T. Stock-based compensation
Stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized over the employee requisite service period. See note A, “Significant Accounting Policies,” for additional information.
The following table presents total stock-based compensation cost included in the Consolidated Statement of Earnings:
| ($ in millions) | |||
| For the year ended December 31: | 2007 | 2006 | 2005 |
|---|---|---|---|
|
* Includes $7 million of credits recorded during the year ended December 31, 2005, as a result of awards forfeited in connection with the second-quarter 2005 workforce resource actions. ** Reflects the one-time effects of the divestiture of the Personal Computing business in the second quarter of 2005 and the divestiture of the Printing Systems business in the second quarter of 2007. |
|||
| Cost | $ 166 | $ 216 | $ 330 |
| Selling, general and administrative* | 480 | 541 | 606 |
| Research, development and engineering | 68 | 89 | 107 |
| Other (income) and expense** | (1) | — | (8) |
| Pre-tax stock-based compensation cost | 713 | 846 | 1,035 |
| Income tax benefits | (248) | (305) | (349) |
| Total stock-based compensation cost | $ 464 | $ 541 | $ 686 |
Total unrecognized compensation cost related to non-vested awards at December 31, 2007 and 2006 was $1,101 million and $1,238 million, respectively, and is expected to be recognized over a weighted-average period of approximately three years.
There was no significant capitalized stock-based compensation cost at December 31, 2007, 2006 and 2005.
Incentive awards
Stock-based incentive awards are provided to employees under the terms of the company’s plans (the “Plans”). The Plans are administered by the Executive Compensation and Management Resources Committee of the Board of Directors (the “Committee”). Awards under the Plans principally include at-the-money stock options, restricted stock units, performance stock units, stock appreciation rights or any combination thereof. The nonmanagement members of the IBM Board of Directors also received stock options under a director stock option plan through December 31, 2006. The director stock option plan was terminated effective January 1, 2007.
The amount of shares originally authorized to be issued under the company’s existing Plans was 274.1 million at December 31, 2007 and 2006. In addition, certain incentive awards granted under previous plans, if and when those awards were canceled, could be reissued under the company’s existing Plans. As such, 46.7 million and 45.9 million additional awards were considered authorized to be issued under the company’s existing Plans as of December 31, 2007 and 2006, respectively. There were 34.8 million and 51.6 million option awards outstanding (which were included in the total options outstanding at December 31, 2007 and 2006, respectively) under previous plans that, if and when canceled, would increase the number of authorized shares. There were 131.4 million and 131.8 million unused shares available to be granted under the Plans as of December 31, 2007 and 2006, respectively.
Under the company’s long-standing practices and policies, all stock option awards are approved prior to or on the date of grant. The exercise price of at-the-money stock options is the average of the high and low market price on the date of grant. The options approval process specifies the individual receiving the grant, the number of options or the value of the award, the exercise price or formula for determining the exercise price and the date of grant. All option awards for senior management are approved by the Committee. All option awards for employees other than senior management are approved by senior management pursuant to a series of delegations that were approved by the Committee. The grants made pursuant to these delegations are reviewed periodically with the Committee. Options that are awarded as part of annual total compensation for senior management and other employees are made on specific cycle dates scheduled in advance. With respect to option awards given in connection with promotions or new hires, the company’s policy requires approval of such awards prior to the grant date, which is typically the date of the promotion or the date of hire. The exercise price of these options is the average of the high and low market price on the date of grant.
STOCK OPTIONS
Stock options are awards which allow the employee to purchase shares of the company’s stock at a fixed price. Stock options are granted at an exercise price equal to or greater than the company stock price on the date of grant. These awards, which generally vest 25 percent per year, are fully vested four years from the date of grant and have a contractual term of 10 years. The company also has a stock-based program for its senior executives, designed to drive improved performance and increase the ownership executives have in the company. These executives have the opportunity to receive at-the-money stock options by agreeing to defer a certain percentage of their annual incentive compensation into IBM equity, where it is held for three years or until retirement. In 2005, this program was expanded to cover all executives of the company. Options under this program become fully vested three years from the date of grant and have a contractual term of 10 years. The plan element permitting deferral of annual incentive compensation into IBM equity and receiving at-the-money stock options was terminated at December 31, 2006.
The company estimates the fair value of stock options using the Black-Scholes valuation model, consistent with the provisions of SFAS No. 123(R), “Share-Based Payment” (SFAS No. 123(R)) and SAB No. 107. Key inputs and assumptions used to estimate the fair value of stock options include the grant price of the award, the expected option term, volatility of the company’s stock, the risk-free rate and the company’s dividend yield. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive equity awards, and subsequent events are not indicative of the reasonableness of the original estimates of fair value made by the company.
