Print PageCUMMINS INC. AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16. STOCK INCENTIVE AND STOCK OPTION PLANS
In September 2003, our shareholders approved the 2003 Stock Incentive Plan (The Plan). The Plan allows for the granting of up to 10.0 million stock-based awards (adjusted for the impact of a two-for-one stock split on April 9, 2007 and an additional two-for-one stock split on January 2, 2008, (See Note 17) to executives and employees, of which one-half must be in the form of stock options. Awards available for grant under the plan include, but are not limited to, stock options, stock appreciation rights, performance shares, restricted stock and other stock awards. Stock options are generally granted with a strike price equal to the fair market value of the stock on the date of grant, a life of 10 years and a two-year vesting period.
The performance shares are granted as target awards and are earned based on our return on equity (ROE) performance. A payout factor has been established ranging from zero to 200 percent of the target award based on the actual ROE performance during the two-year period. Any shares earned are then restricted for one additional year. Employees leaving the company prior to the end of the restriction period forfeit their shares. Compensation expense is recorded ratably over the period beginning on the grant date until the shares become unrestricted and is based on the amount of the award that is expected to be earned under the plan formula, adjusted each reporting period based on current information.
Under the stock incentive plan, restricted common stock is awarded from time to time at no cost to certain employees. Participants are entitled to cash dividends and voting rights. Restrictions limit the sale or transfer of the shares during a defined period. Generally, one-third of the shares are released after two years and one-third of the shares issued are released each year thereafter on the anniversary of the grant date, provided the participant remains an employee. Compensation expense is determined at the grant date and is recognized over the four-year restriction period on a straight-line basis.
Prior to January 1, 2006, we accounted for stock-based employee awards granted on or after January 1, 2003, utilizing the fair value method preferred by SFAS No. 123, ‘‘Accounting for Stock-Based Compensation.’’ For awards granted prior to January 1, 2003, we applied the disclosure-only provisions of SFAS No. 123. In accordance with SFAS No. 123, we applied APB Opinion No. 25, ‘‘Accounting for Stock Issued to Employees’’ and related interpretations in accounting for our plans prior to January 1, 2003 and accordingly, did not recognize compensation expense for these plans because we granted options at exercise prices equal to the market value of our stock on the grant date.
Effective January 1, 2006, we adopted SFAS No. 123R, ‘‘Share-Based Payment,’’ which revised SFAS No. 123 and supersedes APB No. 25. We adopted this statement using the modified prospective transition method which does not require the restatement of prior periods. SFAS No. 123R requires the recognition of expense for share-based payments to be recorded in the consolidated financial statements based on the grant date fair value and to be recognized over their vesting periods. Under SFAS No. 123R, we are required to select a valuation technique or option-pricing model that meets the requirements of the standard. Allowable valuation models include a binomial model and the Black-Scholes model. At the present time, we are continuing to use the Black-Scholes model. Since we had previously accounted for our awards at fair value under SFAS No. 123, the impact of adopting SFAS No. 123R was not material to our Consolidated Financial Statements. The two most significant changes related to accounting for forfeitures and accounting for tax benefits of awards. SFAS No. 123R requires us to estimate forfeitures in calculating the expense relating to share-based compensation as opposed to recognizing these forfeitures and the corresponding reduction in expense as they occur. The cumulative adjustment we recorded upon the adoption of SFAS No. 123R for the estimated forfeitures on grants outstanding on the date of adoption was not material. Excess tax benefits related to share-basedcompensation are now classified as a financing activity in the statement of cash flows rather than an operating activity.
Compensation expense (net of estimated forfeitures) related to our share-based plans for the year ended December 31, 2007, 2006 and 2005 was approximately $28 million, $18 million, and $16 million, respectively. The excess tax benefit associated with our share-based plans for the years ended December 31, 2007, 2006 and 2005, was $11 million, $6 million and $7 million, respectively. The total unrecognized compensation expense (net of estimated forfeitures) related to nonvested awards was approximately $41 million at December 31, 2007 and was expected to be recognized over a weighted-average period of 1.4 years.
The table below summarizes the activity in our stock option plans:
| Options (1) | Weighted-average Exercise Price (1) |
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| Balance, December 31, 2004 | 4,079,960 | $ | 11.35 | ||||
| Granted | 11,600 | 17.56 | |||||
| Reinstated grants | 12,400 | 9.71 | |||||
| Exercised | (2,466,160 | ) | 11.52 | ||||
| Forfeited | (22,200 | ) | 10.45 | ||||
| Expired | (16,800 | ) | 10.29 | ||||
| Balance, December 31, 2005 | 1,598,800 | $ | 11.15 | ||||
| Granted | 1,800 | 26.31 | |||||
| Exercised | (762,240 | ) | 11.45 | ||||
| Expired | (6,600 | ) | 10.16 | ||||
| Balance, December 31, 2006 | 831,760 | $ | 10.91 | ||||
| Granted | 21,000 | 49.42 | |||||
| Exercised | (235,310 | ) | 11.73 | ||||
| Forfeited | (69,700 | ) | 10.11 | ||||
| Expired | (15,000 | ) | 13.25 | ||||
| Balance, December 31, 2007 | 532,750 | $ | 12.10 | ||||
| Exercisable, December 31, 2005 | 1,598,800 | $ | 11.15 | ||||
| Exercisable, December 31, 2006 | 831,760 | $ | 10.91 | ||||
| Exercisable, December 31, 2007 | 532,750 | $ | 12.10 | ||||
| (1) | Options and weighted-average exercise prices were adjusted for the impact of a two-for-one stock split on April 9, 2007 and an additional two-for-one stock split on January 2, 2008 (See Note 17). |
The weighted-average grant date fair value of options granted during the years ended
December 31, 2007, 2006 and 2005, was $49.42, $26.31 and $17.56, respectively. The total intrinsic value of options exercised during the years ended December 31, 2007, 2006 and 2005, was approximately $9 million, $14 million and $34 million, respectively.
