount rate); • certain employee-related factors, such as turnover, retire- Fixed income ment age and mortality; U.S. equity • the expected return on assets in our funded plans; • for pension expense, the rate of salary increases for plans International equity Real estate where benefits are based on earnings; and • for retiree medical expense, health care cost trend rates. 2013 2012 40% 33% 22% 5% 40% 33% 22% 5% 52 2012 PEPSICO ANNUAL REPORT Management’s Discussion and Analysis Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodi- cally rebalance our investments to our target allocations. To calculate the expected return on pension plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, 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. The difference between the actual return on plan assets and the expected return on plan assets is added to, or subtracted from, other gains and losses resulting from actual experi- ence differing from our assumptions and from changes in our assumptions determined at each measurement date. 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 expense for the follow- ing year based upon the average remaining service period of active plan participants, which is approximately 11 years for pension expense and approximately 8 years for retiree medical expense. The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost/(credit)) is included in earnings on a straight-line basis over the average remaining service period of active plan participants. The health care trend rate used to determine our retiree medical plan’s liability and expense is reviewed annually. Our review is based on our claim 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 tech- nologies and changes in medical carriers. Weighted-average assumptions for pension and retiree medical expense are as follows: 2013 2012 2011 Pension Expense discount rate 4.2% 4.6% 5.6% Expected rate of return on plan assets 7.5% 7.6% 7.6% Expected rate of salary increases Retiree medical 3.7% 3.8% 4.1% Expense discount rate 3.7% 4.4% 5.2% Expected rate of return on plan assets 7.8% 7.8% 7.8% Current health care cost trend rate 6.6% 6.8% 7.0% Based on our assumptions, we expect our pension and retiree medical expenses to increase in 2013 primarily driven by lower discount rates, partially offset by the impact of the 2012 lump sum payments offered to certain former employees. Sensitivity of Assumptions A decrease in the discount rate or in the expected rate of return assumptions would increase pension expense. A 25-basis-point decrease in the discount rate and expected rate of return assumptions would increase the 2013 pension expense as follows: Assumption Discount rate Expected rate of return Amount $69 million $33 million See Note  7 to our consolidated financial statements for information about the sensitivity of our retiree medical cost assumptions. Funding We make contributions to pension trusts maintained to provide plan benefits for certain pension plans. These contri- butions 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 ben- efits. 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 contributions for 2012 were $1,614 million, of which $1,375  million was discretionary. Discretionary 2012 contributions included $405 million pertaining to pension lump sum payments. Our retiree medical contributions for 2012 were $251 million, of which $140 million was discretionary. In 2013, we expect to make pension and retiree medi- cal contributions of approximately $240  million, with up to approximately $17 million expected to be discretionary. Our contributions for retiree medical benefits are estimated to be approximately $70  million in 2013. 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. For estimated future benefit payments, including our pay-as-you-go payments, as well as those from trusts, see Note 7 to our consolidated financial statements. 2012 PEPSICO ANNUAL REPORT 53 Management’s Discussion and Analysis Our Financial Results Items Affecting Comparability The year-over-year comparisons of our financial results are affected by the following items: Net revenue 53rd week Operating profit 2012 2011 2010 – $ 623 – Mark-to-market net impact gains/(losses) $ 65 $ (102) $ 91 Merger and integration charges $ (11) $ (313) $ (769) Restructuring and impairment charges $ (279) $ (383) Restructuring and other charges related to the transaction with Tingyi Pension lump sum settlement charge 53rd week $ (150) $ (195) – – – $ 109 – – – – Inventory fair value adjustments – $ (46) $ (398) Venezuela currency devaluation Asset write-off Foundation contribution Bottling equity income Merger and integration charges Gain on previously held equity interests Interest expense – – – – – – $ (120) – $ (145) – $ (100) – $ (9) – $ 735 Merger and integration charges $ (5) $ (16) $ (30) 53rd week Debt repurchase Net income attributable to PepsiCo – $ (16) – – – $ (178) Mark-to-market net impact gains/(losses) $ 41 $ (71) $ 58 Merger and integration charges $ (12) $ (271) $ (648) Restructuring and impairment charges $ (215) $ (286) Restructuring and other charges related to the transaction with Tingyi Pension lump sum settlement charge $ (176) $ (131) Tax benefit related to tax court decision $ 217 – – – 53rd week – $ 64 – – – – – Inventory fair value adjustments – $ (28) $ (333) Gain on previously held equity interests Venezuela currency devaluation Asset write-off Foundation contribution Debt repurchase Net income attributable to PepsiCo per common share —  diluted – – – – – – $ 958 – $ (120) – $ (92) – $ (64) – $ (114) Mark-to-market net impact gains/(losses) $ 0.03 $ (0.04) $ 0.04 Merger and integration charges $ (0.01) $ (0.17) $ (0.40) Restructuring and impairment charges $ (0.14) $ (0.18) Restructuring and other charges related to the transaction with Tingyi Pension lump sum settlement charge $ (0.11) $ (0.08) Tax benefit related to tax court decision $ 0.14 – – – 53rd week – $ 0.04 – – – – – Inventory fair value adjustments – $ (0.02) $ (0.21) Gain on previously held equity interests Venezuela currency devaluation Asset write-off Foundation contribution Debt repurchase – – – – – – $ 0.60 – $ (0.07) – $ (0.06) – $ (0.04) – $ (0.07) 54 2012 PEPSICO ANNUAL REPORT Mark-to-Market Net Impact We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, metals and energy. 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. Therefore, the divisions realize the economic effects of the derivative without experiencing any resulting mark-to-market volatility, which remains in corporate unallocated expenses. In 2012, we recognized $65 million ($41 million after-tax or $0.03 per share) of mark-to-market net gains on commodity hedges in corporate unallocated expenses. In 2011, we recognized $102 million ($71 million after-tax or $0.04 per share) of mark-to-market net losses on commod- ity hedges in corporate unallocated expenses. In 2010, we recognized $91 million ($58 million after-tax or $0.04 per share) of mark-to-market net gains on commodity hedges in corporate unallocated expenses. Merger and Integration Charges In 2012, we incurred merger and integration charges of $16 million ($12 million after-tax or $0.01 per share) related to our acquisition of WBD, including $11 million recorded in the Europe segment and $5 million recorded in interest expense. In 2011, we incurred merger and integration charges of $329 million ($271 million after-tax or $0.17 per share) related to our acquisitions of PBG, PAS and WBD, including $112 mil- lion recorded in the PAB segment, $123  million recorded in the Europe segment, $78 million recorded in corporate unallo- cated expenses and $16 million recorded in interest expense. These charges also include closing costs and advisory fees related to our acquisition of WBD. In 2010, we incurred merger and integration charges of $799  million related to our acquisitions of PBG and PAS, as well as advisory fees in connection with our acquisition of WBD. $467  million of these charges were recorded in the PAB segment, $111 million recorded in the Europe segment, $191 million recorded in corporate unallocated expenses and $30  million recorded in interest expense. The merger and integration charges related to our acquisitions of PBG and PAS were incurred to help create a more fully integrated supply chain and go-to-market business model, to improve the effec- tiveness and efficiency of the distribution of our brands and to enhance our revenue growth. These charges also include clos- ing costs, one-time financing costs and advisory fees related to our acquisitions of PBG and PAS. In addition, we recorded $9 million of merger-related charges, representing our share of the respective merger costs of PBG and PAS, in bottling Management’s Discussion and Analysis equity income. In total, the above charges had an after-tax impact of $648 million or $0.40 per share. Restructuring and Impairment Charges In 2012, we incurred restructuring charges of $279  million ($215 million after-tax or $0.14 per share) in conjunction with our multi-year productivity plan (Productivity Plan), includ- ing $38  million recorded in the FLNA segment, $9  million recorded in the QFNA segment, $50 million recorded in the LAF segment, $102  million recorded in the PAB segment, $42  million recorded in the Europe segment, $28  million recorded in the AMEA segment and $10  million recorded in corporate unallocated expenses. In 2011, we incurred restructuring charges of $383  mil- lion ($286 million after-tax or $0.18 per share) in conjunction with our Productivity Plan, including $76 million recorded in the FLNA segment, $18  million recorded in the QFNA seg- ment, $48 million recorded in the LAF segment, $81 million recorded in the PAB segment, $77  million recorded in the Europe segment, $9  million recorded in the AMEA segment and $74 million recorded in corporate unallocated expenses. The Productivity Plan includes actions in every aspect of our business that we believe will strengthen our complemen- tary food, snack and beverage businesses by leveraging new technologies and processes across PepsiCo’s operations, go- to-market and information systems; heightening the focus on best practice sharing across the globe; consolidating manu- facturing, warehouse and sales facilities; and implementing simplified organization structures, with wider spans of control and fewer layers of management. The Productivity Plan is expected to enhance PepsiCo’s cost-competitiveness, provide a source of funding for future brand-building and innovation initiatives, and serve as a financial cushion for potential mac- roeconomic uncertainty. As a result, we expect to incur pre-tax charges of approximately $910 million, $279 million of which was reflected in our 2012 results, $383 million of which was reflected in our 2011 results, and the balance of which will be reflected in our 2013 through 2015 results. These charges will consist of approximately $540 million of severance and other employee-related costs; approximately $270 million for other costs, including consulting-related costs and the termination of leases and other contracts; and approximately $100  mil- lion for asset impairments (all non-cash) resulting from plant closures and related actions. These charges resulted in cash expenditures of $343 million in 2012 and $30 million in 2011, with the balance of approximately $362  million expected in 2013 through 2015. See Note  3 to our consolidated finan- cial statements. Restructuring and Other Charges Related to the Transaction with Tingyi In 2012, we recorded restructuring and other charges of $150 million ($176 million after-tax or $0.11 per share) in the AMEA segment related to the transaction with Tingyi. See Note 15 to our consolidated financial statements. Pension Lump Sum Settlement Charge In 2012, we recorded a pension lump sum settlement charge in corporate unallocated expenses of $195 million ($131 million after-tax or $0.08 per share). See Note 7 to our consolidated financial statements. Tax Benefit Related to Tax Court Decision In 2012, we recognized a non-cash tax benefit of $217 million ($0.14 per share) associated with a favorable tax court deci- sion related to the classification of financial instruments. See Note 5 to our consolidated financial statements. 53rd Week In 2011, we had an additional week of results (53rd week). Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. The 53rd week increased 2011 net revenue by $623 million and operating profit by $109 million ($64 million after-tax or $0.04 per share). Inventory Fair Value Adjustments In 2011, we recorded $46  million ($28  million after-tax or $0.02 per share) of incremental costs in cost of sales related to fair value adjustments to the acquired inventory included in WBD’s balance sheet at the acquisition date and hedging contracts included in PBG’s and PAS’s balance sheets at the acquisition date. In 2010, we recorded $398 million ($333 million after-tax or $0.21 per share) of incremental costs related to fair value adjustments to the acquired inventory and other related hedg- ing contracts included in PBG’s and PAS’s balance sheets at the acquisition date. Substantially all of these costs were recorded in cost of sales. Gain on Previously Held Equity Interests In 2010, in connection with our acquisitions of PBG and PAS, we recorded a gain on our previously held equity interests of $958 million ($0.60 per share), comprising $735 million which was non-taxable and recorded in bottling equity income and $223 million related to the reversal of deferred tax liabilities associated with these previously held equity interests. 2012 PEPSICO ANNUAL REPORT 55 Management’s Discussion and Analysis Venezuela Currency Devaluation As of the beginning of our 2010 fiscal year, we recorded a $120 million net charge related to our change to hyperinfla- tionary accounting for our Venezuelan businesses and the related devaluation of the bolivar. $129  million of this net charge was recorded in corporate unallocated expenses, with the balance (income of $9 million) recorded in our PAB segment. In total, this net charge had an after-tax impact of $120 million or $0.07 per share. Asset Write-Off In 2010, we recorded a $145 million charge ($92 million after- tax or $0.06 per share) related to a change in scope of one release in our ongoing migration to SAP software. This change was driven, in part, by a review of our North America systems strategy following our acquisitions of PBG and PAS. Foundation Contribution In 2010, we made a $100  million ($64  million after-tax or $0.04 per share) contribution to the PepsiCo Foundation, Inc., in order to fund charitable and social programs over the next several years. This contribution was recorded in corporate unallocated expenses. Debt Repurchase In 2010, we paid $672 million in a cash tender offer to repur- chase $500 million (aggregate principal amount) of our 7.90% senior unsecured notes maturing in 2018. As a result of this debt repurchase, we recorded a $178 million charge to interest expense ($114 million after-tax or $0.07 per share), primarily representing the premium paid in the tender offer. Non-GAAP Measures Certain measures contained in this Annual Report are financial measures that are adjusted for items affecting comparabil- ity (see “Items Affecting Comparability” for a detailed list and description of each of these items), as well as, in certain instances, adjusted for foreign exchange. These measures are not in accordance with Generally Accepted Accounting Principles (GAAP). Items adjusted for currency assume 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 cur- rent year average foreign exchange rates and then multiply or divide, as appropriate, those amounts by the prior year average foreign exchange rates. We believe investors should consider these non-GAAP measures in evaluating our results as they are more indicative of our ongoing performance and with how management evaluates our operational results and trends. These measures are not, and should not be viewed as, a sub- stitute for U.S. GAAP reporting measures. See also “Organic Revenue Growth” and “Management Operating Cash Flow.” 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. Servings Since our divisions each use different measures of physi- cal unit volume (i.e., kilos, gallons, pounds and case sales), a common servings metric is necessary to reflect our con- solidated 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 2012, total servings increased 3% compared to 2011. Excluding the impact of the 53rd week, total servings also increased 3% compared to 2011. In 2011, total servings increased 6% compared to 2010. Excluding the impact of the 53rd week, total servings increased 5% compared to 2010. 2012 and 2011 servings growth reflects an adjustment to the base year for divestitures that occurred in 2012 and 2011, as applicable. 56 2012 PEPSICO ANNUAL REPORT Total Net Revenue and Operating Profit Total net revenue Operating profit FLNA QFNA LAF PAB Europe AMEA Corporate Unallocated Mark-to-market net impact gains/(losses) Merger and integration charges Restructuring and impairment charges Pension lump sum settlement charge 53rd week Venezuela currency devaluation Asset write-off Foundation contribution Other Total operating profit Total operating profit margin n/m represents year-over-year changes that are not meaningful. Management’s Discussion and Analysis 2012 2011 2010 2012 2011 $ 65,492 $ 66,504 $ 57,838 (1.5)% 15 % Change $ 3,646 $ 3,621 $ 3,376 695 1,059 2,937 1,330 747 65 – (10) (195) – – – – 797 1,078 3,273 1,210 887 (102) (78) (74) – (18) – – – (1,162) (961) 741 1,004 2,776 1,054 708 91 (191) – – – (129) (145) (100) (853) $ 9,112 $ 9,633 $ 8,332 1 % (13)% (2)% (10)% 10 % (16)% 7 % 8 % 7 % 18 % 15 % 25 % n/m n/m n/m (59)% (86)% n/m n/m n/m – – – 21 % (5)% – n/m n/m n/m n/m 13 % 16 % 0.1 13.9% 14.5% 14.4% (0.6) 2012 On a reported basis, total operating profit decreased 5% and operating margin decreased 0.6 percentage points. Operating profit performance was primarily driven by cost increases reflecting strategic investments, higher commodity costs, higher advertising and marketing expense and unfavorable foreign exchange, partially offset by effective net pricing. Other corporate unallocated expenses increased 21%, primar- ily driven by increased pension expense. Commodity inflation was approximately $1.2 billion compared to the prior period, primarily attributable to PAB, FLNA and Europe. Operating profit also benefited from actions associated with our pro- ductivity initiatives, which contributed more than $1 billion in cost reductions across a number of expense categories among all of our divisions. Items affecting comparability (see “Items Affecting Comparability”) positively contributed 1.2 percent- age points to the total operating profit performance and 0.4 percentage points to total operating margin. 2011 On a reported basis, total operating profit increased 16% and operating margin increased 0.1  percentage points. Operating profit growth was primarily driven by the net rev- enue growth, partially offset by higher commodity costs. Items affecting comparability (see “Items Affecting Comparability”) contributed 10 percentage points to the total operating profit growth and 1.2  percentage points to the total operating margin increase. 2012 PEPSICO ANNUAL REPORT 57 Management’s Discussion and Analysis Other Consolidated Results Bottling equity income Interest expense, net Annual tax rate Net income attributable to PepsiCo Net income attributable to PepsiCo per common share —  diluted Mark-to-market net impact (gains)/losses Merger and integration charges Restructuring and impairment charges Restructuring and other charges related to the transaction with Tingyi Pension lump sum settlement charge Tax benefit related to tax court decision 53rd week Inventory fair value adjustments Gain on previously held equity interests Venezuela currency devaluation Asset write-off Foundation contribution Debt repurchase Net income attributable to PepsiCo per common share —  diluted, excluding above items* Impact of foreign exchange translation Growth in net income attributable to PepsiCo per common share —  diluted, excluding above items, on a constant currency basis* * See “Non-GAAP Measures” ** Does not sum due to rounding 2012 Net interest expense increased $9 million, primarily reflecting higher average debt balances and higher rates on our debt balances, partially offset by gains in the market value of invest- ments used to economically hedge a portion of our deferred compensation costs and the impact of the 53rd week in the prior year. The tax rate decreased 1.6  percentage points compared to 2011, primarily reflecting the tax impact of a favorable tax court decision combined with the pre-payment of Medicare subsidy liabilities, partially offset by the tax impact of the trans- action with Tingyi and the lapping of prior year tax benefits related to a portion of our international bottling operations. Net income attributable to PepsiCo decreased 4% and net income attributable to PepsiCo per common share decreased 3%. Items affecting comparability (see “Items Affecting Comparability”) positively contributed 4  percentage points to both net income attributable to PepsiCo and net income attributable to PepsiCo per common share. 2011 Bottling equity income decreased $735 million, reflecting the gain in the prior year on our previously held equity interests in connection with our acquisitions of PBG and PAS. Prior to 58 2012 PEPSICO ANNUAL REPORT 2012 – 2011 – $ (808) $ (799) 2010 $ 735 $ (835) 25.2% 26.8% 23.0% $ 6,178 $ 3.92 (0.03) 0.01 0.14 0.11 0.08 (0.14) – – – – – – – $ 6,443 $ 4.03 0.04 0.17 0.18 – – – (0.04) 0.02 – – – – – $ 6,320 $ 3.91 (0.04) 0.40 – – – – – 0.21 (0.60) 0.07 0.06 0.04 0.07 $ 4.10** $ 4.40 $ 4.13** Change 2012 – $ (9) 2011 $ (735) $ 36 (4)% (3)% 2% 3% (7)% 2 7% (1) (5)% 5%** our acquisitions of PBG and PAS on February  26, 2010, we had noncontrolling interests in each of these bottlers and consequently included our share of their net income in bottling equity income. Upon consummation of the acquisitions in the first quarter of 2010, we began to consolidate the results of these bottlers and recorded this gain in bottling equity income associated with revaluing our previously held equity interests in PBG and PAS to fair value. Net interest expense decreased $36  million, primarily reflecting interest expense in the prior year in connection with our cash tender offer to repurchase debt in 2010, partially offset by higher average debt balances in 2011. The tax rate increased 3.8 percentage points compared to 2010, primarily reflecting the prior year non-taxable gain and reversal of deferred taxes attributable to our previously held equity interests in connection with our acquisitions of PBG and PAS. Net income attributable to PepsiCo increased 2% and net income attributable to PepsiCo per common share increased 3%. Items affecting comparability (see “Items Affecting Comparability”) decreased net income attributable to PepsiCo by 3 percentage points and net income attributable to PepsiCo per common share by 3.5 percentage points. Management’s Discussion and Analysis Results of Operations —  Division Review The results and discussions below are based on how our Chief Executive Officer monitors the performance of our divisions. Accordingly, 2012 and 2011 volume growth measures reflect an adjustment to the base year for divestitures that occurred in 2012 and 2011. See “Items Affecting Comparability” for a discussion of items to consider when evaluating our results and related information regarding non-GAAP measures. Net Revenue, 2012 Net Revenue, 2011 % Impact of: Volume(a) Effective net pricing(b) Foreign exchange translation Acquisitions and divestitures Reported growth(c) Net Revenue, 2011 Net Revenue, 2010 % Impact of: Volume(a) Effective net pricing(b) Foreign exchange translation Acquisitions and divestitures Reported growth(c) FLNA $ 13,574 $ 13,322 QFNA $ 2,636 $ 2,656 LAF PAB Europe AMEA Total $ 7,780 $ 21,408 $ 13,441 $ 6,653 $ 65,492 $ 7,156 $ 22,418 $ 13,560 $ 7,392 $ 66,504 (1)% (1)% 4% (3)% –% 8% 3 – – 1 – – 10 (7) 2 3 – (4.5) 4 (7) 2 2 (3) (17) –% 4 (2.5) (3) 2% (1)% 9% (4.5)% (1)% (10)% (1.5)% FLNA $ 13,322 $ 12,573 QFNA $ 2,656 $ 2,656 LAF PAB Europe AMEA Total $ 7,156 $ 22,418 $ 13,560 $ 7,392 $ 66,504 $ 6,315 $ 20,401 $ 9,602 $ 6,291 $ 57,838 2% (5)% 3.5% 3 – – 4 1 – 8 2 – * * 1% * * * 3% * 10% 6 2 – 6% –% 13% 10% 41% 17% * * 1% * 15% (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 nonconsolidated joint venture volume, and, for our beverage businesses, temporary timing differences between BCS and CSE. Our net revenue excludes nonconsolidated 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.   * It is impractical to separately determine and quantify the impact of our acquisitions of PBG and PAS from changes in our pre-existing beverage business since we now manage these businesses as an integrated system. 2012 PEPSICO ANNUAL REPORT 59 Management’s Discussion and Analysis Organic Revenue Growth Organic revenue growth is a significant measure we use to monitor net revenue performance. However, it is not a measure provided by accounting principles generally accepted in the U.S. Therefore, this measure is not, and should not be viewed as, a substitute for U.S. GAAP net revenue growth. In order to compute our organic revenue growth results, we exclude the impact of acquisitions and divestitures, foreign exchange translation and the 53rd week from reported net revenue growth. See also “Non-GAAP Measures.” 2012 Reported Growth % Impact of: Foreign exchange translation Acquisitions and divestitures 53rd week Organic Growth(a) 2011 Reported Growth % Impact of: Foreign exchange translation Acquisitions and divestitures 53rd week Organic Growth(a) FLNA QFNA LAF PAB Europe AMEA Total 2% (1)% 9% (4.5)% (1)% (10)% (1.5)% – – 2 – – 2 7 (2) – – 4.5 1 7 (2) – 3 17 – 4% 1% 14% 1.5% 4% 10% 2.5 3 1 5% FLNA QFNA LAF PAB Europe AMEA Total 6% –% 13% 10% 41% 17% 15% – – (2) (1) – (2) (2) – – 3.5% (2 )% 11% (1) * (1) * (3) * – * (2) – – 16% (1) * (1) * (a) Amounts may not sum due to rounding.   * It is impractical to separately determine and quantify the impact of our acquisitions of PBG and PAS from changes in our pre-existing beverage business since we now manage these businesses as an integrated system. Frito-Lay North America Net revenue 53rd week Net revenue excluding above item* Impact of foreign exchange translation Net revenue growth excluding above item, on a constant currency basis* Operating profit Restructuring and impairment charges 53rd week Operating profit excluding above items* Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis* * See “Non-GAAP Measures” ** Does not sum due to rounding 2012 2011 2010 2012 2011 % Change $ 13,574 $ 13,322 $ 12,573 – (260) – $ 13,574 $ 13,062 $ 12,573 $ 3,646 $ 3,621 $ 3,376 38 – 76 (72) – – $ 3,684 $ 3,625 $ 3,376 2 4 – 4 1 2 – 2 6 4 – 3.5** 7 7 – 7 2012 Net revenue increased 2% and pound volume declined 1%. Net revenue growth was driven by effective net pricing, par- tially offset by the volume decline. The volume performance reflects double-digit declines in trademark SunChips and Rold Gold, a low-single-digit decline in trademark Lay’s and a mid- single-digit decline in trademark Tostitos, partially offset by a high-single-digit increase in variety packs and a double-digit increase in our Sabra joint venture. The impact of the 53rd week in the prior year reduced both volume and net revenue performance by 2 percentage points. Operating profit grew 1%, driven by the net revenue growth and planned cost reductions across a number of expense categories, partially offset by higher commodity costs, pri- marily cooking oil, which reduced operating profit growth by 6  percentage points, and higher advertising and marketing 60 2012 PEPSICO ANNUAL REPORT Management’s Discussion and Analysis expenses. The impact of the 53rd week in the prior year reduced operating profit growth by 2  percentage points. Lower restructuring and impairment charges contributed 1 percentage point to operating profit growth. These gains were partially offset by a double-digit decline in trademark SunChips. Net revenue growth also benefited from effective net pricing. The 53rd week contributed 2 percentage points to both net revenue and volume growth. 2011 Net revenue increased 6% and pound volume grew 3%. The volume growth primarily reflected double-digit growth in our Sabra joint venture and in variety packs, as well as mid- single-digit growth in trademark Doritos, Cheetos and Ruffles. Operating profit grew 7%, primarily reflecting the net rev- enue growth. Restructuring charges reduced operating profit growth by 2 percentage points and were offset by the 53rd week, which contributed 2  percentage points to operating profit growth. Quaker Foods North America Net revenue 53rd week Net revenue excluding above item* Impact of foreign exchange translation Net revenue growth excluding above item, on a constant currency basis* Operating profit Restructuring and impairment charges 53rd week Operating profit excluding above items* Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis* * See “Non-GAAP Measures” ** Does not sum due to rounding 2012 $ 2,636 – 2011 $ 2,656 (42) 2010 $ 2,656 – $ 2,636 $ 2,614 $ 2,656 $ 695 $ 797 $ 741 (13) 9 – 18 (12) – – $ 704 $ 803 $ 741 (12) – (12) % Change 2012 (1) 2011 – 1 – 1 (2) (1) (2)** 8 8 (0.5) 8** 2012 Net revenue and volume declined 1%. The net revenue decline reflects the lower volume, partially offset by effective net pricing. The volume decline primarily reflects a double-digit decline in Chewy granola bars and a low-single-digit decline in oatmeal, partially offset by the introduction of Soft Baked Cookies in the second quarter. The volume and net revenue declines reflect the impact of the 53rd week in 2011, which contributed nearly 2  percentage points to both the net rev- enue and volume declines. Operating profit declined 13%, primarily reflecting higher commodity costs, which negatively impacted operating profit performance by 9 percentage points, partially offset by lower general and administrative expenses and effective net pricing. The net impact of acquisitions and divestitures, including a partnership investment in 2012 and the gain on the divestiture of a business in the prior year, reduced operat- ing profit performance by 5  percentage points. Additionally, the benefit from a change in accounting methodology for inventory and the sale of a distribution center, both of which were recorded in the prior year, each contributed 2 percent- age points to the operating profit decline. The net impact of items affecting comparability in the above table (see “Items Affecting Comparability”) negatively impacted operating profit performance by 1 percentage point. 2011 Net revenue was flat and volume declined 5%. The impact of positive net pricing, driven primarily by price increases taken in the fourth quarter of 2010, was partially offset by negative mix. The volume decline primarily reflects double-digit volume declines in ready-to-eat cereals and Chewy granola bars, as well as a mid-single-digit decline in Aunt Jemima syrup and mix. Favorable foreign exchange contributed nearly 1 percent- age point to the net revenue performance. The 53rd week positively contributed almost 2 percentage points to both the net revenue and volume performance. Operating profit grew 8%, primarily reflecting the favorable effective net pricing, partially offset by the volume declines. Gains on the divestiture of a business and the sale of a distribu- tion center increased operating profit growth by 4 percentage points, and a change in accounting methodology for inven- tory contributed 2  percentage points to operating profit growth (see Note 1 to our consolidated financial statements). 2012 PEPSICO ANNUAL REPORT 61 Management’s Discussion and Analysis Restructuring charges reduced operating profit growth by over 2 percentage points and were mostly offset by the 53rd week, which contributed 2  percentage points to operating profit growth. Latin America Foods Net revenue Impact of foreign exchange translation Net revenue growth, on a constant currency basis* Operating profit Restructuring and impairment charges Operating profit excluding above item* Impact of foreign exchange translation Operating profit growth excluding above item, on a constant currency basis* * See “Non-GAAP Measures” 2012 $ 7,780 2011 $ 7,156 2010 $ 6,315 $ 1,059 $ 1,078 $ 1,004 50 48 – $ 1,109 $ 1,126 $ 1,004 % Change 2012 2011 9 7 16 (2) (1.5) 5.5 4 13 (2) 11 7 12 (1) 11 2012 Net revenue increased 9%, primarily reflecting effective net pricing and volume growth. Acquisitions and divestitures in Argentina and Brazil in the prior year contributed 2 percentage points to net revenue growth. Unfavorable foreign exchange reduced net revenue growth by 7 percentage points. 2011 Net revenue increased 13%, primarily reflecting effective net pricing and volume growth. Favorable foreign exchange contributed 2  percentage points to net revenue growth. Acquisitions and divestitures had a nominal impact on the net revenue growth rate. Volume increased 13%, primarily reflecting a mid-single- digit increase in Mexico and a slight increase in Brazil (excluding the impact of an acquisition). Acquisitions contributed 9 per- centage points to the volume growth. Operating profit decreased 2%, driven by higher commodity costs, which negatively impacted operating profit perfor- mance by 17 percentage points, as well as other cost increases reflecting strategic investments. These impacts were partially offset by the net revenue growth and planned cost reductions across a number of expense categories. The net impact of acquisitions and divestitures reduced operating profit growth by 3.5  percentage points, primarily as a result of a gain in the prior year associated with the sale of a fish business in Brazil. Unfavorable foreign exchange reduced operating profit growth by 5.5 percentage points. Volume increased 5%, primarily reflecting mid-single-digit increases in Brazil (excluding the impact of an acquisition in the fourth quarter) and at Gamesa in Mexico. Additionally, Sabritas in Mexico was up slightly. Acquisitions contributed 1 percent- age point to the volume growth. Operating profit grew 7%, driven by the net revenue growth, partially offset by higher commodity costs. Acquisitions and divestitures, which included a gain from the sale of a fish business in Brazil, contributed nearly 4 percentage points to operating profit growth. Restructuring charges reduced oper- ating profit growth by 5 percentage points. 62 2012 PEPSICO ANNUAL REPORT Management’s Discussion and Analysis PepsiCo Americas Beverages Net revenue 53rd week Net revenue excluding above item* Impact of foreign exchange translation Net revenue growth excluding above item, on a constant currency basis* Operating profit Merger and integration charges Restructuring and impairment charges 53rd week Inventory fair value adjustments Venezuela currency devaluation Operating profit excluding above items* Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis* * See “Non-GAAP Measures” ** Does not sum due to rounding 2012 2011 2010 $ 21,408 $ 22,418 $ 20,401 – (288) – $ 21,408 $ 22,130 $ 20,401 % Change 2012 (4.5) 2011 10 (3) – (3) 8 (1) 8** $ 2,937 $ 3,273 $ 2,776 (10) 18 – 102 – – – 112 467 81 (35) 21 – – – 358 (9) $ 3,039 $ 3,452 $ 3,592 (12) 1 (11) (4) (0.5) (4)** 2012 Net revenue decreased 4.5%, primarily reflecting the dives- titure of our Mexico beverage business in the fourth quarter of 2011, which contributed 5  percentage points to the net revenue decline. Additionally, volume declines were offset by favorable effective net pricing. The impact of the 53rd week in the prior year contributed over 1 percentage point to the net revenue decline. Volume decreased 2%, driven by a 4% decline in North America volume, partially offset by a 2% increase in Latin America volume. North America volume declines were driven by a 4% decline in CSDs and a 3% decline in non-carbonated bev- erage volumes. The non-carbonated beverage volume decline primarily reflected a double-digit decline in Tropicana brands and a low-single-digit decline in Gatorade sports drinks. Latin America volume growth primarily reflected mid-single-digit increases in Mexico and Brazil, partially offset by a high-single- digit decline in Venezuela. The impact of the 53rd week in the prior year contributed 1 percentage point to the volume decline. Reported operating profit decreased 10%, primarily reflect- ing higher commodity costs, which negatively impacted operating profit performance by 12 percentage points, the volume decline and higher advertising and marketing expenses, partially offset by effective net pricing and planned cost reduc- tions across a number of expense categories. Excluding the items affecting comparability in the above table (see “Items Affecting Comparability”) operating profit declined 12%. The divestiture of our Mexico beverage business in 2011 contrib- uted nearly 3  percentage points to the reported operating profit decline and included a one-time gain associated with the contribution of this business to form a joint venture with both Organizacion Cultiba SAB de CV (Cultiba), formerly Geupec, and Empresas Polar. Unfavorable foreign exchange contrib- uted 1 percentage point to the operating profit decline. 2011 Net revenue increased 10%, primarily reflecting the incre- mental finished goods revenue related to our acquisitions of PBG and PAS. Favorable foreign exchange contributed nearly 1 percentage point to net revenue growth and the 53rd week contributed over 1 percentage point to net revenue growth. Volume increased 2%, primarily reflecting a 3% increase in Latin America volume, as well as volume from incremental brands related to our DPSG manufacturing and distribution agreement, which contributed 1 percentage point to volume growth. North America volume, excluding the impact of the incremental DPSG volume, increased slightly, as a 4% increase in non-carbonated beverage volume was partially offset by a 2% decline in CSD volume. The non-carbonated beverage volume growth primarily reflected a double-digit increase in Gatorade sports drinks. The 53rd week contributed 1 percent- age point to volume growth. Reported operating profit increased 18%, primarily reflect- ing the items affecting comparability in the above table (see “Items Affecting Comparability”). Excluding these items, oper- ating profit decreased 4%, mainly driven by higher commodity costs and higher selling and distribution costs, partially offset by the net revenue growth. Operating profit performance also benefited from the impact of certain insurance adjustments and more-favorable settlements of promotional spending accruals in the current year, which collectively contributed 2 percentage points to the reported operating profit growth. 2012 PEPSICO ANNUAL REPORT 63 Management’s Discussion and Analysis The net impact of the divestiture of our Mexico beverage business in the fourth quarter contributed 1 percentage point to reported operating profit growth and included a one-time gain associated with the contribution of this business to form a joint venture with both Cultiba and Empresas Polar. Europe Net revenue 53rd week Net revenue excluding above item* Impact of foreign exchange translation Net revenue growth excluding above item, on a constant currency basis* Operating profit Merger and integration charges Restructuring and impairment charges 53rd week Inventory fair value adjustments Operating profit excluding above items* Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis* * See “Non-GAAP Measures” 2012 2011 $ 13,441 $ 13,560 – (33) 2010 $ 9,602 – $ 13,441 $ 13,527 $ 9,602 $ 1,330 $ 1,210 11 42 – – 123 77 (8) 25 $ 1,054 111 – – 40 $ 1,383 $ 1,427 $ 1,205 % Change 2012 (1) (1) 7 6 10 (3) 6 3 2011 41 41 (3) 38 15 18 (4) 14 2012 Net revenue decreased 1%, primarily reflecting unfavorable foreign exchange, which reduced net revenue growth by 7 per- centage points, partially offset by effective net pricing. Our acquisition of WBD positively contributed 2 percentage points to the net revenue performance. Snacks volume grew 3%, mainly due to our acquisition of WBD, which contributed 2  percentage points to volume growth and declined slightly for the comparable post- acquisition period. Double-digit growth in Russia (ex-WBD) and mid-single-digit growth in South Africa were partially offset by a mid-single-digit decline in Poland. Additionally, the United Kingdom was flat. Beverage volume increased 1%, primarily reflecting our acquisition of WBD, which contributed over 1 percentage point to volume growth and increased at a low-single-digit rate for the comparable post-acquisition period. Volume growth also reflected mid-single-digit growth in Turkey and low- single- digit growth in Russia (ex-WBD) and the United Kingdom. These increases were partially offset by a high-single-digit decline in Poland and a low-single-digit decline in Germany. Operating profit increased 10%, primarily reflecting the items affecting comparability in the above table (see “Items Affecting Comparability”). Excluding these items affect- ing comparability, operating profit declined 3%, driven by higher commodity costs and unfavorable foreign exchange, which reduced operating profit performance by 17 percent- age points and 6 points, respectively, as well as other cost increases reflecting certain strategic investments. These impacts were partially offset by the effective net pricing and planned cost reductions across a number of expense cat- egories. Additionally, certain impairment charges primarily associated with our operations in Greece reduced reported operating profit growth by 2 percentage points. 2011 Net revenue grew 41%, primarily reflecting our acquisition of WBD, which contributed 29 percentage points to net revenue growth, and the incremental finished goods revenue related to our acquisitions of PBG and PAS. Favorable foreign exchange contributed 3 percentage points to net revenue growth. Snacks volume grew 35%, primarily reflecting our acqui- sition of WBD, which contributed 31  percentage points to volume growth. Double-digit growth in Turkey and South Africa and high-single-digit growth in Russia (ex-WBD) were partially offset by a mid-single-digit decline in Spain. Additionally, Walkers in the United Kingdom experienced low- single-digit growth. Beverage volume increased 21%, primarily reflecting our acquisition of WBD, which contributed 20 percentage points to volume growth, and incremental brands related to our acquisi- tions of PBG and PAS, which contributed nearly 1 percentage point to volume growth. A double-digit increase in Turkey and mid-single-digit increases in the United Kingdom and France were offset by a high-single-digit decline in Russia (ex-WBD). Reported operating profit increased 15%, primarily reflecting the net revenue growth, partially offset by higher commodity costs. Our acquisition of WBD contributed 64 2012 PEPSICO ANNUAL REPORT Management’s Discussion and Analysis 19 percentage points to the reported operating profit growth and reflected net charges of $56  million included in items affecting comparability in the above table (see “Items Affecting Comparability”). Excluding the items affecting comparability, operating profit increased 18%. Favorable foreign exchange contributed 4 percentage points to operating profit growth. Asia, Middle East and Africa Net revenue Impact of foreign exchange translation Net revenue growth, on a constant currency basis* Operating profit Restructuring and impairment charges Restructuring and other charges related to the transaction with Tingyi Operating profit excluding above items* Impact of foreign exchange translation Operating profit growth excluding above items, on a constant currency basis* * See “Non-GAAP Measures” ** Does not sum due to rounding 2012 $ 6,653 2011 $ 7,392 2010 $ 6,291 $ 747 $ 887 $ 708 28 150 $ 925 9 – – – $ 896 $ 708 % Change 2012 2011 (10) 3 (7) (16) 3 1 4 17 (2) 16** 25 27 (2.5) 24** 2012 Net revenue declined 10%, reflecting the impact of the trans- action with Tingyi and the deconsolidation of International Dairy and Juice Limited (IDJ), which reduced net revenue per- formance by 15 percentage points and 2 percentage points, respectively, partially offset by volume growth and effective net pricing. Unfavorable foreign exchange negatively impacted net revenue performance by nearly 3 percentage points. Snacks volume grew 14%, reflecting broad-based increases, which included double-digit growth in the Middle East, India and China. Additionally, Australia experienced low-single- digit growth. Beverage volume grew 10%, driven by double-digit growth in India and Pakistan and high-single-digit growth in the Middle East as well as in China, which included the benefit of new co-branded juice products distributed through our joint venture with Tingyi. The Tingyi co-branded volume had a 4- percentage-point impact on AMEA’s reported bever- age volume. Excluding the benefit of the Tingyi co-branded volume, beverage volume in China declined high-single digits due to Tingyi’s transitional impact on AMEA’s legacy juice busi- ness, the introduction of a 500ml PET value package in the third quarter of 2011, which largely replaced our 600ml offer- ing in the market, and the timing of the New Year’s holiday. Operating profit declined 16%, driven by the items affect- ing comparability in the above table (see “Items Affecting Comparability”). Excluding these items affecting compara- bility, operating profit increased 3%, reflecting the volume growth and effective net pricing, partially offset by higher commodity costs, which negatively impacted operating profit performance by 10 percentage points. Excluding the restruc- turing and other charges related to the transaction with Tingyi listed in the above items affecting comparability, the net impact of acquisitions and divestitures reduced reported operating profit by 2 percentage points, primarily as a result of a one-time gain in the prior year associated with the sale of our investment in our franchise bottler in Thailand, which negatively impacted reported operating profit performance by 13 percentage points. This decline was partially offset by the impact of structural changes related to the transaction with Tingyi, which positively contributed 11 percentage points to reported operating profit performance. Unfavorable foreign exchange reduced reported operating profit performance by 1 percentage point. 