The fair value of each stock option grant was estimated at the date of grant using a Black-Scholes option pricing model. The following table presents the weighted-average assumptions used in the valuation and the resulting weighted-average fair value per option granted:
| For the year ended December 31: | 2007 | 2006 | 2005 |
|---|---|---|---|
|
* The Option term is the number of years that the company estimates, based upon history, that options will be outstanding prior to exercise or forfeiture. ** The company’s estimates of expected volatility are principally based on daily price changes of the company’s stock over the expected option term, as well as the additional requirements included in the provisions of SFAS No. 123(R) and the guidance provided by SAB No. 107. |
|||
| Option term (years)* | 5 | 5 | 5 |
| Volatility** | 23.1% | 26.2% | 34.7% |
| Risk-free interest rate (zero coupon U.S. treasury note) | 4.5% | 4.9% | 4.0% |
| Dividend yield | 1.4% | 1.3% | 0.9% |
| Weighted-average fair value per option granted | $ 26 | $ 23 | $ 29 |
The following table summarizes option activity under the Plans during the years ended December 31, 2007, 2006 and 2005:
| 2007 | 2006 | 2005 | ||||
|---|---|---|---|---|---|---|
| Wtd. Avg. Exercise Price | No. of Shares Under Option | Wtd. Avg. Exercise Price | No. of Shares Under Option | Wtd. Avg. Exercise Price | No. of Shares Under Option | |
| Balance at January 1 | $ 95 | 207,663,223 | $ 91 | 236,070,040 | $ 89 | 249,347,906 |
| Options granted | 103 | 1,087,381 | 85 | 2,013,623 | 100 | 13,016,765 |
| Options exercised | 77 | (46,961,380) | 53 | (21,685,948) | 47 | (11,690,186) |
| Options canceled/expired | 106 | (4,127,967) | 100 | (8,734,492) | 97 | (14,604,445) |
| Balance at December 31 | $ 100 | 157,661,257 | $ 95 | 207,663,223 | $ 91 | 236,070,040 |
| Exercisable at December 31 | $ 100 | 144,092,169 | $ 95 | 177,318,905 | $ 92 | 176,962,180 |
During the year ended December 31, 2007, the company did not grant any stock options with exercise prices greater than the stock price at the date of grant. During the years ended December 31, 2006 and 2005, the company granted approximately 0.5 million and 12.5 million stock options, respectively, with exercise prices greater than the stock price at the date of grant. These stock options had weighted-average exercise prices of $91 and $100 for the years ended December 31, 2006 and 2005, respectively, and were included in the table above.
The shares under option at December 31, 2007 were in the following exercise price ranges:
| Options Outstanding | ||||
|---|---|---|---|---|
| Exercise Price Range | Wtd. Avg. Exercise Price | No. of Shares Under Option | Aggregate Intrinsic Value | Wtd. Avg. Remaining Contractual Life (In Years) |
| $ 34 –$ 60 | $ 51 | 3,535,698 | $ 200,389,187 | —* |
| $ 60 –$ 85 | 77 | 31,399,013 | 987,276,354 | 5 |
| $ 85 –$ 105 | 98 | 64,129,462 | 648,821,490 | 5 |
| $ 105 and over | 117 | 58,597,084 | 37,137,467 | 3 |
| $ 100 | 157,661,257 | $1,873,624,498 | 4 | |
| Options Exercisable | ||||
|---|---|---|---|---|
| Exercise Price Range | Wtd. Avg. Exercise Price | No. of Shares Under Option | Aggregate Intrinsic Value | Wtd. Avg. Remaining Contractual Life (In Years) |
|
* Weighted average remaining contractual life is less than one year. |
||||
| $ 34 –$ 60 | $ 51 | 3,535,698 | $ 200,389,187 | —* |
| $ 60 –$ 85 | 76 | 29,754,378 | 945,466,395 | 5 |
| $ 85 –$ 105 | 98 | 53,103,839 | 542,234,878 | 4 |
| $ 105 and over | 117 | 57,698,254 | 35,220,308 | 3 |
| $ 100 | 144,092,169 | $1,723,310,768 | 4 | |
In connection with various acquisition transactions, there were an additional 2.1 million options outstanding at December 31, 2007, as a result of the company’s assumption of options granted by the acquired entities. The weighted-average exercise price of these options was $79 per share.
EXERCISES OF EMPLOYEE STOCK OPTIONS
The total intrinsic value of options exercised during the years ended December 31, 2007, 2006 and 2005 was $1,414 million, $727 million and $470 million, respectively. The total cash received from employees as a result of employee stock option exercises for the years ended December 31, 2007, 2006 and 2005 was approximately $3,619 million, $1,149 million and $550 million, respectively. In connection with these exercises, the tax benefits realized by the company for the years ended December 31, 2007, 2006 and 2005 were $481 million, $242 million and $148 million, respectively.