The weighted-average grant date fair value of performance and restricted shares is as follows:
| Performance Shares(1) |
Weighted-average Fair Value(1) |
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| Nonvested at December 31, 2004 | 2,110,200 | $ | 12.30 | ||||
| Granted | 801,360 | 18.72 | |||||
| Forfeited | (20,960 | ) | 14.60 | ||||
| Nonvested at December 31, 2005 | 2,890,600 | $ | 14.07 | ||||
| Granted | 700,592 | 24.72 | |||||
| Vested | (987,200 | ) | 12.01 | ||||
| Forfeited | (58,812 | ) | 14.03 | ||||
| Nonvested at December 31, 2006 | 2,545,180 | $ | 17.80 | ||||
| Granted | 597,240 | 38.21 | |||||
| Vested | (1,063,160 | ) | 12.56 | ||||
| Forfeited | (4,624 | ) | 27.10 | ||||
| Nonvested at December 31, 2007 | 2,074,636 | $ | 26.34 | ||||
| (1) | Performance shares and weighted-average exercise price fair values were adjusted for the impact of a two-for-one stock split on April 9, 2007 and an additional two-for-one stock split on January 2, 2008 (See Note 17). |
| Restricted Shares (1) |
Weighted- average Fair Value(1) |
||||||
| Nonvested at December 31, 2004 | — | $ | — | ||||
| Granted | 4,000 | 18.72 | |||||
| Nonvested at December 31, 2005 | 4,000 | $ | 18.72 | ||||
| Granted | 200,000 | 26.96 | |||||
| Nonvested at December 31, 2006 | 204,000 | $ | 26.80 | ||||
| Granted | 4,800 | 42.61 | |||||
| Nonvested at December 31, 2007 | 208,800 | $ | 27.16 | ||||
| (1) | Restricted shares and weighted-average fair value were adjusted for the impact of a two-for-one stock split on April 9, 2007 and an additional two-for-one stock split on January 2, 2008 (See Note 17). |
The fair value of each option grant was estimated on the grant date using the Black-Scholes option pricing model with the following assumptions:
| Years ended December 31, | |||||||||
| 2007 | 2006 | 2005 | |||||||
| Expected life (years) | 7 | 7 | 7 | ||||||
| Risk-free interest rate | 4.4 | % | 4.9 | % | 4.1 | % | |||
| Expected volatility | 24.0 | % | 26.4 | % | 38.7 | % | |||
| Dividend yield | 1.5 | % | 1.8 | % | 2.5 | % | |||
Expected life—The expected life of employee stock options represents the weighted-average period the stock options are expected to remain outstanding based upon our historical data.
Risk-free interest rate—The risk-free interest rate assumption is based upon the observed U.S. treasury security rate appropriate for the expected life of our employee stock options.
Expected volatility—The expected volatility assumption is based upon the weighted-average historical daily price changes of our common stock over the most recent period equal to the expected option life of the grant, adjusted for activity which is not expected to occur in the future.
Dividend yield—The dividend yield assumption is based on our history and expectation of dividend payouts.
The table below summarizes stock option information for options outstanding, all of which are currently exercisable at December 31, 2007:
| Options Outstanding and Exercisable | ||||||||||||||
| Exercise Price Range(1) | Number of Options (1) |
Weighted-average Remaining Contractual Life |
Weighted-average Exercise Price (1) |
Aggregate Intrinsic Value (1) |
||||||||||
| $9.300—33.799 | 515,850 | 3.24 | $ | 10.78 | $ | 27,265,498 | ||||||||
| $33.800—57.079 | 8,000 | 9.42 | 44.34 | 178,702 | ||||||||||
| $57.080—63.740 | 8,900 | 9.87 | 59.61 | 36,305 | ||||||||||
| 532,750 | 3.44 | $ | 12.10 | $ | 27,480,505 | |||||||||
| (1) | Adjusted for the impact of a two-for-one stock split on April 9, 2007 and an additional two-for-one stock split on January 2, 2008 (See Note 17). |
The accompanying notes are an integral part of the Consolidated Financial Statements.