2011 Net revenue grew 17%, reflecting volume growth and favor- able effective net pricing. Foreign exchange contributed 2 percentage points to net revenue growth. Acquisitions had a nominal impact on net revenue growth. Snacks volume grew 15%, reflecting broad-based increases driven by double-digit growth in India, China and the Middle East. Beverage volume grew 5%, driven by double-digit growth in India and mid-single-digit growth in China and the Middle East. Acquisitions had a nominal impact on the beverage volume growth rate. Operating profit grew 25%, driven primarily by the net revenue growth, partially offset by higher commodity costs. Acquisitions and divestitures increased operating profit growth by 16 percentage points, primarily as a result of a one- time gain associated with the sale of our investment in our franchise bottler in Thailand. Favorable foreign exchange con- tributed 2.5 percentage points to the operating profit growth. 2012 PEPSICO ANNUAL REPORT 65 Management’s Discussion and Analysis 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 (including long-term debt financing which, depending upon market conditions, we may use to replace a portion of our commercial paper bor- rowings), will be adequate to meet our operating, investing and financing needs. Sources of cash available to us to fund cash outflows, such as our anticipated share repurchases and dividend payments, include cash from operations and pro- ceeds obtained in the U.S. debt markets. 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 9 to our consolidated financial statements for a description of our credit facilities. See also “Unfavorable economic conditions may have an adverse impact on our business results or finan- cial condition.” in “Our Business Risks.” As of December  29, 2012, we had cash, cash equivalents and short-term investments of $5.3  billion outside the U.S. To the extent foreign earnings are repatriated, such amounts would be subject to income tax liabilities, both in the U.S. and in various applicable foreign jurisdictions. In addition, currency restrictions enacted by the government in Venezuela have impacted our ability to pay dividends outside of the country from our snack and beverage operations in Venezuela. As of December  29, 2012, our operations in Venezuela com- prised 7% of our cash and cash equivalents balance. Effective February 2013, the Venezuelan government devalued the bolivar by resetting the official exchange rate to 6.3 bolivars per dollar. For additional information on the impact of the devaluation, see “Market Risks — Foreign Exchange” in “Our Business Risks.” 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 con- tinuing basis, we consider various transactions to increase shareholder value and enhance our business results, including acquisitions, divestitures, joint ventures, share repurchases and other structural changes. These transactions may result in future cash proceeds or payments. The table below summarizes our cash activity: Net cash provided by operating activities $ 8,479 $ 8,944 $ 8,448 2012 2011 2010 Net cash used for investing activities Net cash (used for)/provided by $ (3,005) $ (5,618) $ (7,668) financing activities $ (3,306) $ (5,135) $ 1,386 66 2012 PEPSICO ANNUAL REPORT Operating Activities During 2012, net cash provided by operating activities was $8.5 billion, compared to net cash provided of $8.9 billion in the prior year. The operating cash flow performance primarily reflects discretionary pension and retiree medical contribu- tions of $1.5  billion ($1.1  billion after-tax) in 2012, partially offset by favorable working capital comparisons to 2011. During 2011, net cash provided by operating activities was $8.9 billion, compared to net cash provided of $8.4 billion in the prior year. The increase over 2010 primarily reflects the overlap of discretionary pension contributions of $1.3 billion ($1.0 billion after-tax) in 2010, partially offset by unfavorable working capital comparisons to the prior year. Also see “Management Operating Cash Flow” below for certain other items impacting net cash provided by operat- ing activities. Investing Activities During 2012, net cash used for investing activities was $3.0 bil- lion, primarily reflecting $2.6  billion for net capital spending and $0.3 billion of cash payments related to the transaction with Tingyi. During 2011, net cash used for investing activities was $5.6  billion, primarily reflecting $3.3  billion for net capital spending and $2.4 billion of cash paid, net of cash and cash equivalents acquired, in connection with our acquisition of WBD. We expect 2013 net capital spending to be approximately $3.0 billion, within our long-term capital spending target of less than or equal to 5% of net revenue. Financing Activities During 2012, net cash used for financing activities was $3.3 billion, primarily reflecting the return of operating cash flow to our shareholders through dividend payments and share repurchases of $6.5  billion as well as net repayments of  short-term borrowings of $1.5  billion, partially offset by net  proceeds from long-term debt of $3.6  billion and stock option proceeds of $1.1 billion. During 2011, net cash used for financing activities was $5.1 billion, primarily reflecting the return of operating cash flow to our shareholders through share repurchases and divi- dend payments of $5.6 billion, our purchase of an additional $1.4 billion of WBD ordinary shares (including shares under- lying American Depositary Shares (ADS)) and our repurchase of certain WBD debt obligations of $0.8 billion, partially offset by net proceeds from long-term debt of $1.4 billion and stock option proceeds of $0.9 billion. We annually review our capital structure with our Board of Directors, including our dividend policy and share repur- chase activity. In the first quarter of 2013, we approved a new share repurchase program providing for the repurchase of up to $10  billion of PepsiCo common stock from July  1, 2013 through June 30, 2016, which will succeed the current repur- chase program that expires on June 30, 2013. In addition, we announced a 5.6% increase in our annualized dividend to $2.27 per share from $2.15 per share, effective with the dividend payable in June 2013. Under these programs, we expect to return a total of $6.4 billion to shareholders in 2013 through dividends of approximately $3.4 billion and share repurchases of approximately $3.0 billion. Management Operating Cash Flow We focus on management operating cash flow as a key element in achieving maximum shareholder value. 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 inves- tors should also consider net capital spending when evaluating our cash from operating activities. Additionally, we consider certain items (included in the table below) in evaluating man- agement operating cash flow. We believe investors should consider these items in evaluating our management operating cash flow results. Management operating cash flow excluding certain items is the primary measure we use to monitor cash flow performance. However, it is not a measure provided by U.S. GAAP. Therefore, this measure is not, and should not be viewed as, a substitute for U.S. GAAP cash flow measures. The table below reconciles net cash provided by operat- ing activities, as reflected in our cash flow statement, to our management operating cash flow excluding the impact of the items below. Net cash provided by operating activities Capital spending Sales of property, plant and equipment 2012 2011 2010 $ 8,479 $ 8,944 $ 8,448 (2,714) (3,339) (3,253) 95 84 81 Management operating cash flow 5,860 5,689 5,276 Discretionary pension and retiree medical contributions (after-tax) 1,051 44 983 Merger and integration payments (after-tax) 63 283 299 Payments related to restructuring charges (after-tax) 260 21 20 Capital investments related to the PBG/PAS integration 10 108 138 Capital investments related to the Productivity Plan 26 – – Payments for restructuring and other charges related to the transaction with Tingyi (after-tax) Foundation contribution (after-tax) Debt repurchase (after-tax) Management operating cash flow 117 – – – – – 64 – 112 excluding above items $ 7,387 $ 6,145 $ 6,892 Management’s Discussion and Analysis In all years presented, management operating cash flow was used primarily to repurchase shares and pay dividends. We expect to continue to return management operating cash flow to our shareholders through dividends and share repurchases while maintaining credit ratings that provide us with ready access to global and capital credit markets. However, see “Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings.” in “Our Business Risks” for certain fac- tors that may impact our operating cash flows. Any downgrade of our credit ratings by a credit rating agency, especially any downgrade to below investment grade, could increase our future borrowing costs or 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 financ- ing. See “Our Business Risks,” Note  9 to our consolidated financial statements and “Our borrowing costs and access to capital and credit markets may be adversely affected by a downgrade or potential downgrade of our credit ratings.” in “Our Business Risks.” Credit Facilities and Long-Term Contractual Commitments See Note  9 to our consolidated financial statements for a description of our credit facilities and long-term contrac- tual commitments. Off-Balance-Sheet Arrangements It is not our business practice to enter into off-balance-sheet arrangements, other than in the normal course of business. Additionally, we do not enter into off-balance-sheet transac- tions specifically structured to provide income or tax benefits or to avoid recognizing or disclosing assets or liabilities. See Note 9 to our consolidated financial statements. 2012 PEPSICO ANNUAL REPORT 67 Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2012, December 31, 2011 and December 25, 2010 (in millions except per share amounts) Net Revenue Cost of sales Selling, general and administrative expenses Amortization of intangible assets Operating Profit Bottling equity income Interest expense Interest income and other Income before income taxes Provision for income taxes Net income Less: Net income attributable to noncontrolling interests Net Income Attributable to PepsiCo Net Income Attributable to PepsiCo per Common Share Basic Diluted Weighted-average common shares outstanding Basic Diluted Cash dividends declared per common share See accompanying notes to consolidated financial statements. 2012 2011 2010 $ 65,492 $ 66,504 $ 57,838 31,291 24,970 119 9,112 – (899) 91 8,304 2,090 6,214 36 31,593 25,145 133 9,633 – (856) 57 8,834 2,372 6,462 19 26,575 22,814 117 8,332 735 (903) 68 8,232 1,894 6,338 18 $ 6,178 $ 6,443 $ 6,320 $ 3.96 $ 4.08 $ 3.97 $ 3.92 $ 4.03 $ 3.91 1,557 1,575 1,576 1,597 1,590 1,614 $ 2.1275 $ 2.025 $ 1.89 68 2012 PEPSICO ANNUAL REPORT Consolidated Statement of Comprehensive Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2012, December 31, 2011 and December 25, 2010 (in millions) Net income Other Comprehensive Income Currency translation adjustment Cash flow hedges: Net derivative losses Reclassification of net losses to net income Pension and retiree medical: Net prior service cost Net losses Unrealized gains on securities Other Total Other Comprehensive Income Comprehensive income Comprehensive income attributable to noncontrolling interests Comprehensive Income Attributable to PepsiCo Net income Other Comprehensive Loss Currency translation adjustment Cash flow hedges: Net derivative losses Reclassification of net losses to net income Pension and retiree medical: Net prior service cost Net losses Unrealized losses on securities Other Total Other Comprehensive Loss Comprehensive income Comprehensive income attributable to noncontrolling interests Comprehensive Income Attributable to PepsiCo Net income Other Comprehensive Income Currency translation adjustment Cash flow hedges: Net derivative losses Reclassification of net losses to net income Pension and retiree medical: Net prior service credit Net losses Unrealized gains on securities Other Total Other Comprehensive Income Comprehensive income Comprehensive income attributable to noncontrolling interests Comprehensive Income Attributable to PepsiCo See accompanying notes to consolidated financial statements. 2012 Tax benefit/ (expense) Pre-tax amounts After-tax amounts $ 6,214 $ 737 $ – 737 (50) 90 (32) (41) 18 – 10 (32) 12 (11) – 36 $ 722 $ 15 2011 Tax benefit/ (expense) Pre-tax amounts (40) 58 (20) (52) 18 36 737 6,951 (31) $ 6,920 After-tax amounts $ 6,462 $ (1,464) $ – (1,464) (126) 5 (18) (1,468) (27) (16) 43 4 8 501 19 5 $ (3,114) $ 580 2010 Tax benefit/ (expense) Pre-tax amounts (83) 9 (10) (967) (8) (11) (2,534) 3,928 (84) $ 3,844 After-tax amounts $ 6,338 $ 299 $ – 299 (69) 75 35 (260) 24 (25) 23 (25) (13) 124 (1) (36) $ 79 $ 72 (46) 50 22 (136) 23 (61) 151 6,489 (5) $ 6,484 2012 PEPSICO ANNUAL REPORT 69 Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2012, December 31, 2011 and December 25, 2010 (in millions) Operating Activities Net income Depreciation and amortization Stock-based compensation expense Merger and integration costs Cash payments for merger and integration costs Restructuring and impairment charges Cash payments for restructuring charges Restructuring and other charges related to the transaction with Tingyi Cash payments for restructuring and other charges related to the transaction with Tingyi Gain on previously held equity interests in PBG and PAS Asset write-off Non-cash foreign exchange loss related to Venezuela devaluation Excess tax benefits from share-based payment arrangements Pension and retiree medical plan contributions Pension and retiree medical plan expenses Bottling equity income, net of dividends Deferred income taxes and other tax charges and credits Change in accounts and notes receivable Change in inventories Change in prepaid expenses and other current assets Change in accounts payable and other current liabilities Change in income taxes payable Other, net Net Cash Provided by Operating Activities Investing Activities Capital spending Sales of property, plant and equipment Acquisitions of PBG and PAS, net of cash and cash equivalents acquired Acquisition of manufacturing and distribution rights from DPSG Acquisition of WBD, net of cash and cash equivalents acquired Investment in WBD Cash payments related to the transaction with Tingyi Other acquisitions and investments in noncontrolled affiliates Divestitures Short-term investments, by original maturity More than three months —  purchases More than three months —  maturities Three months or less, net Other investing, net Net Cash Used for Investing Activities (Continued on following page) 2012 2011 2010 $ 6,214 $ 6,462 $ 6,338 2,689 278 16 (83) 279 (343) 176 (109) – – – (124) (1,865) 796 – 321 (250) 144 89 548 (97) (200) 8,479 2,737 326 329 (377) 383 (31) – – – – – (70) (349) 571 – 495 (666) (331) (27) 520 (340) (688) 8,944 2,327 299 808 (385) – (31) – – (958) 145 120 (107) (1,734) 453 42 500 (268) 276 144 488 123 (132) 8,448 (2,714) (3,339) (3,253) 95 – – – – (306) (121) (32) – – 61 12 84 – – (2,428) (164) – (601) 780 – 21 45 (16) 81 (2,833) (900) – (463) – (83) 12 (12) 29 (229) (17) (3,005) (5,618) (7,668) 70 2012 PEPSICO ANNUAL REPORT Consolidated Statement of Cash Flows (continued) Fiscal years ended December 29, 2012, December 31, 2011 and December 25, 2010 (in millions) Financing Activities Proceeds from issuances of long-term debt Payments of long-term debt Debt repurchase Short-term borrowings, by original maturity More than three months —  proceeds More than three months —  payments Three months or less, net Cash dividends paid Share repurchases —  common Share repurchases —  preferred Proceeds from exercises of stock options Excess tax benefits from share-based payment arrangements Acquisition of noncontrolling interests Other financing Net Cash (Used for)/Provided by Financing Activities Effect of exchange rate changes on cash and cash equivalents Net Increase/(Decrease) in Cash and Cash Equivalents Cash and Cash Equivalents, Beginning of Year Cash and Cash Equivalents, End of Year Non-cash activity: Issuance of common stock and equity awards in connection with our acquisitions of PBG and PAS, as reflected in investing and financing activities See accompanying notes to consolidated financial statements. PepsiCo, Inc. and Subsidiaries 2012 2011 2010 $ 5,999 $ 3,000 $ 6,451 (2,449) – 549 (248) (1,762) (3,305) (3,219) (7) 1,122 124 (68) (42) (1,596) (771) 523 (559) 339 (3,157) (2,489) (7) 945 70 (1,406) (27) (3,306) (5,135) 62 2,230 4,067 (67) (1,876) 5,943 (59) (500) 227 (96) 2,351 (2,978) (4,978) (5) 1,038 107 (159) (13) 1,386 (166) 2,000 3,943 $ 6,297 $ 4,067 $ 5,943 $ 4,451 2012 PEPSICO ANNUAL REPORT 71 Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries 2012 2011 $ 6,297 $ 4,067 322 7,041 3,581 1,479 18,720 19,136 1,781 16,971 14,744 31,715 1,633 1,653 358 6,912 3,827 2,277 17,441 19,698 1,888 16,800 14,557 31,357 1,477 1,021 $ 74,638 $ 72,882 $ 4,815 $ 6,205 11,903 11,757 371 17,089 23,544 6,543 5,063 52,239 192 18,154 20,568 8,266 4,995 51,983 41 (164) 41 (157) 26 4,178 43,158 (5,487) (19,458) 22,417 105 26 4,461 40,316 (6,229) (17,870) 20,704 311 22,399 20,899 $ 74,638 $ 72,882 December 29, 2012 and December 31, 2011 (in millions except per share amounts) ASSETS Current Assets Cash and cash equivalents Short-term investments Accounts and notes receivable, net Inventories Prepaid expenses and other current assets Total Current Assets Property, Plant and Equipment, net Amortizable Intangible Assets, net Goodwill Other nonamortizable intangible assets Nonamortizable Intangible Assets Investments in Noncontrolled Affiliates Other Assets Total Assets LIABILITIES AND EQUITY Current Liabilities Short-term obligations Accounts payable and other current liabilities Income taxes payable Total Current Liabilities Long-Term Debt Obligations Other Liabilities Deferred Income Taxes Total Liabilities Commitments and Contingencies Preferred Stock, no par value Repurchased Preferred Stock 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: 1,544 and 1,565 shares, respectively) Capital in excess of par value Retained earnings Accumulated other comprehensive loss Repurchased common stock, in excess of par value (322 and 301 shares, respectively) Total PepsiCo Common Shareholders’ Equity Noncontrolling interests Total Equity Total Liabilities and Equity See accompanying notes to consolidated financial statements. 72 2012 PEPSICO ANNUAL REPORT Consolidated Statement of Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 29, 2012, December 31, 2011 and December 25, 2010 (in millions) Preferred Stock Repurchased Preferred Stock Balance, beginning of year Redemptions Balance, end of year Common Stock Balance, beginning of year Repurchased common stock Shares issued in connection with our acquisitions of PBG and PAS Balance, end of year Capital in Excess of Par Value Balance, beginning of year Stock-based compensation expense Stock option exercises/RSUs converted(a) Withholding tax on RSUs converted Equity issued in connection with our acquisitions of PBG and PAS Other Balance, end of year Retained Earnings Balance, beginning of year Net income attributable to PepsiCo Cash dividends declared —  common Cash dividends declared —  preferred Cash dividends declared —  RSUs Other Balance, end of year Accumulated Other Comprehensive Loss Balance, beginning of year Currency translation adjustment Cash flow hedges, net of tax: Net derivative losses Reclassification of net losses to net income Pension and retiree medical, net of tax: Net pension and retiree medical losses Reclassification of net losses to net income Unrealized gains/(losses) on securities, net of tax Other Balance, end of year Repurchased Common Stock Balance, beginning of year Share repurchases Stock option exercises Other Balance, end of year Noncontrolling Interests Balance, beginning of year Net income attributable to noncontrolling interests Distributions to noncontrolling interests, net Currency translation adjustment Acquisitions and divestitures Other, net Balance, end of year Total Equity 2012 2011 2010 Shares Amount Shares Amount Shares Amount 0.8 $ 41 0.8 $ 41 0.8 $ 41 (0.6) – (0.6) 1,565 (21) – 1,544 (157) (7) (164) 26 – – 26 (0.6) – (0.6) 1,582 (17) – 1,565 (150) (7) (157) 26 – – 26 (0.6) – (0.6) 1,566 (67) 83 1,582 4,461 4,527 278 (431) (70) – (60) 4,178 40,316 6,178 (3,312) (1) (23) – 43,158 (6,229) 742 (40) 58 (493) 421 18 36 (5,487) (17,870) (3,219) 1,488 143 (301) (47) 24 2 (284) (39) 20 2 (322) (19,458) (301) 311 36 (37) (5) (200) – 105 326 (361) (56) – 25 4,461 37,090 6,443 (3,192) (1) (24) – 40,316 (3,630) (1,529) (83) 9 (1,110) 133 (8) (11) (6,229) (16,740) (2,489) 1,251 108 (17,870) 20,704 312 19 (24) 65 (57) (4) 311 (217) (76) 24 (15) (284) (145) (5) (150) 26 (1) 1 26 250 299 (500) (68) 4,451 95 4,527 33,805 6,320 (3,028) (1) (12) 6 37,090 (3,794) 312 (46) 50 (280) 166 23 (61) (3,630) (13,379) (4,977) 1,487 129 (16,740) 21,273 638 18 (6) (13) (326) 1 312 Total PepsiCo Common Shareholders’ Equity 22,417 (a) Includes total tax benefits of $84 million in 2012, $43 million in 2011 and $75 million in 2010. See accompanying notes to consolidated financial statements. 2012 PEPSICO ANNUAL REPORT 73 $ 22,399 $ 20,899 $ 21,476 Notes to Consolidated Financial Statements Note 1 —  Basis of Presentation and Our Divisions Basis of Presentation Our financial statements 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 less than 50%. Intercompany balances and transac- tions are eliminated. Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. In 2011, we had an additional week of results (53rd week). On February  26, 2010, we completed our acquisitions of PBG and PAS. The results of the acquired companies in the U.S. and Canada were reflected in our consolidated results as of the acquisition date, and the international results of the acquired companies have been reported as of the beginning of the second quarter of 2010, consistent with our monthly international reporting calendar. The results of the acquired companies in the U.S., Canada and Mexico are reported within our PAB segment, and the results of the acquired companies in Europe, including Russia, are reported within our Europe seg- ment. Prior to our acquisitions of PBG and PAS, we recorded our share of equity income or loss from the acquired compa- nies in bottling equity income in our income statement. Our share of income or loss from other noncontrolled affiliates is reflected as a component of selling, general and administrative expenses. Additionally, in the first quarter of 2010, in con- nection with our acquisitions of PBG and PAS, we recorded a gain on our previously held equity interests of $958 million, comprising $735 million which was non-taxable and recorded in bottling equity income and $223 million related to the rever- sal of deferred tax liabilities associated with these previously held equity interests. See Notes 8 and 15 to our consolidated financial statements, and for additional unaudited informa- tion on items affecting the comparability of our consolidated results see “Items Affecting Comparability” in Management’s Discussion and Analysis. As of the beginning of our 2010 fiscal year, the results of our Venezuelan businesses are reported under hyperinflationary accounting. See “Our Business Risks” and “Items Affecting Comparability” in Management’s Discussion and Analysis. In the first quarter of 2011, QFNA changed its method of accounting for certain U.S. inventories from the last-in, first- out (LIFO) method to the average cost method as we believe that the average cost method of accounting improves our financial reporting by better matching revenues and expenses and better reflecting the current value of inventory. The impact of this change on consolidated net income in the first quarter of 2011 was approximately $9  million (or less than a penny per share). Prior periods were not restated as the impact of the change on previously issued financial statements was not considered material. Raw materials, direct labor and plant overhead, as well as purchasing and receiving costs, costs directly related to pro- duction planning, inspection costs and raw material handling facilities, are included in cost of sales. The costs of moving, storing and delivering finished product are included in selling, general and administrative expenses. The preparation of our consolidated financial statements in conformity with generally accepted accounting principles 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, stock-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 cur- rent 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. While our North America results are reported on a weekly calendar basis, most of our international operations report on a monthly calendar basis. In 2011, we had an additional week of results (53rd week). The following chart details our quarterly reporting schedule for all other reporting periods presented: Quarter U.S. and Canada International First Quarter Second Quarter Third Quarter Fourth Quarter 12 weeks 12 weeks 12 weeks 16 weeks January, February March, April and May June, July and August September, October, November and December See “Our Divisions” below, and for additional unaudited information on items affecting the comparability of our con- solidated results, see “Items Affecting Comparability” in Management’s Discussion and Analysis. 