The company settles employee stock option exercises primarily with newly issued common shares and, occasionally, with treasury shares. Total treasury shares held at December 31, 2007 and 2006 were approximately 672 million and 502 million shares, respectively.
STOCK AWARDS
In addition to stock options, the company grants its employees stock awards. These awards are made in the form of Restricted Stock Units (RSUs), including Retention Restricted Stock Units (RRSUs), or Performance Stock Units (PSUs). RSUs are stock awards granted to employees that entitle the holder to shares of common stock as the award vests, typically over a two- to five-year period. The fair value of the awards is determined and fixed on the grant date based on the company’s stock price. During the year ended December 31, 2006, the company modified its equity compensation plans to increase awards of RSUs compared to stock options. RSUs awarded during the year ended December 31, 2005 were not material when compared to the value of stock options awarded during that year.
The following table summarizes RSU activity under the Plans during the years ended December 31, 2007 and 2006:
| 2007 | 2006 | |||
|---|---|---|---|---|
| Wtd. Avg. Grant Price | Number of Units | Wtd. Avg. Grant Price | Number of Units | |
| Balance at January 1 | $ 84 | 10,217,258 | $ 83 | 6,813,698 |
| RSUs granted | 104 | 4,929,141 | 85 | 4,831,227 |
| RSUs released | 77 | (2,747,110) | 76 | (1,037,927) |
| RSUs canceled/forfeited | 88 | (511,543) | 85 | (389,740) |
| Balance at December 31 | $ 94 | 11,887,746 | $ 84 | 10,217,258 |
The remaining weighted-average contractual term of RSUs at December 31, 2007 and 2006 is the same as the period over which the remaining cost of the awards will be recognized, which is approximately three years. The fair value of RSUs granted during the years ended December 31, 2007 and 2006 was $513 million and $410 million, respectively. The total fair value of RSUs vested and released during the years ended December 31, 2007 and 2006 was $213 million and $79 million. As of December 31, 2007 and 2006, there was $740 million and $501 million, respectively, of unrecognized compensation cost related to nonvested RSUs. The company received no cash from employees as a result of employee vesting and release of RSUs for the years ended December 31, 2007 and 2006.
PSUs are stock awards where the number of shares ultimately received by the employee depends on the company’s performance against specified targets and typically vest over a three-year period. The fair value of each PSU is determined on the grant date, based on the company’s stock price, and assumes that performance targets will be achieved. Over the performance period, the number of shares of stock that will be issued is adjusted upward or downward based upon the probability of achievement of performance targets. The ultimate number of shares issued and the related compensation cost recognized as expense will be based on a comparison of the final performance metrics to the specified targets. The fair value of PSUs granted during the years ended December 31, 2007 and 2006 was $116 million and $104 million, respectively. Total fair value of PSUs vested and released during the years ended December 31, 2007 and 2006 was $88 million and $67 million, respectively.
In connection with employee vesting and release of RSUs and PSUs, the tax benefits realized by the company for the years ended December 31, 2007 and 2006 were $133 million and $59 million, respectively.
IBM employees stock purchase plan
The company maintains an Employees Stock Purchase Plan (ESPP). The ESPP enables eligible participants to purchase full or fractional shares of IBM common stock through payroll deductions of up to 10 percent of eligible compensation. Eligible compensation includes any compensation received by the employee during the year. The ESPP provides for offering periods during which shares may be purchased and continues as long as shares remain available under the ESPP, unless terminated earlier at the discretion of the Board of Directors. Individual ESPP participants are restricted from purchasing more than $25,000 of common stock in one calendar year or 1,000 shares in an offering period.
Prior to April 1, 2005, the ESPP was considered compensatory under the provisions of SFAS No. 123(R). The share price paid by an employee prior to April 1, 2005 was the lesser of 85 percent of the average market price on the first business day of each offering period or 85 percent of the average market price on the last business day of each pay period. Effective April 1, 2005, the company modified the terms of the plan whereas eligible participants may purchase full or fractional shares of IBM common stock under the ESPP at a five-percent discount off the average market price on the day of the purchase. In accordance with the provisions of SFAS No. 123(R), effective April 1, 2005, the ESPP is not considered compensatory.
Employees purchased 4.0 million, 5.8 million and 6.7 million shares under the ESPP during the years ended December 31, 2007, 2006 and 2005, respectively. Cash dividends declared and paid by the company on its common stock also include cash dividends on the company stock purchased through the ESPP. Dividends are paid on full and fractional shares and can be reinvested in the ESPP. The company stock purchased through the ESPP is considered outstanding and is included in the weighted-average outstanding shares for purposes of computing basic and diluted earnings per share.
Approximately 16.3 million, 20.3 million and 26.2 million shares were available for purchase under the ESPP at December 31, 2007, 2006 and 2005, respectively.
