Pepsi 2005 Annual Report Download - page 38

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We believe that we will achieve our best
results if our employees act and are
rewarded as business owners. Therefore,
we believe stock ownership and stock-
based incentive awards are the best way to
align the interests of employees with those
of our shareholders. Historically, following
competitive market practices, we have
used stock option grants as our primary
form of long-term incentive compensation.
These grants are made at the current stock
price, meaning each employee’s exercise
price is equivalent to our stock price on
the date of grant. Employees must gener-
ally provide three additional years of serv-
ice to earn the grant, referred to as the
vesting period. Our options generally have
a 10-year term, which means our employ-
ees would have up to seven years after the
vesting period to elect to pay the exercise
price to purchase one share of our stock
for each option exercised. Employees bene-
fit from stock options to the extent our
stock price appreciates above the exercise
price after vesting and during the term of
the grant. There have been no reductions
to the exercise price of previously issued
awards, and any repricing of awards would
require approval of our shareholders.
Our new executive compensation pro-
gram, which became effective in 2004,
strengthens the relationship between pay
and individual performance through greater
differentiation in the amount of base pay,
bonus and stock-based compensation
based on an employee’s job level and per-
formance. The new program results in a
shift of both cash and stock-based com-
pensation to our top performing executives.
In addition, our new program provides
executives, who are awarded long-term
incentives based on their performance,
with a choice of stock options or restricted
stock units (RSUs). RSU expense is based
on the fair value of PepsiCo stock on the
date of grant and is amortized over the
vesting period, generally three years. Each
restricted stock unit can be settled in a
We believe that we will
achieve our best results if our
employees act and are
rewarded as business owners.
Stock-Based Compensation Expense
Income Tax Expense and Accruals
Our annual tax rate is based on our
income, statutory tax rates and tax plan-
ning opportunities available to us in the
various jurisdictions in which we operate.
Significant judgment is required in deter-
mining our annual tax rate and in evaluat-
ing 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. See Note 5 for additional
information regarding our tax reserves.
An estimated effective tax rate for a year
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
benefits from the resolution of prior year tax
matters to be 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 dif-
ferent than that reported in our tax returns
(our cash tax rate). Some of these differ-
ences are permanent, such as expenses
that are not deductible in our tax return,
and some differences reverse over time,
such as depreciation expense. These
temporary differences create deferred tax
assets and liabilities. Deferred tax assets
generally represent items that can be used
as a tax deduction or credit in our tax
returns in future years for which we have
already recorded the tax benefit in our
income statement. We establish valuation
allowances for our deferred tax assets
when we believe expected future taxable
income is not likely to support the use of a
deduction or credit in that tax jurisdiction.
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 we have not yet recognized as expense
in our financial statements.
The American Jobs Creation Act of
2004 (AJCA) created a one-time incentive
for U.S. corporations to repatriate undis-
tributed international earnings by providing
an 85% dividends received deduction. As
approved by our Board of Directors in July
2005, we repatriated approximately
$7.5 billion in earnings previously consid-
ered indefinitely reinvested outside the
U.S. in the fourth quarter of 2005. In
2005, we recorded income tax expense of
$460 million associated with this repatria-
tion. Other than the earnings repatriated,
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. At
December 31, 2005, we had approxi-
mately $7.5 billion of undistributed
international earnings.
In 2005, our annual tax rate for contin-
uing operations was 36.1% compared to
24.7% in 2004 as discussed in “Other
Consolidated Results.” The tax rate in
2005 increased 11.4 percentage points
primarily as a result of the AJCA tax charge
and the absence of the 2004 tax benefits
related to the favorable resolution of cer-
tain open tax items. For 2006, our annual
tax rate is expected to be 28.0%, primarily
reflecting the absence of the AJCA tax
charge and changes in our concentrate
sourcing around the world.
We repatriated approximately
$7.5 billion in earnings
previously considered
indefinitely reinvested
outside the U.S. in the fourth
quarter of 2005 in connection
with the AJCA.