74 2012 PEPSICO ANNUAL REPORT Notes to Consolidated Financial Statements Tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless noted, and are based on unrounded amounts. Certain reclassifications were made to prior years’ amounts to conform to the 2012 presentation. 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. Our Divisions We manufacture or use contract manufacturers, market and sell a variety of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages, dairy products and other foods in over 200 countries and terri- tories with our largest operations in North America (United States and Canada), Russia, Mexico, 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. For additional unaudited information on our divisions, see “Our Operations” in Management’s Discussion and Analysis. The accounting policies for the divisions are the same as those described in Note 2, except for the following allocation methodologies: • stock-based compensation expense; • pension and retiree medical expense; and • derivatives. Stock-Based Compensation Expense Our divisions are held accountable for stock-based compensa- tion expense and, therefore, this expense is allocated to our divisions as an incremental employee compensation cost. The allocation of stock-based compensation expense in 2012 was approximately 16% to FLNA, 2% to QFNA, 5% to LAF, 25% to PAB, 14% to Europe, 12% to AMEA and 26% to corporate unallocated expenses. We had similar allocations of stock- based compensation expense to our divisions in 2011 and 2010. The expense allocated to our divisions excludes any impact of changes in our assumptions during the year which Pension and Retiree Medical Expense Pension and retiree medical service costs measured at a fixed discount rate, as well as amortization of costs related to cer- tain pension plan amendments and gains and losses due to demographics, including salary experience, are reflected in division results for North American employees. Division results also include interest costs, measured at a fixed discount rate, for retiree medical plans. Interest costs for the pension plans, pension asset returns and the impact of pension funding, and gains and losses other than those due to demographics, are all reflected in corporate unallocated expenses. In addition, cor- porate unallocated expenses include the difference between the service costs measured at a fixed discount rate (included in division results as noted above) and the total service costs determined using the plans’ discount rates as disclosed in Note 7 to our consolidated financial statements. Derivatives We centrally manage commodity derivatives on behalf of our divisions. These commodity derivatives include agricultural products, metals and energy. 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. 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 speculative purposes. 2012 PEPSICO ANNUAL REPORT 75 Notes to Consolidated Financial Statements FLNA QFNA LAF PAB Europe(b) AMEA Total division Corporate Unallocated Mark-to-market net impact gains/(losses) Merger and integration charges Restructuring and impairment charges Pension lump sum settlement charge 53rd week Venezuela currency devaluation Asset write-off Foundation contribution Other Net Revenue Operating Profit(a) 2012 2011 2010 2012 2011 $ 13,574 $ 13,322 $ 12,573 $ 3,646 $ 3,621 2,636 7,780 21,408 13,441 6,653 65,492 2,656 7,156 22,418 13,560 7,392 66,504 2,656 6,315 20,401 9,602 6,291 57,838 695 1,059 2,937 1,330 747 10,414 65 – (10) (195) – – – – 797 1,078 3,273 1,210 887 10,866 (102) (78) (74) – (18) – – – (1,162) (961) 2010 $ 3,376 741 1,004 2,776 1,054 708 9,659 91 (191) – – – (129) (145) (100) (853) (a) For information on the impact of restructuring, impairment and integration charges on our divisions, see Note 3 to our consolidated financial statements. (b) Change in net revenue in 2011 relates primarily to our acquisition of WBD. $ 65,492 $ 66,504 $ 57,838 $ 9,112 $ 9,633 $ 8,332 Net Revenue Division Operating Profit AMEA FLNA 10% 21% Europe 20% QFNA 4% 12% LAF 33% PAB AMEA Europe 7% 13% 28% PAB FLNA 35% 7% 10% LAF QFNA Corporate Corporate includes costs of our corporate headquarters, centrally managed initiatives such as our ongoing global business transformation initiative and research and development projects, unallocated insurance and benefit programs, foreign exchange transaction gains and losses, certain commodity derivative gains and losses and certain other items. Other Division Information FLNA QFNA LAF PAB Europe(a) AMEA Total division Corporate(b) Investments in bottling affiliates Total Assets Capital Spending 2012 2011 2010 $ 5,332 $ 5,384 $ 5,276 966 4,993 30,899 19,218 5,738 67,146 7,492 – 1,024 4,721 31,142 18,461 6,038 66,770 6,112 – 1,062 4,041 31,571 13,018 5,557 60,525 7,389 239 2012 $ 365 37 436 702 575 510 2,625 89 – 2011 $ 439 43 413 1,006 588 693 3,182 157 – 2010 $ 515 48 370 973 517 610 3,033 220 – $ 74,638 $ 72,882 $ 68,153 $ 2,714 $ 3,339 $ 3,253 (a) Changes in total assets in 2011 relate primarily to our acquisition of WBD. (b) Corporate assets consist principally of cash and cash equivalents, short-term investments, derivative instruments and property, plant and equipment. 76 2012 PEPSICO ANNUAL REPORT Total Assets Capital Spending Notes to Consolidated Financial Statements QFNA 1% LAF 7% 41% PAB Corporate FLNA AMEA 10% 7% 8% Europe 26% FLNA QFNA LAF PAB Europe AMEA Total division Corporate U.S. Russia(b) Mexico Canada United Kingdom Brazil All other countries Corporate 3% FLNA AMEA 19% 13% QFNA 2% 16% LAF 21% Europe 26% PAB Amortization of Intangible Assets Depreciation and Other Amortization 2012 $ 7 – 10 59 36 7 119 – 2011 $ 7 – 10 65 39 12 133 – 2010 $ 7 – 6 56 35 13 117 – 2012 $ 445 53 248 855 522 305 2,428 142 2011 $ 458 54 238 865 522 350 2,487 117 2010 $ 448 52 213 749 355 294 2,111 99 $ 119 $ 133 $ 117 $ 2,570 $ 2,604 $ 2,210 Net Revenue Long-Lived Assets(a) 2012 2011 2010 2012 2011 2010 $ 33,348 $ 33,053 $ 30,618 $ 28,344 $ 28,999 $ 28,631 4,861 3,955 3,290 2,102 1,866 16,070 4,749 4,782 3,364 2,075 1,838 16,643 1,890 4,531 3,081 1,888 1,582 14,248 8,603 1,237 3,294 1,053 1,134 10,600 8,121 1,027 3,097 1,011 1,124 11,041 2,744 1,671 3,133 1,019 677 11,020 $ 65,492 $ 66,504 $ 57,838 $ 54,265 $ 54,420 $ 48,895 (a) Long-lived assets represent property, plant and equipment, nonamortizable intangible assets, amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. (b) Change in 2011 relates primarily to our acquisition of WBD. Net Revenue Other 25% Brazil 3% United Kingdom 3% Canada 5% Mexico 6% 7% Russia 51% United States Long-Lived Assets Other Brazil 2% United Kingdom 2% Canada Mexico 2% 20% 6% 16% Russia 52% United States 2012 PEPSICO ANNUAL REPORT 77 Notes to Consolidated Financial Statements Note 2 —  Our Significant Accounting Policies Revenue Recognition We recognize revenue upon shipment or delivery to our cus- tomers 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. Based on our experience with this practice, we have reserved for anticipated damaged and out-of-date products. For additional unaudited informa- tion on our revenue recognition and related policies, including our policy on bad debts, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis. We are exposed to concentration of credit risk by our customers, including Wal-Mart. In 2012, Wal-Mart (including Sam’s) represented approximately 11% of our total net revenue, including con- centrate sales to our independent bottlers which are used in finished goods sold by them to Wal-Mart. We have not experi- enced 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 totaled $34.7 billion in 2012, $34.6 billion in 2011 and $29.1 billion in 2010. Sales incentives and discounts include payments to customers for performing merchandising 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. It also includes support provided to our independent bottlers through funding of advertising and other marketing activities. While most of these incentive arrangements have terms of no more than one year, certain arrangements, such as fountain pouring rights, may extend beyond one year. Costs incurred to obtain these arrangements are recognized over the shorter of the eco- nomic or contractual life, as a reduction of revenue, and the remaining balances of $335 million as of December 29, 2012 and $313  million as of December  31, 2011, are included in current assets and other assets on our balance sheet. For additional unaudited information on our sales incentives, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis. Advertising and other marketing activities, reported as sell- ing, general and administrative expenses, totaled $3.7 billion in 2012, $3.5 billion in 2011 and $3.4 billion in 2010, including 78 2012 PEPSICO ANNUAL REPORT advertising expenses of $2.2  billion in 2012 and $1.9  billion in both 2011 and 2010. 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 $88 million and $163 million at year-end 2012 and 2011, respectively, are classified as pre- paid expenses on our balance sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $9.1 billion in 2012, $9.2 billion in 2011 and $7.7 billion in 2010. 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 devel- opment 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 only (i) external direct costs of materials and ser- vices utilized in developing or obtaining computer software, (ii) compensation and related benefits for employees who are directly associated with the software project and (iii) inter- est 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 5 to 10 years. Software amortization totaled $196 million in 2012, $156 mil- lion in 2011 and $137 million in 2010. Net capitalized software and development costs were $1.1 billion as of December 29, 2012 and $1.3 billion as of December 31, 2011. 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 information on our commitments, see Note 9 to our consolidated financial statements. Research and Development We engage in a variety of research and development activities and continue to invest to accelerate growth in these activi- ties and to drive innovation globally. These activities principally involve the development of new products, improvement in the quality of existing products, improvement and modernization of production processes, and the development and imple- mentation of new technologies to enhance the quality and value of both current and proposed product lines. Consumer research is excluded from research and development costs and included in other marketing costs. Research and develop- ment costs were $552 million in 2012, $525 million in 2011 and $488 million in 2010 and are reported within selling, gen- eral and administrative expenses. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: • Property, Plant and Equipment and Intangible Assets —  Note 4, and for additional unaudited information on goodwill and other intangible assets see “Our Critical Accounting Policies” in Management’s Discussion and Analysis. • Income Taxes —  Note 5, and for additional unaudited informa- tion see “Our Critical Accounting Policies” in Management’s Discussion and Analysis. • Stock-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. • Financial Instruments —  Note  10, and for additional unau- dited information, see “Our Business Risks” in Management’s Discussion and Analysis. • Inventories —  Note  14. Inventories are valued at the lower of cost or market. Cost is determined using the average; first-in, first-out (FIFO) or last-in, first-out (LIFO) methods. • Translation of Financial Statements of Foreign Subsid- iaries —  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 transla- tion adjustment. Notes to Consolidated Financial Statements Recent Accounting Pronouncements In July 2012, the Financial Accounting Standards Board (FASB) issued new accounting guidance that permits an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform a quantitative impairment test. An entity would continue to cal- culate the fair value of an indefinite-lived intangible asset if the asset fails the qualitative assessment, while no further analysis would be required if it passes. The provisions of the new guid- ance are effective as of the beginning of our 2013 fiscal year. We do not expect the new guidance to have an impact on the 2013 impairment test results. In September 2011, the FASB issued new accounting guid- ance that permits an entity to first assess qualitative factors of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two- step goodwill impairment test. An entity would continue to perform the historical first step of the impairment test if it fails the qualitative assessment, while no further analysis would be required if it passes. The provisions of the new guidance were effective for, and had no impact on, our 2012 annual goodwill impairment test results. In December 2011, the FASB issued new disclosure require- ments that are intended to enhance current disclosures on offsetting financial assets and liabilities. The new disclosures require an entity to disclose both gross and net information about derivative instruments accounted for in accordance with the guidance on derivatives and hedging that are eligible for offset on the balance sheet and instruments and trans- actions subject to an agreement similar to a master netting arrangement. The provisions of the new disclosure require- ments are effective as of the beginning of our 2014 fiscal year. We are currently evaluating the impact of the new guidance on our financial statements. In September 2011, the FASB amended its guidance regard- ing the disclosure requirements for employers participating in multiemployer pension and other postretirement benefit plans (multiemployer plans) to improve transparency and increase awareness of the commitments and risks involved with partici- pation in multiemployer plans. The new accounting guidance requires employers participating in multiemployer plans to provide additional quantitative and qualitative disclosures to provide users with more detailed information regarding an employer’s involvement in multiemployer plans. The provisions of this new guidance were effective as of the beginning of our 2011 fiscal year and did not have a material impact on our financial statements. 2012 PEPSICO ANNUAL REPORT 79 Notes to Consolidated Financial Statements In June 2011, the FASB amended its accounting guidance on the presentation of comprehensive income in financial statements to improve the comparability, consistency and transparency of financial reporting and to increase the promi- nence of items that are recorded in other comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The provisions of the guidance were effective as of the beginning of our 2012 fiscal year. Accordingly, we have presented the components of net income and other comprehensive income for the fiscal years ended December  29, 2012, December  31, 2011 and December 25, 2010 as separate but consecutive statements. In February 2013, the FASB issued guidance that would require an entity to provide enhanced footnote disclosures to explain the effect of reclassification adjustments on other comprehensive income by component and provide tabular disclosure in the footnotes showing the effect of items reclas- sified from accumulated other comprehensive income on the line items of net income. The provisions of this new guidance are effective as of the beginning of our 2013 fiscal year. We do not expect the adoption of this new guidance to have a mate- rial impact on our financial statements. In the second quarter of 2010, the Patient Protection and Affordable Care Act (PPACA) was signed into law. The PPACA changes the tax treatment related to an existing retiree drug subsidy (RDS) available to sponsors of retiree health benefit plans that provide a benefit that is at least actuarially equiva- lent to the benefits under Medicare Part D. As a result of the PPACA, RDS payments will effectively become taxable in tax years beginning in 2013, by requiring the amount of the subsidy received to be offset against our deduction for health care expenses. The provisions of the PPACA required us to record the effect of this tax law change beginning in our second quarter of 2010, and consequently we recorded a one- time related tax charge of $41 million in the second quarter of 2010. In the first quarter of 2012, we began pre-paying funds within our 401(h) voluntary employee beneficiary associations (VEBA) trust to fully cover prescription drug benefit liabilities for Medicare eligible retirees. As a result, the receipt of future Medicare subsidy payments for prescription drugs will not be taxable and consequently we recorded a $55 million tax ben- efit reflecting this change in the first quarter of 2012. Note 3 —  Restructuring, Impairment and Integration Charges In 2012, we incurred restructuring charges of $279  million ($215  million after-tax or $0.14 per share) in conjunction with our Productivity Plan. In 2011, we incurred restructuring charges of $383  million ($286  million after-tax or $0.18 per share) in conjunction with our Productivity Plan. All of these charges were recorded in selling, general and administrative expenses and primarily relate to severance and other employee related costs, asset impairments, and consulting and contract termination costs. The Productivity Plan includes actions in every aspect of our business that we believe will strengthen our complementary food, snack and beverage businesses by leveraging new technologies and processes across PepsiCo’s operations; go-to-market and information systems; height- ening the focus on best practice sharing across the globe; consolidating manufacturing, warehouse and sales facilities; and implementing simplified organization structures, with wider spans of control and fewer layers of management. The Productivity Plan is expected to enhance PepsiCo’s cost-competitiveness, provide a source of funding for future brand-building and innovation initiatives, and serve as a financial cushion for potential macroeconomic uncertainty. A summary of our Productivity Plan charges in 2012 was as follows: FLNA QFNA LAF PAB Europe AMEA Corporate Severance and Other Employee Costs Asset Impairments Other Costs $ 14 $ 8 $ 16 – 15 34 14 18 (6) – 8 43 16 – – 9 27 25 12 10 16 Total $ 38 9 50 102 42 28 10 $ 89 $ 75 $ 115 $ 279 A summary of our Productivity Plan charges in 2011 was as follows: FLNA QFNA LAF PAB Europe AMEA Corporate Severance and Other Employee Costs Other Costs $ 74 $ 2 18 46 75 65 9 40 – 2 6 12 – 34 Total $ 76 18 48 81 77 9 74 $ 327 $ 56 $ 383 80 2012 PEPSICO ANNUAL REPORT A summary of our Productivity Plan activity in 2011 and 2012 was as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total $ 327 $ – $ 56 $ 383 (1) (77) – – (29) – (30) (77) 2011 restructuring charges Cash payments Non-cash charges Liability as of December 31, 2011 249 – 27 276 Notes to Consolidated Financial Statements enhance our revenue growth. These charges also include clos- ing costs, one-time financing costs and advisory fees related to our acquisitions of PBG and PAS. In addition, we recorded $9 million of merger-related charges, representing our share of the respective merger costs of PBG and PAS, in bottling equity income. Substantially all cash payments related to the above charges were made by the end of 2011. In total, these charges had an after-tax impact of $648  million or $0.40 per share. A summary of our merger and integration activity was 2012 restructuring charges Cash payments Non-cash charges Liability as of 89 (239) (8) 75 – (75) 115 (104) (2) 279 (343) (85) as follows: Severance and Other Employee Costs Asset Impairments Other Costs Total December 29, 2012 $ 91 $ – $ 36 $ 127 In 2012, we incurred merger and integration charges of $16 million ($12 million after-tax or $0.01 per share) related to our acquisition of WBD, including $11  million recorded in the Europe segment and $5  million recorded in interest expense. All of these net charges, other than the interest expense portion, were recorded in selling, general and admin- istrative expenses. The majority of cash payments related to these charges were paid by the end of 2012. In 2011, we incurred merger and integration charges of $329 million ($271 million after-tax or $0.17 per share) related to our acquisitions of PBG, PAS and WBD, including $112 mil- lion recorded in the PAB segment, $123  million recorded in the Europe segment, $78 million recorded in corporate unallo- cated expenses and $16 million recorded in interest expense. All of these net charges, other than the interest expense portion, were recorded in selling, general and administrative expenses. These charges also include closing costs and advi- sory fees related to our acquisition of WBD. Substantially all cash payments related to the above charges were made by the end of 2011. In 2010, we incurred merger and integration charges of $799  million related to our acquisitions of PBG and PAS, as well as advisory fees in connection with our acquisition of WBD. $467  million of these charges were recorded in the PAB segment, $111 million recorded in the Europe segment, $191 million recorded in corporate unallocated expenses and $30 million recorded in interest expense. All of these charges, other than the interest expense portion, were recorded in selling, general and administrative expenses. The merger and integration charges related to our acquisitions of PBG and PAS were incurred to help create a more fully integrated supply chain and go-to-market business model, to improve the effec- tiveness and efficiency of the distribution of our brands and to 2010 merger and integration charges $ 396 $ 132 $ 280 $ 808 Cash payments Non-cash charges Liability as of (114) (103) – (132) (271) 16 (385) (219) December 25, 2010 179 – 25 204 2011 merger and integration charges Cash payments Non-cash charges Liability as of 146 (191) (36) 34 – (34) 149 (186) 19 329 (377) (51) December 31, 2011 98 2012 merger and integration charges Cash payments Non-cash charges Liability as of (3) (65) (12) – 1 – (1) 7 105 18 (18) (1) 16 (83) (14) December 29, 2012 $ 18 $ – $ 6 $ 24 Note 4 —  Property, Plant and Equipment and Intangible Assets Average Useful Life (Years) 2012 2011 2010 Property, plant and equipment, net Land and improvements 10–34 $ 1,890 $ 1,951 Buildings and improvements 15–44 7,792 7,565 Machinery and equipment, including fleet and software 5–15 24,743 23,798 Construction in progress Accumulated depreciation 1,737 1,826 36,162 35,140 (17,026) (15,442) $ 19,136 $ 19,698 Depreciation expense $ 2,489 $ 2,476 $2,124 2012 PEPSICO ANNUAL REPORT 81 Notes to Consolidated Financial Statements 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. Amortizable intangible assets, net Acquired franchise rights Reacquired franchise rights Brands Average Useful Life (Years) 56–60 1–14 5–40 Other identifiable intangibles 10–24 Amortization expense 2012 2011 2010 Gross Accumulated Amortization Net Gross Accumulated Amortization Net $ 931 $ (67) $ 864 $ 916 $ (42) $ 874 110 1,422 736 (68) (980) (303) $ 3,199 $ (1,418) 42 442 433 $ 1,781 $ 119 110 1,417 777 (47) (945) (298) $ 3,220 $ (1,332) 63 472 479 $ 1,888 $ 133 $ 117 Amortization of intangible assets for each of the next five years, based on existing intangible assets as of December 29, 2012 and using average 2012 foreign exchange rates, is expected to be as follows: Five-year projected amortization 2013 2014 2015 2016 2017 $110 $95 $86 $78 $72 Depreciable and amortizable assets are only 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 impair- ment, 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 revi- sion. For additional unaudited information on our policies for amortizable brands, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis. 82 2012 PEPSICO ANNUAL REPORT Notes to Consolidated Financial Statements Nonamortizable Intangible Assets Perpetual brands and goodwill are assessed for impairment at least annually. If the carrying amount of a perpetual brand exceeds its fair value, as determined by its discounted cash flows, an impairment loss is recognized in an amount equal to that excess. We did not recognize any impairment charges for goodwill in the years presented. We recorded impairment charges on certain brands in Europe of $23 million and $14 million in 2012 and 2011, respectively. The change in the book value of nonamortizable intangible assets is as follows: Balance, Beginning 2011 Acquisitions/ (Divestitures) Translation and Other Balance, End of 2011 Acquisitions/ (Divestitures) Translation and Other Balance, End of 2012 $ 313 $ –  $ $ 311 $ –  $ 5 $ 316 FLNA Goodwill Brands QFNA Goodwill LAF Goodwill Brands PAB Goodwill Reacquired franchise rights Acquired franchise rights Brands Other Europe(a) Goodwill Reacquired franchise rights Acquired franchise rights Brands AMEA Goodwill Brands Total goodwill Total reacquired franchise rights Total acquired franchise rights Total brands Total other 31 344 175 497 143 640 9,946 7,283 1,565 182 10 18,986 3,040 793 227 1,380 5,440 690 169 859 14,661 8,076 1,792 1,905 10 – – – 331 20 351 (27) 77 (1) (20) (9) 20 2,131 – – 3,114 5,245 – – – 2,435 77 (1) 3,114 (9) (2) (1) (3) 30 341 – 175 (35) (6) (41) 13 (18) (2) 6 (1) (2) (271) (61) (9) (316) (657) (1) 1 – (296) (79) (11) (316) (1) 793 157 950 9,932 7,342 1,562 168 – 19,004 4,900 732 218 4,178 10,028 689 170 859 16,800 8,074 1,780 4,703 – – – – (61) 75 14 23 (33) 9 – – (1) 78 – – (96) (18) (142) (24) (166) (102) (33) 9 (45) – 1 6 – (16) (9) (25) 33 28 2 (15) – 48 236 40 5 202 483 15 2 17 273 68 7 181 – 31 347 175 716 223 939 9,988 7,337 1,573 153 – 19,051 5,214 772 223 4,284 10,493 562 148 710 16,971 8,109 1,796 4,839 – (a) Net increase in 2011 relates primarily to our acquisition of WBD. $ 26,444 $ 5,616 $ (703) $ 31,357 $ (171) $ 529 $ 31,715 2012 PEPSICO ANNUAL REPORT 83 Notes to Consolidated Financial Statements Note 5 —  Income Taxes Income before income taxes U.S. Foreign Provision for income taxes Current: U.S. Federal Foreign State Deferred: U.S. Federal Foreign State Tax rate reconciliation U.S. Federal statutory tax rate State income tax, net of U.S. Federal tax benefit Lower taxes on foreign results Tax benefit related to tax court decision Acquisitions of PBG and PAS Other, net Annual tax rate Deferred tax liabilities Investments in noncontrolled 2012 2011 2010 $ 3,234 5,070 $ 8,304 $ 3,964 4,870 $ 8,834 $ 4,008 4,224 $ 8,232 $ 911 940 153 2,004 154 (95) 27 86 $ 2,090 $ 611 882 124 1,617 789 (88) 54 755 $ 2,372 $ 932 728 137 1,797 78 18 1 97 $ 1,894 35.0% 35.0% 35.0% 1.4 (6.9) 1.3 (8.7) 1.1 (9.4) (2.6) – (1.7) 25.2% – – (0.8) 26.8% – (3.1) (0.6) 23.0% affiliates $ 48 $ 41 Debt guarantee of wholly owned subsidiary Property, plant and equipment Intangible assets other than nondeductible goodwill Other Gross deferred tax liabilities Deferred tax assets Net carryforwards Stock-based compensation Retiree medical benefits Other employee-related benefits Pension benefits Deductible state tax and interest benefits Long-term debt obligations acquired Other Gross deferred tax assets Valuation allowances Deferred tax assets, net Net deferred tax liabilities 345 164 863 4,858 (1,233) 3,625 $ 4,323 828 2,424 4,388 260 7,948 1,378 378 411 672 647 828 2,466 4,297 184 7,816 1,373 429 504 695 545 339 223 822 4,930 (1,264) 3,666 $ 4,150 Deferred taxes included within: Assets: Prepaid expenses and other current assets $ 740 $ 845 Liabilities: Deferred income taxes $ 5,063 $ 4,995 Analysis of valuation allowances Balance, beginning of year Provision Other (deductions)/additions Balance, end of year $ 1,264 68 (99) $ 1,233 $ 875 464 (75) $ 1,264 $ 586 75 214 $ 875 84 2012 PEPSICO ANNUAL REPORT For additional unaudited information on our income tax poli- cies, including our reserves for income taxes, see “Our Critical Accounting Policies” in Management’s Discussion and Analysis. 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 jurisdic- tions and the related open tax audits are as follows: • U.S. —  during 2012, we received a favorable tax court deci- sion related to the classification of financial instruments. We continue to dispute three matters related to the 2003– 2007 audit cycle with the IRS Appeals Division. We are currently under audit for tax years 2008–2009; • Mexico —  audits have been completed for all taxable years through 2005. We are currently under audit for 2006–2008; • United Kingdom —  audits have been completed for all tax- able years through 2009; • Canada —  domestic audits have been substantially com- pleted for all taxable years through 2008. International audits have been completed for all taxable years through 2005; and • Russia —  audits have been substantially completed for all taxable years through 2008. We are currently under audit for 2009–2011. 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 resolu- tion of open tax issues, see “Other Consolidated Results” in Management’s Discussion and Analysis. We believe that it is reasonably possible that our reserves for uncertain tax positions could decrease by approximately $1.5  billion within the next twelve months as a result of the completion of audits in various jurisdictions, including the potential settlement with the IRS for the taxable years 2003–2009. As of December 29, 2012, the total gross amount of reserves for income taxes, reported in income taxes payable and other liabilities, was $2,425  million. Any prospective adjustments to these reserves will be recorded as an increase or decrease to our provision for income taxes and would impact our effective tax rate. In addition, we accrue interest related to Notes to Consolidated Financial Statements 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 $670  million as of December 29, 2012, of which $10 million was recognized in 2012. The gross amount of interest accrued, reported in other liabilities, was $660 million as of December 31, 2011, of which $90 million was recognized in 2011. A rollforward of our reserves for all federal, state and for- eign tax jurisdictions, is as follows: Balance, beginning of year 2012 2011 $ 2,167 $ 2,022 In 2012, certain executive officers were granted PepsiCo equity performance units (PEPUnits). These PEPUnits are earned based on achievement of a cumulative net income per- formance target and provide an opportunity to earn shares of PepsiCo common stock with a value that adjusts based upon absolute changes in PepsiCo’s stock price as well as PepsiCo’s Total Shareholder Return relative to the S&P 500 over a three- year performance period. The Company may use either authorized and unissued shares or repurchased common stock to meet share require- ments resulting from the exercise of stock options and the vesting of restricted stock awards. Additions for tax positions related to the current year 275 233 At year-end 2012, 124  million shares were available for Additions for tax positions from prior years 161 147 future stock-based compensation grants. Reductions for tax positions from prior years (172) (46) The following table summarizes our total stock-based com- Settlement payments Statute of limitations expiration Translation and other Balance, end of year (17) (156) (3) 14 (15) (18) $ 2,425 $ 2,167 Carryforwards and Allowances Operating loss carryforwards totaling $10.4 billion at year-end 2012 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operat- ing losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.2  billion in 2013, $8.2  billion between 2014 and 2032 and $2.0  billion may be carried forward indefinitely. We establish valuation allowances for our deferred tax assets if, based on the avail- able evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Undistributed International Earnings As of December 29, 2012, we had approximately $32.2 billion of undistributed international earnings. We intend to continue to reinvest earnings outside the U.S. for the foreseeable future and, therefore, have not recognized any U.S. tax expense on these earnings. Note 6 —  Stock-Based Compensation Our stock-based compensation program is designed to attract and retain employees while also aligning employees’ inter- ests with the interests of our shareholders. Stock options and restricted stock units (RSU) are granted to employees under the shareholder-approved 2007 Long-Term Incentive Plan (LTIP). pensation expense: Stock-based compensation expense Merger and integration charges Restructuring and impairment (benefits)/charges Total(a) Income tax benefits recognized in earnings related 2012 2011 2010 $ 278 $ 326 $ 299 2 13 53 (7) 4 – $ 273 $ 343 $ 352 to stock-based compensation $ 73 $ 101 $ 89 (a) $86 million recorded in 2010 was related to the unvested PBG/PAS acquisition- related grants. In connection with our acquisition of PBG in 2010, we issued 13.4 million stock options and 2.7 million RSUs at weighted- average grant prices of $42.89 and $62.30, respectively, to replace previously held PBG equity awards. In connection with our acquisition of PAS in 2010, we issued 0.4  million stock options at a weighted-average grant price of $31.72 to replace previously held PAS equity awards. Our equity issu- ances included 8.3 million stock options and 0.6 million RSUs which were vested at the acquisition date and were included in the purchase price. The remaining 5.5 million stock options and 2.1 million RSUs issued were unvested at the issuance date and are being amortized over their remaining vesting period, up to three years from the issuance date. As a result of our annual benefits review in 2010, the Company approved certain changes to our benefits pro- grams to remain market competitive relative to other leading global companies. These changes included ending the Company’s broad-based SharePower stock option pro- gram. Consequently, beginning in 2011, no new awards were granted under the SharePower program. Outstanding SharePower awards from 2010 and earlier continue to vest and are exercisable according to the terms and conditions of the program. See Note 7 for additional information regarding other related changes. 2012 PEPSICO ANNUAL REPORT 85 Notes to Consolidated Financial Statements Method of Accounting and Our Assumptions 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. In addition, we use the Monte-Carlo simulation option-pricing model to determine the fair value of market-based awards. The Monte-Carlo simulation option-pricing 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 awards with a market-based condition are recognized regardless of whether the market condition is satisfied, provided that the requisite service has been provided. All stock option grants have an exercise price equal to the fair market value of our common stock on the date of grant and gen- erally have a 10-year term. We do not backdate, reprice or grant stock-based compensation awards retroactively. Repricing of awards would require shareholder approval under the LTIP. The fair value of stock option grants is amortized to expense over the vesting period, generally 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. Executives who are awarded long-term incentives based on Our Stock Option Activity their performance are generally offered the choice of stock options or RSUs. Executives who elect RSUs receive one RSU for every four stock options that would have otherwise been granted. Senior officers do not have a choice and, through 2012, are granted 50% stock options and 50% performance- based RSUs. Our weighted-average Black-Scholes fair value assumptions are as follows: Expected life Risk-free interest rate Expected volatility Expected dividend yield 2012 2011 2010 6 years 6 years 5 years 1.3% 17% 3.0% 2.5% 16% 2.9% 2.3% 17% 2.8% 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 inter- est 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-based compensation activity for the year ended December 29, 2012 is presented below: Outstanding at December 31, 2011 Granted Exercised Forfeited/expired Outstanding at December 29, 2012 Exercisable at December 29, 2012 Expected to vest as of December 29, 2012 Options(a) 91,075 3,696 (23,585) (3,041) 68,145 48,366 19,432 Average Price(b) Average Life (years)(c) Aggregate Intrinsic Value(d) $ 55.92 $ 67.13 $ 47.33 $ 63.81 $ 59.15 $ 56.44 $ 65.79 5.04 4.45 7.85 $ 614,322 $ 567,761 $ 45,374 (a) Options are in thousands and include options previously granted under PBG, PAS and Quaker legacy plans. No additional options or shares may be granted under the PBG, PAS and Quaker plans. (b) Weighted-average exercise price. (c) Weighted-average contractual life remaining. (d) In thousands. 86 2012 PEPSICO ANNUAL REPORT Our RSU Activity Outstanding at December 31, 2011 Granted Converted Forfeited Outstanding at December 29, 2012 Expected to vest as of December 29, 2012 Notes to Consolidated Financial Statements Average Intrinsic Value(b) Average Life (years)(c) Aggregate Intrinsic Value(d) $62.96 $66.64 $57.76 $64.80 $65.60 $65.58 1.49 1.34 $815,051 $790,128 RSUs(a) 12,340 4,404 (3,436) (1,326) 11,982 11,616 (a) RSUs are in thousands and include RSUs previously granted under a PBG plan. No additional RSUs or shares may be granted under the PBG plan. (b) Weighted-average intrinsic value at grant date. (c) Weighted-average contractual life remaining. (d) In thousands. Our PEPUnit Activity Outstanding at December 31, 2011 Granted Converted Forfeited Outstanding at December 29, 2012 Expected to vest as of December 29, 2012 (a) PEPUnits are in thousands. (b) Weighted-average intrinsic value at grant date. (c) Weighted-average contractual life remaining. (d) In thousands. PEPUnits(a) Average Intrinsic Value(b) Average Life (years)(c) Aggregate Intrinsic Value(d) – 410 – (42) 368 334 $ – $ 64.85 $ – $ 64.51 $ 64.89 $ 64.85 2.26 2.26 $25,031 $22,721 Other Stock-Based Compensation Data Stock Options Weighted-average fair value of options granted $ 6.86 $ 7.79 $ 13.93 2012 2011 2010 Total intrinsic value of options exercised(a) RSUs Total number of RSUs granted(a) Weighted-average intrinsic value of RSUs granted Total intrinsic value of RSUs converted(a) PEPUnits Total number of PEPUnits granted(a) Weighted-average intrinsic $ 512,636 $ 385,678 $ 502,354 4,404 5,333 8,326 $ 66.64 $ 63.87 $ 65.01 $ 236,575 $ 173,433 $ 202,717 410 value of PEPUnits granted $ 64.85 Total intrinsic value of PEPUnits converted(a) (a) In thousands. – As of December 31, 2012, there was $389 million of total unrecognized compensation cost related to nonvested share- based compensation grants. This unrecognized compensation is expected to be recognized over a weighted-average period of two years. Note 7 —  Pension, Retiree Medical and Savings Plans Our pension plans cover certain full-time employees in the U.S. 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 medi- cal) 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 costs. 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, and from changes in our assumptions are determined at each measurement date. 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 expense for the following year based upon the average remaining service period of active plan participants, which is approximately 11 years for pension expense and approximately 8 years for retiree medical expense. The cost or benefit of plan changes that increase or decrease benefits for 2012 PEPSICO ANNUAL REPORT 87 Notes to Consolidated Financial Statements prior employee service (prior service cost/(credit)) is included in earnings on a straight-line basis over the average remaining service period of active plan participants. In connection with our acquisitions of PBG and PAS, we assumed sponsorship of pension and retiree medical plans that provide benefits to certain U.S. and international employ- ees. Subsequently, during 2010, we merged the pension plan assets of the legacy PBG and PAS U.S. pension plans with those of PepsiCo into one master trust. During 2010, the Compensation Committee of PepsiCo’s Board of Directors approved certain changes to the U.S. pen- sion and retiree medical plans, effective January  1, 2011. Pension plan design changes included implementing a new employer contribution to the 401(k) savings plan for all future salaried new hires of the Company, as salaried new hires are no longer eligible to participate in the defined benefit pension plan, as well as implementing a new defined benefit pen- sion formula for certain hourly new hires of the Company. Pension plan design changes also included implementing a new employer contribution to the 401(k) savings plan for certain legacy PBG and PAS salaried employees (as such employees are also not eligible to participate in the defined benefit pension plan), as well as implementing a new defined benefit pension formula for certain legacy PBG and PAS hourly employees. The retiree medical plan design change included phasing out Company subsidies of retiree medical benefits. As a result of these changes, we remeasured our pension and retiree medical expenses and liabilities in 2010, which resulted in a one-time pre-tax curtailment gain of $62 million included in retiree medical expenses. In the fourth quarter of 2012, the Company offered certain former employees who have vested benefits in our defined benefit pension plans the option of receiving a one-time lump sum payment equal to the present value of the participant’s pension benefit (payable in cash or rolled over into a quali- fied retirement plan or IRA). In December 2012, we made a discretionary contribution of $405  million to fund substan- tially all of these payments. The Company recorded a pre-tax non-cash settlement charge of $195  million ($131  million after-tax or $0.08 per share) as a result of this transaction. See “Items Affecting Comparability” in Management’s Discussion and Analysis. The provisions of both the PPACA and the Health Care and Education Reconciliation Act are reflected in our retiree medical expenses and liabilities and were not material to our financial statements. Selected financial information for our pension and retiree medical plans is as follows: Change in projected benefit liability Liability at beginning of year Acquisitions/(divestitures) Service cost Interest cost Plan amendments Participant contributions Experience loss/(gain) Benefit payments Settlement/curtailment Special termination benefits Foreign currency adjustment Other Liability at end of year Change in fair value of plan assets Fair value at beginning of year Acquisitions/(divestitures) Actual return on plan assets Employer contributions/funding Participant contributions Benefit payments Settlement Foreign currency adjustment Fair value at end of year Funded status 88 2012 PEPSICO ANNUAL REPORT Pension Retiree Medical U.S. International 2012 2011 2012 2011 2012 2011 $ 11,901 $ 9,851 $ 2,381 $ 2,142 $ 1,563 $ 1,770 – 407 534 15 – 932 (278) (633) 8 – – 11 350 547 21 – – 100 115 – 3 (63) 95 117 (16) 3 1,484 200 224 (414) (20) 71 – – (76) (40) 1 102 2 (69) (15) 1 (41) 3 – 50 65 – – – 51 88 3 – (63) (111) (239) (110) – 5 2 – – 1 (1) – $ 12,886 $ 11,901 $ 2,788 $ 2,381 $ 1,511 $ 1,563 $ 9,072 $ 8,870 $ 2,031 $ 1,896 $ 190 $ 190 – 1,282 1,368 – (278) (627) – 11 542 63 – (414) – – – 206 246 3 (76) (33) 86 (1) 79 – 35 – – 176 251 110 3 (69) (30) (23) – – (111) (110) – – – – $ 10,817 $ 9,072 $ (2,069) $ (2,829) $ 2,463 $ (325) $ 2,031 $ (350) $ 365 $ (1,146) $ 190 $ (1,373) Amounts recognized Other assets Other current liabilities Other liabilities Net amount recognized Notes to Consolidated Financial Statements Pension Retiree Medical U.S. International 2012 2011 2012 2011 2012 2011 $ – $ – $ 51 $ 55 $ – $ – (51) (91) (2,018) (2,738) $ (2,069) $ (2,829) (2) (374) $ (325) (1) (404) $ (350) (71) (1,075) (124) (1,249) $ (1,146) $ (1,373) Amounts included in accumulated other comprehensive loss (pre-tax) Net loss/(gain) Prior service cost/(credit) Total $ 4,212 $ 4,217 $ 1,096 $ 977 $ (44) $ 32 121 122 (3) (2) (92) (118) $ 4,333 $ 4,339 $ 1,093 $ 975 $ (136) $ (86) Components of the (decrease)/increase in net loss/(gain) included in accumulated other comprehensive loss Change in discount rate $ Employee-related assumption changes Liability-related experience different from assumptions Actual asset return different from expected return Amortization and settlement of losses Other, including foreign currency adjustments 776 135 66 (486) (451) (45) $ 1,710 $ 188 $ 302 $ 84 $ 115 (140) (85) 162 (147) (9) (2) 14 (60) (64) 43 (51) (27) 57 (55) (16) (67) (80) (13) – – (125) (210) 14 (12) (20) $ (76) $ (238) Total Liability at end of year for service to date $ (5) $ 1,491 $ 11,643 $ 11,205 $ 119 $ 2,323 $ 210 $ 1,921 The components of benefit expense are as follows: Components of benefit expense Service cost Interest cost Expected return on plan assets Amortization of prior service cost/(credit) Amortization of net loss Settlement/curtailment loss/(gain)(a) Special termination benefits Total $ 614 2012 U.S. 2011 Pension Retiree Medical International 2010 2012 2011 2010 2012 2011 2010 $ 407 $ 350 $ 299 $ 100 $ 95 $ 81 $ 50 $ 51 $ 54 534 (796) 17 259 421 185 8 547 (704) 14 145 352 (8) 71 $ 415 506 (643) 12 119 293 (2) 45 115 (146) 1 53 123 4 1 117 (136) 2 40 118 30 1 106 (123) 2 24 90 1 3 65 (22) (26) – 67 – 5 88 (14) (28) 12 109 – 1 93 (1) (22) 9 133 (62) 3 $ 336 $ 128 $ 149 $ 94 $ 72 $ 110 $ 74 (a) Includes pension lump sum settlement charge of $195 million in 2012. This charge is reflected in items affecting comparability (see “Items Affecting Comparability” in Management’s Discussion and Analysis). The estimated amounts to be amortized from accumulated other comprehensive loss into expense in 2013 for our pension and retiree medical plans are as follows: Net loss Prior service cost/(credit) Total Pension Retiree Medical U.S. $289 18 $307 International $ 68 1 $ 69 $ 1 (22) $ (21) 2012 PEPSICO ANNUAL REPORT 89 Notes to Consolidated Financial Statements The following table provides the weighted-average assumptions used to determine projected benefit liability and benefit expense for our pension and retiree medical plans: 2012 U.S. 2011 Pension Retiree Medical International 2010 2012 2011 2010 2012 2011 2010 Weighted-average assumptions Liability discount rate Expense discount rate 4.2% 4.6% 5.7% 4.4% 4.8% 5.5% 3.7% 4.4% 4.6% 5.7% 6.0% 4.8% 5.5% 6.0% 4.4% 5.2% Expected return on plan assets 7.8% 7.8% 7.8% 6.7% 6.7% 7.1% 7.8% 7.8% Liability rate of salary increases 3.7% 3.7% 4.1% 3.9% 4.1% Expense rate of salary increases 3.7% 4.1% 4.4% 4.1% 4.1% 4.1% 4.1% 5.2% 5.8% 7.8% The following table provides selected information about plans with liability for service to date and total benefit liability in excess of plan assets: Pension Retiree Medical U.S. International 2012 2011 2012 2011 2012 2011 Selected information for plans with liability for service to date in excess of plan assets Liability for service to date Fair value of plan assets $ (11,643) $ (11,205) $ (711) $ (471) $ 10,817 $ 9,072 $ 552 $ 344 Selected information for plans with projected benefit liability in excess of plan assets Benefit liability Fair value of plan assets $ (12,886) $ (11,901) $ (2,542) $ (2,191) $ (1,511) $ (1,563) $ 10,817 $ 9,072 $ 2,166 $ 1,786 $ 365 $ 190 Of the total projected pension benefit liability at year-end 2012, $761 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Future Benefit Payments and Funding Our estimated future benefit payments are as follows: Pension Retiree medical(a) 2013 $560 $120 2014 $570 $125 2015 $600 $125 2016 $650 $130 2017 $705 $130 2018–22 $ 4,465 $ 655 (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 $13 million for each of the years from 2013 through 2017 and approximately $90 million in total for 2018 through 2022. These future benefits to beneficiaries include payments from both funded and unfunded plans. In 2013, we expect to make pension and retiree medi- cal contributions of approximately $240  million, with up to approximately $17 million expected to be discretionary. Our contributions for retiree medical are estimated to be approxi- mately $70 million in 2013. 90 2012 PEPSICO ANNUAL REPORT Notes to Consolidated Financial Statements Plan Assets Pension Our pension plan investment strategy includes the use of actively managed securities and is reviewed periodically in conjunction with plan liabilities, an evaluation of market con- ditions, tolerance for risk and cash requirements for benefit payments. Our investment objective is to ensure that funds are available to meet the plans’ benefit obligations when they become due. Our overall investment strategy is to prudently invest plan assets in a well-diversified portfolio of equity and high-quality debt securities to achieve our long-term return expectations. Our investment policy also permits the use of derivative instruments which are primarily used to reduce risk. Our expected long-term rate of return on U.S. plan assets is 7.8%. Our target investment allocations are as follows: Fixed income U.S. equity International equity Real estate 2013 2012 40% 33% 22% 5% 40% 33% 22% 5% Actual investment allocations may vary from our target investment allocations due to prevailing market conditions. We regularly review our actual investment allocations and periodi- cally rebalance our investments to our target allocations. The expected return on pension plan assets is based on our pension plan 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 histori- cal 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 pension plan assets, our market-related value of assets for fixed income is the actual fair value. For all other asset categories, we use a method that recognizes invest- ment 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. Our pension contributions for 2012 were $1,614  million, of which $1,375 million was discretionary. Discretionary con- tributions included $405  million pertaining to pension lump sum payments. Retiree Medical In 2012 and 2011, we made non-discretionary contributions of $111  million and $110  million, respectively, to fund the payment of retiree medical claims. In 2012, we made a dis- cretionary contribution of $140  million to fund future U.S. retiree medical plan benefits. This contribution was invested consistently with the allocation of existing assets in the U.S. pension plan. Fair Value The guidance on fair value measurements defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The fair value framework requires the categorization of assets and liabilities into three levels based upon the assumptions (inputs) used to price the assets. Level 1 provides the most reliable measure of fair value, whereas Level 3 generally requires significant management judgment. 2012 PEPSICO ANNUAL REPORT 91 Notes to Consolidated Financial Statements Plan assets measured at fair value as of fiscal year-end 2012 and 2011 are categorized consistently by level in both years, and are as follows: U.S. plan assets* Equity securities: U.S. common stock(a) U.S. commingled funds(b) International common stock(a) International commingled fund(c) Preferred stock(d) Fixed income securities: Government securities(d) Corporate bonds(d)(e) Mortgage-backed securities(d) Other: Contracts with insurance companies(f) Real estate commingled funds(g) Cash and cash equivalents Sub-total U.S. plan assets Dividends and interest receivable Total U.S. plan assets International plan assets Equity securities: U.S. commingled funds(b) International commingled funds(c) Fixed income securities: Government securities(d) Corporate bonds(d) Fixed income commingled funds(h) Other: Contracts with insurance companies(f) Currency commingled funds(i) Real estate commingled fund(g) Cash and cash equivalents Sub-total international plan assets Dividends and interest receivable Total international plan assets Total Level 1 Level 2 Level 3 2012 2011 Total $ 626 $ 626 3,106 1,597 948 20 1,287 2,962 110 27 331 117 11,131 51 $ 11,182 $ 278 863 202 230 600 35 64 60 – 1,597 – – – – – – – 117 $ 2,340 $ – – – – – – – – 125 $ 125 125 2,457 6 $ 2,463 $ – 3,106 – 948 20 1,287 2,962 110 – – – $ 8,433 $ 278 863 202 230 600 – 64 – – $ – $ 514 – – – – – – – 27 331 – $ 358 3,003 1,089 776 19 1,032 2,653 24 24 – 78 9,212 50 $ 9,262 $ – – $ 246 729 – – – 35 – 60 – 171 196 530 30 52 56 16 2,026 5 $ 2,031 $ 2,237 $ 95 (a) Based on quoted market prices in active markets. (b) Based on the fair value of the investments owned by these funds that track various U.S. large, mid-cap and small company indices. Includes one large-cap fund that repre- sents 25% and 30%, respectively, of total U.S. plan assets for 2012 and 2011. (c) Based on the fair value of the investments owned by these funds that track various non-U.S. equity indices. (d) Based on quoted bid prices for comparable securities in the marketplace and broker/dealer quotes that are not observable. (e) Corporate bonds of U.S.-based companies represent 22% and 24%, respectively, of total U.S. plan assets for 2012 and 2011. (f ) Based on the fair value of the contracts as determined by the insurance companies using inputs that are not observable. (g) Based on the appraised value of the investments owned by these funds as determined by independent third parties using inputs that are not observable. (h) Based on the fair value of the investments owned by these funds that track various government and corporate bond indices. ( i ) Based on the fair value of the investments owned by these funds. Includes managed hedge funds that invest primarily in derivatives to reduce currency exposure.   * 2012 and 2011 amounts include $365 million and $190 million, respectively, of retiree medical plan assets that are restricted for purposes of providing health benefits for U.S. retirees and their beneficiaries. The change in Level 3 plan assets for 2012 is as follows: Real estate commingled funds Contracts with insurance companies Total 92 2012 PEPSICO ANNUAL REPORT Balance, End of 2011 Return on Assets Held at Year End Return on Assets Sold Purchases and Sales, Net Balance, End of 2012 $ 56 54 $ 110 $ 15 9 $ 24 $ 1 – $ 1 $ 319 (1) $ 318 $ 391 62 $ 453 Notes to Consolidated Financial Statements Retiree Medical Cost Trend Rates An average increase of 7% in the cost of covered retiree medi- cal benefits is assumed for 2013. This average increase is then projected to decline gradually to 5% in 2020 and thereafter. 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. In addition, as of January  1, 2011, the Company started phasing out Company subsidies of retiree medical benefits. A 1- percentage-point change in the assumed health care trend rate would have the following effects: 2012 Service and interest cost components 2012 Benefit liability 1% Increase 1% Decrease $ 4 $ 40 $ (4) $ (38) Savings Plan Certain U.S. employees are eligible to participate in 401(k) sav- ings plans, which are voluntary defined contribution plans. The plans are designed to help employees accumulate additional savings for retirement, and we make Company matching con- tributions on a portion of eligible pay based on years of service. In 2010, in connection with our acquisitions of PBG and PAS, we also made Company retirement contributions for certain employees on a portion of eligible pay based on years of service. As of January  1, 2011, a new employer contribution to the 401(k) savings plan became effective for certain eligible legacy PBG and PAS salaried employees as well as all eligible salaried new hires of PepsiCo who were not eligible to par- ticipate in the defined benefit pension plan as a result of plan design changes approved during 2010. In 2012 and 2011, our total Company contributions were $109 million and $144 mil- lion, respectively. As of February 2012, certain U.S. employees earning a benefit under one of our defined benefit pension plans were no longer eligible for the Company matching contributions on their 401(k) contributions. 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. Note 8 —  Related Party Transactions On February 26, 2010, we completed our acquisitions of PBG and PAS, at which time we gained control over their opera- tions and began to consolidate their results. See Notes 1 and 15 to our consolidated financial statements. Prior to these acquisitions, our significant related party transactions were with PBG and PAS as they represented our most significant noncontrolled bottling affiliates. In 2010, prior to the date of acquisition of PBG and PAS, we reflected the following related party transactions in our consolidated financial statements: net revenue of $993 million, cost of sales of $116 million and selling, general and administrative expenses of $6 million. As a result of these acquisitions, our related party transactions in 2011 and 2012 were not material. We also coordinate, on an aggregate basis, the contract negotiations of sweeteners and other raw material require- ments, including aluminum cans and plastic bottles and closures for certain of our independent bottlers. Once we have negotiated the contracts, the bottlers order and take deliv- ery directly from the supplier and pay the suppliers directly. Consequently, these transactions are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any non- payment by our bottlers, but we consider this exposure to be remote. In addition, our joint ventures with Unilever (under the Lipton brand name) and Starbucks sell finished goods (ready-to- drink teas and coffees) to our noncontrolled bottling affiliates. Consistent with accounting for equity method investments, our joint venture revenue is not included in our consolidated net revenue. In 2010, we repurchased $357  million (5.5  million shares) of PepsiCo stock from the master trust which holds assets of PepsiCo’s U.S. qualified pension plans at market value. Note 9 —  Debt Obligations and Commitments Short-term debt obligations Current maturities of long-term debt $ 2,901 $ 2,549 2012 2011 Commercial paper (0.1% and 0.1%) Other borrowings (7.4% and 7.6%) Long-term debt obligations Notes due 2012 (3.0%) Notes due 2013 (2.3%) Notes due 2014 (4.4% and 4.6%) Notes due 2015 (1.5% and 2.3%) Notes due 2016 (3.9%) Notes due 2017 (2.0% and 5.0%) Notes due 2018–2042 (4.4% and 4.8%) Other, due 2013–2020 (9.3% and 9.9%) Less: current maturities of long-term debt obligations Total 1,101 813 2,973 683 $ 4,815 $ 6,205 $ – $ 2,353 2,891 3,237 3,300 1,878 1,250 13,781 108 26,445 2,841 3,335 1,632 1,876 258 10,548 274 23,117 (2,901) (2,549) $ 23,544 $ 20,568 The interest rates in the above table reflect weighted-average rates at year-end. 2012 PEPSICO ANNUAL REPORT 93 Notes to Consolidated Financial Statements In 2012, we issued: • $750 million of 0.750% senior notes maturing in March 2015; • $900  million of 0.700% senior notes maturing in August 2015; • $1 billion of 1.250% senior notes maturing in August 2017; • $1.250  billion of 2.750% senior notes maturing in March 2022; • £500  million of 2.500% senior notes maturing in November 2022; • $750  million of 4.000% senior notes maturing in March 2042; and • $600  million of 3.600% senior notes maturing in August 2042. The net proceeds from the issuances of all the above notes were used for general corporate purposes, including the repayment of commercial paper. Long-Term Contractual Commitments(a) In the second quarter of 2012, we extended the termination date of our four-year unsecured revolving credit agreement (Four-Year Credit Agreement) from June 14, 2015 to June 14, 2016 and the termination date of our 364-day unsecured revolving credit agreement (364-Day Credit Agreement) from June  12, 2012 to June  11, 2013. Funds borrowed under the Four-Year Credit Agreement and the 364-Day Credit Agreement may be used for general corporate purposes of PepsiCo and its subsidiaries, including, but not limited to, working capital, capital investments and acquisitions. In addition, as of December  29, 2012, our international debt of $857 million related to borrowings from external par- ties 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. Long-term debt obligations(b) Interest on debt obligations(c) Operating leases Purchasing commitments(d) Marketing commitments(d) Payments Due by Period Total 2013 2014–2015 2016–2017 2018 and beyond $ 22,858 $ – $ 6,450 $ 3,105 $ 13,303 8,772 2,061 1,738 2,332 915 445 741 298 1,477 634 808 605 1,252 362 135 490 5,128 620 54 939 $ 37,761 $ 2,399 $ 9,974 $ 5,344 $ 20,044 (a) Based on year-end foreign exchange rates. (b) Excludes $2,901 million related to current maturities of long-term debt, $349 million related to the fair value step-up of debt acquired in connection with our acquisitions of PBG and PAS and $337 million related to the increase in carrying value of long-term debt representing the gains on our fair value interest rate swaps. (c) Interest payments on floating-rate debt are estimated using interest rates effective as of December 29, 2012. (d) Primarily reflects non-cancelable commitments as of December 29, 2012. Off-Balance-Sheet Arrangements It is not our business practice to enter into off-balance-sheet arrangements, other than in the normal course of business. See Note 8 to our consolidated financial statements regarding contracts related to certain of our bottlers. See “Our Liquidity and Capital Resources” in Management’s Discussion and Analysis for further unaudited information on our borrowings. Most long-term contractual commitments, except for our long-term debt obligations, are not recorded on our balance sheet. Operating leases primarily represent building leases. Non-cancelable purchasing commitments are primarily for packaging materials, oranges and orange juice, and sugar and other sweeteners. Non-cancelable marketing commit- ments are primarily for sports marketing. Bottler funding to independent bottlers is not reflected in our long-term con- tractual 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 because they do not represent expected future cash out- flows. See Note  7 to our consolidated financial statements for additional information regarding our pension and retiree medical obligations. 94 2012 PEPSICO ANNUAL REPORT Notes to Consolidated Financial Statements Note 10 —  Financial Instruments We are exposed to market risks arising from adverse changes in: • commodity prices, affecting the cost of our raw materials and energy; • foreign exchange risks and currency restrictions; and • interest rates. In the normal course of business, we manage these risks through a variety of strategies, including the use of deriva- tives. 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 com- modity, foreign exchange or interest risks are classified as operating activities. We classify both the earnings and cash flow impact from these derivatives consistent with the under- lying hedged item. See “Our Business Risks” in Management’s Discussion and Analysis for further unaudited information on our business risks. For cash flow hedges, changes in fair value are deferred in accumulated other comprehensive loss within common shareholders’ equity until the underlying hedged item is rec- ognized in net income. For fair value hedges, changes in fair value are recognized immediately in earnings, consistent with the underlying hedged item. Hedging transactions are limited to an underlying exposure. As a result, any change in the value of our derivative instruments would be substantially offset by an opposite change in the value of the underlying hedged items. Hedging ineffectiveness and a net earnings impact occur when the change in the value of the hedge does not offset the change in the value of the underlying hedged item. If the derivative instrument is terminated, we continue to defer the related gain or loss and then include it as a component of the cost of the underlying hedged item. Upon determination that the underlying hedged item will not be part of an actual transaction, we recognize the related gain or loss on the hedge in net income immediately. We also use derivatives that do not qualify for hedge accounting treatment. We account for such derivatives at market value with the resulting gains and losses reflected in our income statement. We do not use derivative instru- ments for trading or speculative purposes. We perform assessments of our counterparty credit risk regularly, includ- ing 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 deriva- tive 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 purchase orders, pricing agreements and derivatives. 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 com- modity purchases, primarily for agricultural products, metals and energy. For those derivatives that qualify for hedge accounting, any ineffectiveness is recorded immediately in corporate unallocated expenses. Ineffectiveness was not material for all periods presented. During the next 12 months, we expect to reclassify net losses of $12  million related to these hedges from accumulated other comprehensive loss into net income. Derivatives used to hedge commodity price risk that do not qualify for hedge accounting are marked to market each period and reflected in our income statement. Our open commodity derivative contracts that qualify for hedge accounting had a face value of $507  million as of December 29, 2012 and $598 million as of December 31, 2011. Our open commodity derivative contracts that do not qual- ify for hedge accounting had a face value of $853 million as of December 29, 2012 and $630 million as of December 31, 2011. Foreign Exchange Our operations outside of the U.S. generate 49% of our net revenue, with Russia, Mexico, Canada, the United Kingdom and Brazil comprising approximately 25% of our net revenue. As a result, we are exposed to foreign currency risks. Additionally, we are also exposed to foreign currency risk from 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 sup- pliers, 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 in our income statement as incurred. Our foreign currency derivatives had a total face value of $2.8  billion as of December  29, 2012 and $2.3  billion as of December 31, 2011. During the next 12 months, we expect to reclassify net losses of $14 million related to foreign currency contracts that qualify for hedge accounting from accumu- lated other comprehensive loss into net income. Additionally, 2012 PEPSICO ANNUAL REPORT 95 Notes to Consolidated Financial Statements ineffectiveness for our foreign currency hedges was not mate- rial for all periods presented. For foreign currency derivatives that do not qualify for hedge accounting treatment, all losses and gains were offset by changes in the underlying hedged items, resulting in no net material impact on earnings. Interest Rates We centrally manage our debt and investment portfolios con- sidering 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 has been swapped to floating rates. The notional amount, interest payment and maturity date of the interest rate and cross-currency 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 relat- ing to forecasted debt transactions. The notional amounts of the interest rate derivative instruments outstanding as of December  29, 2012 and December 31, 2011 were $8.1 billion and $8.3 billion, respec- tively. For those interest rate derivative instruments that qualify for cash flow hedge accounting, any ineffectiveness is recorded immediately. Ineffectiveness was not material for all periods presented. During the next 12 months, we expect to reclassify net losses of $23 million related to these hedges from accumulated other comprehensive loss into net income. As of December 29, 2012, approximately 27% of total debt, after the impact of the related interest rate derivative instru- ments, was exposed to variable rates, compared to 38% as of December 31, 2011. Fair Value Measurements The fair values of our financial assets and liabilities as of December 29, 2012 and December 31, 2011 are categorized as follows: Available-for-sale securities(b) Short-term investments —  index funds(c) Prepaid forward contracts(d) Deferred compensation(e) Derivatives designated as fair value hedging instruments: Interest rate derivatives(f) Derivatives designated as cash flow hedging instruments: Foreign exchange contracts(g) Interest rate derivatives(f) Commodity contracts(h) Derivatives not designated as hedging instruments: Foreign exchange contracts(g) Interest rate derivatives(f) Commodity contracts(h) Total derivatives at fair value Total 2012 2011 Assets(a) Liabilities(a) Assets(a) Liabilities(a) $ 79 $ 161 $ 33 $ – $ – $ – $ – $ 492 $ 59 $ 157 $ 40 $ – $ – $ – $ – $ 519 $ 276 $ – $ 300 $ – $ 5 6 8 $ 19 $ 8 123 40 $ 171 $ 466 $ 739 $ 19 – 24 $ 43 $ 6 153 45 $ 204 $ 247 $ 739 $ 25 – 3 $ 28 $ 17 107 10 $ 134 $ 462 $ 718 $ 5 69 78 $ 152 $ 20 141 62 $ 223 $ 375 $ 894 (a) Financial assets are classified on our balance sheet within prepaid expenses and other current assets and other assets, with the exception of available-for-sale securities and short-term investments, which are classified as short-term investments. Financial liabilities are classified on our balance sheet within accounts payable and other current liabilities and other liabilities. Unless specifically indicated, all financial assets and liabilities are categorized as Level 2 assets or liabilities. (b) Based on the price of common stock. Categorized as a Level 1 asset. (c) Based on price changes in index funds used to manage a portion of market risk arising from our deferred compensation liability. Categorized as a Level 1 asset. (d) Based primarily on the price of our common stock. (e) Based on the fair value of investments corresponding to employees’ investment elections. As of December 29, 2012 and December 31, 2011, $10 million and $44 million, respectively, are categorized as Level 1 liabilities. The remaining balances are categorized as Level 2 liabilities. (f ) Based on LIBOR forward rates and recently reported market transactions of spot and forward rates. (g) Based on recently reported market transactions of spot and forward rates. (h) Based on recently reported transactions in the marketplace, primarily swap arrangements. 96 2012 PEPSICO ANNUAL REPORT The effective portion of the pre-tax (gains)/losses on our derivative instruments are categorized in the table below. Notes to Consolidated Financial Statements Fair Value/ Non-designated Hedges Cash Flow Hedges (Gains)/Losses 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) 2012 $ (23) 17 (23) $ (29) 2011 $ 14 (113) 25 $ (74) 2012 $ 41 (2) 11 $ 50 2011 $ (9) 84 51 $ 126 2012 $ 8 19 63 $ 90 2011 $ 26 15 (36) $ 5 Foreign exchange contracts Interest rate derivatives Commodity contracts Total (a) Interest rate derivative losses are primarily from fair value hedges and are included in interest expense. These losses are substantially offset by decreases in the value of the underlying debt, which is also included in interest expense. All other gains/losses are from non-designated hedges and are included in corporate unallocated expenses. (b) Interest rate derivative losses are included in interest expense. All other gains/losses are primarily included in cost of sales. The carrying amounts of our cash and cash equivalents and short-term investments approximate fair value due to the short-term maturity. Short-term investments consist prin- cipally of short-term time deposits and index funds used to manage a portion of market risk arising from our deferred compensation liability. The fair value of our debt obligations as of December 29, 2012 and December 31, 2011 was $30.5 bil- lion and $29.8 billion, respectively, based upon prices of similar instruments in the marketplace. Note 11 —  Net Income Attributable to PepsiCo per Common Share Basic net income attributable to PepsiCo per common share is net income available for PepsiCo common shareholders divided by the weighted average of common shares outstanding during the period. Diluted net income attributable to PepsiCo per common share is calculated using the weighted average of common shares outstanding adjusted to include the effect that would occur if in-the-money employee stock options were exercised and RSUs and preferred shares were converted into common shares. Options to purchase 9.6 million shares in 2012, 25.9 million shares in 2011 and 24.4 million shares in 2010 were not included in the calculation of diluted earnings per common share because these options were out-of-the-money. Out-of-the- money options had average exercise prices of $67.64 in 2012, $66.99 in 2011 and $67.26 in 2010. The computations of basic and diluted net income attributable to PepsiCo per common share are as follows: 2012 2011 2010 Net income attributable to PepsiCo Preferred shares: Dividends Redemption premium Shares(a) Income $ 6,178 (1) (6) Net income available for PepsiCo common shareholders $ 6,171 1,557 Basic net income attributable to PepsiCo per common share $ 3.96 Net income available for PepsiCo common shareholders $ 6,171 1,557 Dilutive securities: Stock options and RSUs Employee Stock Ownership Plan (ESOP) convertible preferred stock Diluted – 7 17 1 $ 6,178 1,575 Diluted net income attributable to PepsiCo per common share $ 3.92 (a) Weighted-average common shares outstanding (in millions). Income $ 6,443 (1) (6) $ 6,436 $ 4.08 $ 6,436 – 7 $ 6,443 $ 4.03 Shares(a) 1,576 1,576 20 1 1,597 Income $ 6,320 (1) (5) $ 6,314 $ 3.97 $ 6,314 – 6 $ 6,320 $ 3.91 Shares(a) 1,590 1,590 23 1 1,614 2012 PEPSICO ANNUAL REPORT 97 Notes to Consolidated Financial Statements Note 12 —  Preferred Stock As of December 29, 2012 and December 31, 2011, there were 3 million shares of convertible preferred stock authorized. The preferred stock was issued for an ESOP established by Quaker and these shares are redeemable for common stock by the ESOP participants. The preferred stock accrues dividends at an annual rate of $5.46 per share. At year-end 2012 and 2011, there were 803,953 preferred shares issued and 186,553 and 206,653 shares outstanding, respectively. The outstanding preferred shares had a fair value of $63 million as of December 29, 2012 and $68 million as of December 31, 2011. Each share is convertible at the option of the holder into 4.9625 shares of common stock. The preferred shares may be called by us upon written notice at $78 per share plus accrued and unpaid dividends. Quaker made the final award to its ESOP plan in June 2001. Preferred stock Repurchased preferred stock Balance, beginning of year Redemptions Balance, end of year (a) In millions. 2012 2011 2010 Shares(a) Amount Shares(a) Amount Shares(a) Amount 0.8 0.6 – 0.6 $ 41 $ 157 7 $ 164 0.8 0.6 – 0.6 $ 41 $ 150 7 $ 157 0.8 0.6 – 0.6 $ 41 $ 145 5 $ 150 Note 13 —  Accumulated Other Comprehensive Loss Attributable to PepsiCo Note 14 —  Supplemental Financial Information Comprehensive income is a measure of income which includes both net income and other comprehensive income or loss. Other comprehensive income or loss results from items deferred from recognition into our income statement. Accumulated other comprehensive income or loss is separately presented on our balance sheet as part of common sharehold- ers’ equity. Other comprehensive income/(loss) attributable to PepsiCo was $742 million in 2012, $(2,599) million in 2011 and $164  million in 2010. The accumulated balances for each component of other comprehensive loss attributable to PepsiCo were as follows: Accounts receivable Trade receivables Other receivables Allowance, beginning of year Net amounts charged to expense Deductions(a) Other(b) 2012 2011 2010 $ 6,215 $ 6,036 983 7,198 157 28 (27) (1) 1,033 7,069 144 30 (41) 24 $ 90 12 (37) 79 Allowance, end of year 157 157 $ 144 Net receivables Inventories(c) Raw materials $ 7,041 $ 6,912 $ 1,875 $ 1,883 173 1,533 207 1,737 $ 3,581 $ 3,827 Currency translation adjustment $ (1,946) $ (2,688) $ (1,159) Finished goods Cash flow hedges, net of tax (94) (112) (38) 2012 2011 2010 Work-in-process Unamortized pension and retiree medical, net of tax(a) Unrealized gain on securities, net of tax Other (3,491) (3,419) (2,442) (a) Includes accounts written off. (b) Includes adjustments related to acquisitions, currency translation and other adjustments. 80 (36) 62 (72) 70 (61) (c) Approximately 3%, in both 2012 and 2011, of the inventory cost was computed using the LIFO method. The differences between LIFO and FIFO methods of valu- ing these inventories were not material. Accumulated other comprehensive loss attributable to PepsiCo $ (5,487) $ (6,229) $ (3,630) (a) Net of taxes of $1,832 million in 2012, $1,831 million in 2011 and $1,322 million in 2010. 98 2012 PEPSICO ANNUAL REPORT Notes to Consolidated Financial Statements Other assets Noncurrent notes and accounts receivable $ Deferred marketplace spending Pension plans Other investments(a) Other 2012 2011 136 195 62 718 542 $ 159 186 65 89 522 Accounts payable and other current liabilities Accounts payable Accrued marketplace spending Accrued compensation and benefits Dividends payable Other current liabilities $ 1,653 $ 1,021 $ 4,451 $ 4,083 2,187 1,705 838 2,722 2,105 1,771 813 2,985 $ 11,903 $ 11,757 (a) Net increase in 2012 primarily relates to our 5% indirect equity interest in Tingyi- Asahi Beverages Holding Co. Ltd. (TAB). 2012 2011 2010 Other supplemental information Rent expense Interest paid $ 581 $ 589 $ 526 $ 1,074 $ 1,039 $ 1,043 Income taxes paid, net of refunds $ 1,840 $ 2,218 $ 1,495 Note 15 —  Acquisitions and Divestitures PBG and PAS On February  26, 2010, we acquired PBG and PAS to create a more fully integrated supply chain and go-to-market busi- ness model, improving the effectiveness and efficiency of the distribution of our brands and enhancing our revenue growth. The total purchase price was approximately $12.6 bil- lion, which included $8.3 billion of cash and equity and the fair value of our previously held equity interests in PBG and PAS of $4.3  billion. The acquisitions were accounted for as busi- ness combinations, and, accordingly, the identifiable assets acquired and liabilities assumed were recorded at their esti- mated fair values at the date of acquisition. Our fair market valuations of the identifiable assets acquired and liabilities assumed were completed in the first quarter of 2011. WBD On February 3, 2011, we acquired the ordinary shares, includ- ing shares underlying ADSs and Global Depositary Shares (GDS), of WBD, a company incorporated in the Russian Federation, which represented in the aggregate approxi- mately 66% of WBD’s outstanding ordinary shares, pursuant to the purchase agreement dated December 1, 2010 between PepsiCo and certain selling shareholders of WBD for approxi- mately $3.8  billion in cash (or $2.4 billion, net of cash and cash equivalents acquired). The acquisition of those shares increased our total ownership to approximately 77%, giving us a controlling interest in WBD. Under the guidance on account- ing for business combinations, once a controlling interest is obtained, we were required to recognize and measure 100% of the identifiable assets acquired, liabilities assumed and noncontrolling interests at their full fair values. Our fair market valuations of the identifiable assets acquired and liabilities assumed were completed in the first quarter of 2012 and the final valuations did not materially differ from those fair values reported as of December 31, 2011. On March 10, 2011, we commenced tender offers in Russia and the U.S. for all remaining outstanding ordinary shares and  ADSs of WBD for 3,883.70 Russian rubles per ordinary share and 970.925 Russian rubles per ADS, respectively. The Russian offer was made to all holders of ordinary shares and the U.S. offer was made to all holders of ADSs. We com- pleted the Russian offer on May 19, 2011 and the U.S. offer on May 16, 2011. After completion of the offers, we paid approxi- mately $1.3 billion for WBD’s ordinary shares (including shares underlying ADSs) and increased our total ownership of WBD to approximately 98.6%. On June 30, 2011, we elected to exercise our squeeze-out rights under Russian law with respect to all remaining WBD ordinary shares not already owned by us. Therefore, under Russian law, all remaining WBD shareholders were required to sell their ordinary shares (including those underlying ADSs) to us at the same price that was offered to WBD shareholders in the Russian tender offer. Accordingly, all registered holders of ordinary shares on August  15, 2011 (including the ADSs depositary) received 3,883.70 Russian rubles per ordinary share. After completion of the squeeze-out in September 2011, we paid approximately $79 million for WBD’s ordinary shares (including shares underlying ADSs) and increased our total ownership to 100% of WBD. Tingyi-Asahi Beverages Holding Co. Ltd. On March 31, 2012, we completed a transaction with Tingyi. Under the terms of the agreement, we contributed our com- pany-owned and joint venture bottling operations in China to Tingyi’s beverage subsidiary, TAB, and received as consider- ation a 5% indirect equity interest in TAB. As a result of this transaction, TAB is now our franchise bottler in China. We also have a call option to increase our indirect holding in TAB to 20% by 2015. We recorded restructuring and other charges of $150  million ($176  million after-tax or $0.11 per share), primarily consisting of employee-related charges, in our 2012 results. This charge is reflected in items affecting compara- bility. See “Items Affecting Comparability” in Management’s Discussion and Analysis. 2012 PEPSICO ANNUAL REPORT 99 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 sustained growth, through empowered people, operating with respon- sibility 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 con- sistently 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 objec- tivity 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. The system is designed to provide reasonable assurance that transac- tions are executed as authorized and accurately recorded; that assets are safeguarded; and that accounting records are sufficiently reliable to permit the preparation of finan- cial statements that conform in all material respects with accounting principles generally accepted in the U.S. We main- tain disclosure controls and procedures designed to ensure that information required to be disclosed in reports under the Securities Exchange Act of 1934 is recorded, processed, sum- marized 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. 100 2012 PEPSICO ANNUAL REPORT 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 poli- cies, financial reporting and internal control matters with them and encourage their direct communication with KPMG LLP, with our General Auditor, and with our General Counsel. We also have a Compliance & Ethics Department, led by our Chief Compliance & Ethics Officer, to coordinate our compliance policies and practices. Providing investors with financial results that are complete, transparent and understandable. The consolidated financial statements and financial infor- mation included in this report are the responsibility of management. This includes preparing the financial statements in accordance with accounting principles generally accepted in the U.S., 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 ethi- cal 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 21, 2013 Marie T. Gallagher Senior Vice President and Controller Hugh F. Johnston Chief Financial Officer Indra K. Nooyi Chairman of the Board of Directors and Chief Executive Officer Management’s Report on Internal Control Over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial report- ing, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effective- ness of our internal control over financial reporting based upon the framework in Internal Control —  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our man- agement concluded that our internal control over financial reporting was effective as of December 29, 2012. KPMG LLP, an independent registered public account- ing firm, has audited the consolidated financial statements included in this Annual Report and, as part of their audit, has issued their report, included herein, on the effectiveness of our internal control over financial reporting. During our fourth fiscal quarter of 2012, we continued migrating certain of our financial processing systems to an enterprise-wide systems solution. These systems implemen- tations are part of our ongoing global business transformation initiative, and we plan to continue implementing such systems throughout other parts of our businesses over the course of the next few years. Moreover, we continue to integrate our WBD business, which was acquired in 2011. In connection with these implementations and integration, and resulting business process changes, we continue to enhance the design and documentation of our internal control over financial reporting processes to maintain suitable controls over our financial reporting. Except as described above, there were no changes in our internal control over financial reporting during our fourth fiscal quarter of 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. February 21, 2013 Marie T. Gallagher Senior Vice President and Controller Hugh F. Johnston Chief Financial Officer Indra K. Nooyi Chairman of the Board of Directors and Chief Executive Officer 2012 PEPSICO ANNUAL REPORT 101 Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders PepsiCo, Inc.: We have audited the accompanying Consolidated Balance Sheets of PepsiCo, Inc. and subsidiaries (“PepsiCo, Inc.” or “the Company”) as of December 29, 2012 and December 31, 2011, 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, 2012. We also have audited PepsiCo, Inc.’s internal control over financial reporting as of December 29, 2012, based on criteria established in Internal Control —  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). PepsiCo, Inc.’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 finan- cial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the con- solidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluat- ing the overall financial statement presentation. 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 test- ing 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. 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 poli- cies 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 com- pany; (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 com- pany are being made only in accordance with authorizations of management and directors of the company; and (3) pro- vide 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 inad- equate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PepsiCo, Inc. as of December  29, 2012 and December 31, 2011, and the results of its operations and its cash flows for each of the fiscal years in the three-year period ended December  29, 2012, in conformity with U.S. generally accepted accounting principles. Also in our opinion, PepsiCo, Inc. maintained, in all material respects, effective internal control over financial reporting as of December  29, 2012, based on criteria established in Internal Control —  Integrated Framework issued by COSO. New York, New York February 21, 2013 102 2012 PEPSICO ANNUAL REPORT Selected Financial Data 2012 2011 (in millions except per share amounts, unaudited) First Quarter Second Quarter Third Quarter Fourth Quarter First Quarter Second Quarter Third Quarter Fourth Quarter Net revenue $ 12,428 $ 16,458 $ 16,652 $ 19,954 $ 11,937 $ 16,827 $ 17,582 $ 20,158 Gross profit Mark-to-market net impact(a) Merger and integration charges(b) Restructuring and impairment charges(c) Restructuring and other charges related to the transaction with Tingyi(d) Pension lump sum settlement charge(e) Tax benefit related to tax court decision(f) 53rd week(g) Inventory fair value adjustments(h) $ 6,539 $ 8,543 $ 8,819 $ 10,300 $ 6,490 $ 8,864 $ 9,130 $ 10,427 $ $ $ (84) 2 33 $ $ $ 79 $ (121) 3 77 $ $ 2 83 – – – – – $ 137 – – – – – – – – – $ $ $ $ $ 61 9 86 13 195 $ (217) – – $ $ (31) 55 $ $ 9 58 $ $ 53 61 – – – – – $ 34 $ – – – – – 4 $ – – – – – 3 $ 71 $ 155 $ 383 – – – $ $ (94) 5 Net income attributable to PepsiCo $ 1,127 $ 1,488 $ 1,902 $ 1,661 $ 1,143 $ 1,885 $ 2,000 $ 1,415 Net income attributable to PepsiCo per common share —  basic $ 0.72 $ 0.95 $ 1.22 $ 1.07 $ 0.72 $ 1.19 $ 1.27 $ 0.90 Net income attributable to PepsiCo per common share —  diluted $ 0.71 $ 0.94 $ 1.21 $ 1.06 $ 0.71 $ 1.17 $ 1.25 $ 0.89 Cash dividends declared per common share Stock price per share(i) $ 0.515 $ 0.5375 $ 0.5375 $ 0.5375 $ 0.48 $ 0.515 $ 0.515 $ 0.515 High Low Close $ 67.19 $ 69.74 $ 73.66 $ 72.09 $ 67.46 $ 71.89 $ 70.75 $ 66.78 $ 62.15 $ 64.64 $ 68.10 $ 67.72 $ 62.05 $ 63.50 $ 60.10 $ 58.50 $ 65.30 $ 69.48 $ 72.10 $ 68.02 $ 63.24 $ 68.69 $ 63.30 $ 66.35 (a) In 2012, we recognized $65 million ($41 million after-tax or $0.03 per share) of mark-to-market net gains on commodity hedges in corporate unallocated expenses. In 2011, we recognized $102 million ($71 million after-tax or $0.04 per share) of mark-to-market net losses on commodity hedges in corporate unallocated expenses. (b) In 2012, we incurred merger and integration charges of $16 million ($12 million after-tax or $0.01 per share) related to our acquisition of WBD. In 2011, we incurred merger and integration charges of $329 million ($271 million after-tax or $0.17 per share) related to our acquisitions of PBG, PAS and WBD. See Note 3 to our consolidated finan- cial statements. (c) In 2012, restructuring and impairment charges were $279 million ($215 million after-tax or $0.14 per share). Restructuring and impairment charges in 2011 were $383 mil- lion ($286 million after-tax or $0.18 per share). See Note 3 to our consolidated financial statements. (d) In 2012, we recorded restructuring and other charges of $150 million ($176 million after-tax or $0.11 per share) related to the transaction with Tingyi. See Note 15 to our consolidated financial statements. (e) In 2012, we recorded a pension lump sum settlement charge of $195 million ($131 million after-tax or $0.08 per share). See Note 7 to our consolidated financial statements. (f ) In 2012, we recognized a non-cash tax benefit of $217 million ($0.14 per share) associated with a favorable tax court decision related to the classification of financial instruments. See Note 5 to our consolidated financial statements. (g) The 2011 fiscal year consisted of fifty-three weeks compared to fifty-two weeks in our normal fiscal year. The 53rd week increased 2011 net revenue by $623 million, gross profit by $358 million, pre-tax income by $94 million and net income attributable to PepsiCo by $64 million or $0.04 per share. (h) In 2011, we recorded $46 million ($28 million after-tax or $0.02 per share) of incremental costs related to fair value adjustments to the acquired inventory included in WBD’s balance sheet at the acquisition date and hedging contracts included in PBG’s and PAS’s balance sheets at the acquisition date. See Note 15 to our consolidated financial statements. ( i ) Represents the composite high and low sales price and quarterly closing prices for one share of PepsiCo common stock. 2012 PEPSICO ANNUAL REPORT 103 Five-Year Summary (unaudited) Net revenue 2012 2011 2010 2009 2008 $ 65,492 $ 66,504 $ 57,838 $ 43,232 $ 43,251 Net income attributable to PepsiCo $ 6,178 $ 6,443 $ 6,320 $ 5,946 $ 5,142 Net income attributable to PepsiCo per common share —  basic $ 3.96 $ 4.08 $ 3.97 $ 3.81 $ 3.26 Net income attributable to PepsiCo per common share —  diluted $ 3.92 $ 4.03 $ 3.91 $ 3.77 $ 3.21 Cash dividends declared per common share $ 2.1275 $ 2.025 $ 1.89 $ 1.775 $ 1.65 Total assets Long-term debt Return on invested capital(a) $ 74,638 $ 72,882 $ 68,153 $ 39,848 $ 35,994 $ 23,544 $ 20,568 $ 19,999 $ 7,400 $ 7,858 13.7% 14.3% 17.0% 27.5% 24.0% (a) Return on invested capital is defined as adjusted net income attributable to PepsiCo divided by the sum of average common shareholders’ equity and average total debt. Adjusted net income attributable to PepsiCo is defined as net income attributable to PepsiCo plus interest expense after-tax. Interest expense after-tax was $576 million in 2012, $548 million in 2011, $578 million in 2010, $254 million in 2009 and $210 million in 2008. • Includes mark-to-market net (gains)/losses of: Pre-tax After-tax Per share 2012 $ (65) $ (41) $ (0.03) 2011 $ 102 $ 71 $ 0.04 2010 $ (91) $ (58) $ (0.04) 2009 $ (274) $ (173) $ (0.11) • • In 2012, we incurred merger and integration charges of $16 million ($12 million after-tax or $0.01 per share) related to our acquisition of WBD. Includes restructuring and impairment charges of: Pre-tax After-tax Per share 2012 $ 279 $ 215 $ 0.14 2011 $ 383 $ 286 $ 0.18 2009 $ 36 $ 29 $ 0.02 2008 $ 346 $ 223 $ 0.14 2008 $ 543 $ 408 $ 0.25 • • • In 2012, we recorded restructuring and other charges of $150 million ($176 million after-tax or $0.11 per share) related to the transaction with Tingyi. In 2012, we recorded a pension lump sum settlement charge of $195 million ($131 million after-tax or $0.08 per share). In 2012, we recognized a non-cash tax benefit of $217  million ($0.14 per share) associated with a favorable tax court decision related to the classification of finan- cial instruments. In 2011, we incurred merger and integration charges of $329 million ($271 million after-tax or $0.17 per share) related to our acquisitions of PBG, PAS and WBD. • • The 2011 fiscal year consisted of fifty-three weeks compared to fifty-two weeks in our normal fiscal year. The 53rd week increased 2011 net revenue by $623 million and net income attributable to PepsiCo by $64 million or $0.04 per share. In 2011, we recorded $46 million ($28 million after-tax or $0.02 per share) of incremental costs related to fair value adjustments to the acquired inventory included in WBD’s balance sheet at the acquisition date and hedging contracts included in PBG’s and PAS’s balance sheets at the acquisition date. In 2010, we incurred merger and integration charges of $799 million related to our acquisitions of PBG and PAS, as well as advisory fees in connection with our acquisition of WBD. In addition, we recorded $9 million of merger-related charges, representing our share of the respective merger costs of PBG and PAS. In total, these costs had an after-tax impact of $648 million or $0.40 per share. In 2010, we recorded $398 million ($333 million after-tax or $0.21 per share) of incremental costs related to fair value adjustments to the acquired inventory and other related hedging contracts included in PBG’s and PAS’s balance sheets at the acquisition date. In 2010, in connection with our acquisitions of PBG and PAS, we recorded a gain on our previously held equity interests of $958 million ($0.60 per share), comprising $735 million which was non-taxable and recorded in bottling equity income and $223 million related to the reversal of deferred tax liabilities associated with these previ- ously held equity interests. In 2010, we recorded a $120 million net charge ($120 million after-tax or $0.07 per share) related to our change to hyperinflationary accounting for our Venezuelan busi- nesses and the related devaluation of the bolivar. In 2010, we recorded a $145 million charge ($92 million after-tax or $0.06 per share) related to a change in scope of one release in our ongoing migration to SAP software. In 2010, we made a $100 million ($64 million after-tax or $0.04 per share) contribution to the PepsiCo Foundation Inc., in order to fund charitable and social programs over the next several years. In 2010, we paid $672 million in a cash tender offer to repurchase $500 million (aggregate principal amount) of our 7.90% senior unsecured notes maturing in 2018. As a result of this debt repurchase, we recorded a $178 million charge to interest expense ($114 million after-tax or $0.07 per share), primarily representing the premium paid in the tender offer. In 2009, we recognized $50 million of merger-related charges related to our acquisitions of PBG and PAS, as well as an additional $11 million of costs in bottling equity income representing our share of the respective merger costs of PBG and PAS. In total, these costs had an after-tax impact of $44 million or $0.03 per share. In 2008, we recognized $138 million ($114 million after-tax or $0.07 per share) of our share of PBG’s restructuring and impairment charges. • • • • • • • • • • 104 2012 PEPSICO ANNUAL REPORT Reconciliation of GAAP and Non- GAAP Information Core results, core constant currency results and division oper- ating profit are non-GAAP financial measures as they exclude certain items noted below. However, we believe investors should consider these measures as they are more indicative of our ongoing performance and with how management evalu- ates our operational results and trends. Commodity Mark-to-Market Net Impact In the year ended December  29, 2012, we recognized $65  million of mark-to-market net gains on commodity hedges in corporate unallocated expenses. In the year ended December  31, 2011, we recognized $102  million of mark- to-market net losses on commodity hedges in corporate unallocated expenses. We centrally manage commodity deriv- atives on behalf of our divisions. These commodity derivatives include agricultural products, metals and energy. 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 unallo- cated expenses. These gains and losses are subsequently reflected in division results when the divisions take delivery of the underlying commodity. Merger and Integration Charges In the year ended December 29, 2012, we incurred merger and integration charges of $16 million related to our acquisition of WBD, including $11  million recorded in the Europe segment and $5 million recorded in interest expense. In the year ended December  31, 2011, we incurred merger and integration charges of $329 million related to our acquisitions of PBG, PAS and WBD, including $112 million recorded in the PAB segment, $123  million recorded in the Europe segment, $78  million recorded in corporate unallocated expenses and $16  million recorded in interest expense. These charges also include clos- ing costs and advisory fees related to our acquisition of WBD. Restructuring and Impairment Charges In the year ended December 29, 2012, we incurred restructur- ing charges of $279 million, in conjunction with our multi-year productivity plan (Productivity Plan), including $38  million recorded in the FLNA segment, $9  million recorded in the QFNA segment, $50  million recorded in the LAF segment, $102 million recorded in the PAB segment, $42 million recorded in the Europe segment, $28  million recorded in the AMEA segment and $10  million recorded in corporate unallocated expenses. In the year ended December 31, 2011, we incurred restructuring charges of $383 million in conjunction with our Productivity Plan, including $76 million recorded in the FLNA segment, $18 million recorded in the QFNA segment, $48 mil- lion recorded in the LAF segment, $81 million recorded in the PAB segment, $77  million recorded in the Europe segment, $9  million recorded in the AMEA segment and $74  million recorded in corporate unallocated expenses. The Productivity Plan includes actions in every aspect of our business that we believe will strengthen our complementary food, snack and bev- erage businesses by leveraging new technologies and processes across PepsiCo’s operations, go-to-market and information systems; heightening the focus on best practice sharing across the globe; consolidating manufacturing, warehouse and sales facilities; and implementing simplified organization structures, with wider spans of control and fewer layers of management. Restructuring and Other Charges Related to the Transaction with Tingyi In the year ended December 29, 2012, we recorded restruc- turing and other charges $150 million in the AMEA segment related to the transaction with Tingyi. Pension Lump Sum Settlement Charge In the year ended December 29, 2012, we recorded a pension lump sum settlement charge of $195 million. Tax Benefit Related to Tax Court Decision In the year ended December  29, 2012, we recognized  a non-cash tax benefit of $217 million associated with a favor- able tax court decision related to the classification of financial instruments. 53rd Week Impact In 2011, we had an extra reporting week (53rd week). Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. The 53rd week increased net revenue by $623  mil- lion and operating profit by $109  million in the year ended December 31, 2011. Inventory Fair Value Adjustments In the year ended December 31, 2011, we recorded $46 million of incremental costs in cost of sales related to fair value adjust- ments to the acquired inventory included in WBD’s balance sheet at the acquisition date and hedging contracts included in PBG’s and PAS’s balance sheets at the acquisition date. Management Operating Cash Flow (Excluding Certain Items) Additionally, management operating cash flow (excluding the items noted in the Net Cash Provided by Operating Activities Reconciliation table) is the primary measure management uses to monitor cash flow performance. This is not a measure defined by GAAP. 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 2012 PEPSICO ANNUAL REPORT 105 (269) (309) Reported Diluted EPS $ 3.92 $ 4.03 (3)% Total Reported Operating Profit $ 9,112 $ 9,633 (5)% Pension Lump Sum Settlement Charge Net Income Attributable to PepsiCo Reconciliation Reported Net Income Attributable to PepsiCo $6,178 $6,443 (4)% Year Ended 12/29/12 12/31/11 Growth Mark-to-Market Net Impact Merger and Integration Charges Restructuring and Impairment Charges Restructuring and Other Charges Related to the Transaction with Tingyi Pension Lump Sum Settlement Charge Tax Benefit Related to Tax Court (41) 12 215 176 131 (217) – – 71 271 286 – – – (64) 28 Inventory Fair Value Adjustments Core Net Income Attributable to PepsiCo $6,454 $7,035 (8)% Diluted EPS Reconciliation Year Ended 12/29/12 12/31/11 Growth Mark-to-Market Net Impact Merger and Integration Charges Restructuring and Impairment Charges Restructuring and Other Charges Related to the Transaction with Tingyi Tax Benefit Related to Tax Court Decision 53rd Week Inventory Fair Value Adjustments (0.03) 0.01 0.04 0.17 0.14 0.18 0.11 0.08 (0.14) – – – – – (0.04) 0.02 Core Diluted EPS $ 4.10 $ 4.40 (7)% Reconciliation of GAAP and Non- GAAP Information (continued) of cash. As such, we believe investors should also consider net capital spending when evaluating our cash from operat- ing activities. Additionally, we consider certain other items (included in the Net Cash Provided by Operating Activities Reconciliation table) in evaluating management operating cash flow which we believe investors should consider in evaluating our management operating cash flow results. Net Revenue Reconciliation Reported Net Revenue $65,492 $66,504 (1.5)% Year Ended 12/29/12 12/31/11 Growth 53rd Week Core Net Revenue – (623) $65,492 $65,881 (1)% Decision 53rd Week Division Operating Profit Reconciliation Year Ended 12/29/12 12/31/11 Growth Core Division Operating Profit $ 10,844 $ 11,329 (4)% Merger and Integration Charges (11) (235) Restructuring and Impairment Charges Restructuring and Other Charges Related to the Transaction with Tingyi 53rd Week Inventory Fair Value Adjustments (150) – – – 127 (46) Division Operating Profit 10,414 10,866 Impact of Corporate Unallocated (1,302) (1,233) Total Operating Profit Reconciliation Reported Operating Profit $ 9,112 $ 9,633 (5)% Year Ended 12/29/12 12/31/11 Growth Mark-to-Market Net Impact Merger and Integration Charges Restructuring and Impairment Charges Restructuring and Other Charges Related to the Transaction with Tingyi (65) 11 102 313 279 383 150 – – Pension Lump Sum Settlement Charge 195 53rd Week Inventory Fair Value Adjustments – – (109) 46 Core Operating Profit $ 9,682 $ 10,368 (7)% 106 2012 PEPSICO ANNUAL REPORT Net Cash Provided by Operating Activities Reconciliation Return on Invested Capital (ROIC) Reconciliation Net Cash Provided by Operating Activities Capital Spending Sales of Property, Plant and Equipment Year Ended 12/29/12 12/31/11 Growth Reported ROIC Impact of Cash, Cash Equivalents and Short-Term $ 8,479 $ 8,944 (5)% (2,714) (3,339) Investments Core Net ROIC 95 84 Note: The impact of all other reconciling items to reported ROIC round to zero. Management Operating Cash Flow 5,860 5,689 3% Discretionary Pension and Retiree Medical Contributions (after-tax) 1,051 44 Return on Equity (ROE) Reconciliation Year Ended 12/29/12 14% 1 15% Year Ended 12/29/12 29% (1) 28% Merger and Integration Payments (after-tax) Payments Related to Restructuring 63 283 Charges (after-tax) 260 21 Capital Investments Related to the PBG/PAS Integration 10 108 Capital Investments Related to the Productivity Plan 26 Payments for Restructuring and Other Charges Related to the Transaction with Tingyi Management Operating Cash Flow 117 – – excluding above Items $ 7,387 $ 6,145 20% Cumulative Total Shareholder Return Return on PepsiCo stock investment (including dividends), the S&P 500 and the S&P Average of Industry Groups* in U.S. dollars 150 100 50 2007 2008 2009 2010 2011 2012  PepsiCo, Inc.    S&P 500®    S&P® Avg. of Industry Groups* Reported ROE Certain Other Items* Core ROE * Certain Other Items includes the items affecting comparability (See “Items Affecting Comparability” on pages 54–56). The impact of these reconciling items to reported ROE rounds to zero. Note: Certain amounts above may not sum due to rounding. PepsiCo, Inc. S&P 500® S&P® Avg. of Industry 12/07 12/08 12/09 12/10 12/11 12/12 $100 $100 $74 $63 $ 85 $ 80 $ 94 $ 92 $ 98 $ 94 $105 $109 Groups* $100 $82 $100 $117 $132 $143 *  The S&P Average of Industry Groups is derived by weighting the returns of two applicable S&P Industry Groups (Non-Alcoholic Beverages and Food) by PepsiCo’s sales in its beverages and foods businesses. The return for PepsiCo, the S&P 500 and the S&P Average indices are calculated through December 31, 2012. 2012 PEPSICO ANNUAL REPORT 107 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. 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 hedg- ing instruments and hedged items is highly effective, and only prospectively from the date a hedging relationship is formally documented. Bottler funding: financial incentives we give to our indepen- dent bottlers to assist in the distribution and promotion of our beverage products. Independent bottlers: customers to whom we have granted exclusive contracts to sell and manufacture certain beverage products bearing our trademarks within a specific geographi- cal area. 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. Management operating cash flow: net cash provided by operating activities less capital spending plus sales of prop- erty, plant and equipment. Mark-to-market net gain or loss or impact: change in market value for commodity 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 recently reported transactions in the marketplace. Organic: a measure that adjusts for impacts of acquisitions, divestitures and other structural changes and foreign exchange translation. This measure also excludes the impact of an extra reporting week in 2011. 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. Derivatives: financial instruments, such as futures, swaps, Treasury locks, cross currency swaps, options and forward contracts that we use to manage our risk arising from changes in commodity prices, interest rates, foreign exchange rates and stock prices. 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. 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. 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. 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. 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. 108 2012 PEPSICO ANNUAL REPORT Common Stock Information Stock Trading Symbol — PEP Stock Exchange Listings The New York Stock Exchange is the prin- cipal market for PepsiCo common stock, which is also listed on the Chicago and Swiss Stock Exchanges. Shareholders As of February  13, 2013, there were approximately 152,290 shareholders of record. Dividend Policy Dividends are usually declared in late January or early February, May, July and November and paid at the end of March, June and September and the beginning of January. The dividend record dates for these payments are, subject to approval by the Board of Directors, expected to be March  1, June  7, September  6 and December 6, 2013. We have paid consecu- tive quarterly cash dividends since 1965. Stock Performance PepsiCo was formed through the 1965 merger of Pepsi-Cola Company and Frito- Lay, Inc. A $1,000 investment in our stock made on December  31, 2007 was worth about $1,046 on December  31, 2012, assuming the reinvestment of dividends into PepsiCo stock. This performance rep- resents a compounded annual growth rate of 0.9 percent. Year-end Market Price of Stock Based on calendar year end (in $) 80 60 40 20 0 08 09 10 11 12 Shareholder Information Annual Meeting The Annual Meeting of Shareholders will be held at the North Carolina History Center at Tryon Palace, 529 South Front Street, New Bern, North Carolina, on Wednesday, May  1, 2013, at 9:00 a.m. local time. Proxies for the meeting will be solicited by an independent proxy solicitor. This annual report is not part of the proxy solicitation. Inquiries Regarding Your Stock Holdings Registered Shareholders (shares held by you in your name) should address communications concerning transfers, statements, dividend payments, address changes, lost certificates and other admin- istrative matters to: Computershare P.O. Box 43078 Providence, RI 02940 Telephone: 800-226-0083 201-680-6578 (Outside the U.S.) E-mail: web.queries@computershare.com Website: www.computershare.com/ Cash Dividends Declared Per Share (in $) investor or 12 11 10 09 08 2.1275 2.0250 1.8900 1.7750 1.6500 The closing price for a share of PepsiCo common stock on the New York Stock Exchange was the price as reported by Bloomberg for the years ending 2008– 2012. Past performance is not necessarily indicative of future returns on investments in PepsiCo common stock. Manager Shareholder Relations PepsiCo, Inc. 700 Anderson Hill Road Purchase, NY 10577 Telephone: 914-253-3055 E-mail: investor@pepsico.com In all correspondence or telephone inqui- ries, please mention PepsiCo, your name as printed on your stock certificate, your holder ID, your address and your tele- phone number. SharePower Participants (associates with SharePower Options) should address all questions regarding your account, outstanding options or shares received through option exercises to: Merrill Lynch 1400 Merrill Lynch Drive MSC NJ2-140-03-17 Pennington, NJ 08534 Telephone: 800-637-6713 (U.S., Puerto Rico and Canada) 609-818-8800 (all other locations) In all correspondence, please provide your account number (for U.S. citizens, this is your Social Security number), your address and your telephone number, and men- tion PepsiCo SharePower. For telephone inquiries, please have a copy of your most recent statement available. Associate Benefit Plan Participants PepsiCo 401(k) Plan The PepsiCo Savings & Retirement Center at Fidelity P.O. Box 770003 Cincinnati, OH 45277-0065 Telephone: 800-632-2014 (Overseas: Dial your country’s AT&T Access Number +800-632-2014. In the U.S., access numbers are available by calling 800-331-1140. From anywhere in the world, access numbers are available online at www.att.com/traveler.) Website: www.netbenefits.com/pepsico PepsiCo Stock Purchase Program: Fidelity Investments P.O. Box 770001 Cincinnati, OH 45277-0002 Telephone: 800-632-2014 Website: www.netbenefits.com/pepsico Please have a copy of your most recent statement available when calling with inquiries. 2012 PEPSICO ANNUAL REPORT 109 Shareholder Services Direct Stock Purchase Interested investors can make their initial purchase directly through Computershare, transfer agent for PepsiCo and Adminis- trator for the Plan. A brochure detailing the Plan is available on our website, www. pepsico.com, or from our transfer agent: Computershare P.O. Box 43078 Providence, RI 02940 Telephone: 800-226-0083 201-680-6578 (Outside the U.S.) E-mail: web.queries@computershare.com Website: www.computershare.com/ investor Other services include dividend reinvest- ment, direct deposit of dividends, optional cash investments by electronic funds transfer or check drawn on a U.S. bank, sale of shares, online account access, and elec- tronic delivery of shareholder materials. Financial and Other Information PepsiCo’s 2013 quarterly earnings releases are expected to be issued the weeks of April  22, July  22, October  14, 2013 and February 10, 2014. Copies of PepsiCo’s SEC reports, earnings and other financial releases, corporate news and additional company information are available on our website, www.pepsico.com. Independent Auditors KPMG LLP 345 Park Avenue New York, NY 10154-0102 Telephone: 212-758-9700 Corporate Headquarters PepsiCo, Inc. 700 Anderson Hill Road Purchase, NY 10577 Telephone: 914-253-2000 PepsiCo Website www.pepsico.com © 2012 PepsiCo, Inc. PepsiCo’s Annual Report contains many of the valuable trademarks owned and/or used by PepsiCo and its subsidiaries and affiliates in the United States and inter- nationally to distinguish products and services of outstanding quality. All other trademarks featured herein are the prop- erty of their respective owners. PepsiCo’s Values We are committed to delivering sustained growth through empowered people, acting responsibly and building trust. Guiding Principles We must always strive to: Care for customers, consumers and the world we live in. Sell only products we can be proud of. Speak with truth and candor. Balance short term and long term. Win with diversity and inclusion. Respect others and succeed together. F P O Environmental Profile This annual report was printed with Forest Stewardship Council™ (FSC®) certified paper, the use of 100  percent certified renewable wind power resources and soy ink. PepsiCo continues to reduce the costs and environmental impact of annual report printing and mailing by utilizing a distri- bution model that drives increased online readership and fewer printed copies. You can learn more about our environmental efforts at www.pepsico.com. 2012 Diversity and Inclusion Statistics Contribution Summary Board of Directors(a) Senior Executives(b) Executives All Managers All Associates(c) Total Women 13 12 2,755 16,969 97,781 4 3 852 5,618 18,144 % 31 25 31 33 19 People of Color 5 3 609 4,522 33,173 % 38 25 22 27 34 At year-end, we had approximately 278,000 associates worldwide. (a) Our Board of Directors is pictured on page 33. (b) Composed of PepsiCo Executive Officers listed on page 34. (c) Includes full-time associates only. Executives, All Managers and All Associates are approximate numbers as of 12/31/12 for U.S. associates only. Data in this chart is based on the U.S. definition for people of color. (in millions) PepsiCo Foundation Corporate Contributions Division Contributions Division Estimated In-Kind Donations Total(a) (a) Does not sum due to rounding. 2012 $25.7 4.9 10.1 58.6 $99.3 110 2012 PEPSICO ANNUAL REPORT 

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