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NOTE 18: SHARE-BASED COMPENSATION Share-based compensation expense for the last three years was • $41 million in 2007; • $28 million in 2006; and • $11 million in 2005. Share-based compensation for each of these years includes expense related to: • 2007 – equity-classified awards granted in 2006 and 2007 and all outstanding liability-classified awards. • 2006 – equity-classified awards granted in 2006 and all outstanding liability-classified awards. • 2005 – outstanding liability-classified awards. The $28 million share-based compensation expense in 2006 included a $6 million charge in the first quarter, reflecting an increase in the value of stock appreciation rights outstanding as of December 25, 2005. We re-measured the value of the stock appreciation rights from the intrinsic value of the outstanding awards to the estimated fair value of the outstanding awards in connection with our implementation of Statement 123R. This note provides details about: • our Long-Term Incentive Compensation Plan; • how we account for share-based awards; • tax benefits of share-based awards; • pro forma effect on net earnings; • types of share-based compensation; and • unrecognized share-based compensation. OUR LONG-TERM INCENTIVE COMPENSATION PLAN Our Long-Term Incentive Compensation Plan (the Plan) provides for share-based awards that include: • stock options; • stock appreciation rights; • restricted stock; • restricted stock units; • performance shares; and • performance share units. We may issue grants of up to 17 million shares under the Plan. That is in addition to up to 1.9 million shares subject to outstanding awards under prior plans that cease to be subject to such awards. For stock options and stock appreciation rights: • an individual participant may receive a grant of up to 500,000 shares in any one calendar year; and • the exercise price is required to be the market price on the date of the grant. For restricted stock, restricted stock units, performance shares, performance share units or other equity grants: • an individual participant may receive a grant of up to 200,000 shares annually; and • the maximum aggregate number of shares that may be issued as grants is 3.4 million shares. The Compensation Committee of our board of directors (the Committee) annually establishes an overall pool of stock awards available for grants based on performance. For stock-settled awards, we: • issue new stock into the marketplace; and • generally do not repurchase shares in connection with issuing new awards. Prior to 2006, we issued only stock options and stock appreciation rights under the Plan. Beginning in 2006, we also issued restricted stock units and performance share units. Our common shares would increase by approximately 19 million shares if all share-based awards were exercised or vested. These include: • all options, restricted stock units, and performance share units outstanding at December 30, 2007 under the Plan; • all options outstanding at December 30, 2007 under earlier plans; and • all remaining options, restricted stock units, and performance share units that could be granted under the Plan. HOW WE ACCOUNT FOR SHARE-BASED AWARDS We account for the Plan under Statement 123R. We implemented Statement 123R as of the beginning of fiscal year 2006. Statement 123R revises Statement 123 and supersedes APB 25. Statement 123R requires us to: • use a fair-value-based measurement for share-based awards; and • recognize the cost of share-based awards in our Consolidated Financial Statements. We recognize the cost of share-based awards in our Consolidated Statement of Earnings over the required service period – generally the period from the date of the grant to the date when it is vested. Special situations are: • awards that vest upon retirement – the required service period ends on the date an employee is eligible for retirement, including early retirement; and • awards that continue to vest following job elimination – the required service period ends on the date the job is eliminated. In these special situations, compensation expense from share-based awards is recognized over a period that is shorter than the stated vesting period. Prior to adopting Statement 123R, we: • defined the past year as the required service period; and • recognized share-based compensation expense for stock options in our pro forma disclosures at the option grant dates. We used the modified prospective method to transition to Statement 123R. Accordingly, prior period amounts were not restated. Also, no additional compensation expense related to equity-classified awards issued prior to 2006 will be recognized unless those awards are modified. If the awards are modified, we will recognize any additional compensation expense in our Consolidated Statement of Earnings. TAX BENEFITS OF SHARE-BASED AWARDS Our total income tax benefit from share-based awards – as recognized in our Consolidated Statement of Earnings – for the last three years was: • $12 million in 2007; • $9 million in 2006; and • $4 million in 2005. Tax benefits for share-based awards are accrued as stock compensation expense is recognized in the Consolidated Statement of Earnings. Tax benefits on share-based awards are realized when: • restricted shares and restricted share units vest; • performance shares and performance share units vest; • stock options are exercised; and • stock appreciation rights are exercised. When actual tax benefits realized exceed the tax benefits that were accrued for share-based awards, we realize an excess tax benefit. Statement 123R requires us to report the excess tax benefit as financing cash inflows rather than operating cash inflows. Over the last two years, our excess tax benefits were: • $51 million in 2007; and • $23 million in 2006. These items are shown as excess tax benefits from share-based payment arrangements on our Consolidated Statement of Cash Flows. In 2005, our tax benefits realized on the exercise of stock options were $15 million. That amount was included in other operating cash flows and has not been reclassified. PRO FORMA EFFECT ON NET EARNINGS Prior to adopting Statement 123R in 2006, we used the intrinsic value method of accounting for share-based awards. As a result, we: • did not recognize compensation expense related to the issuance of stock options; and • did recognize compensation expense related to changes in the intrinsic value of stock appreciation rights. While we have not restated prior-period amounts, the following table shows the effect on our 2005 earnings if we had used fair value-based measurements required by Statement 123. Effect on 2005 Earnings Had We Used Fair Value-Based Measurements Required by Statement 123  TYPES OF SHARE-BASED COMPENSATION Our share-based compensation is in the form of: • stock options; • restricted stock units; • performance share units; • stock appreciation rights; and • deferred compensation stock equivalent units. STOCK OPTIONS Through the Plan, we award stock options. Stock options entitle award recipients to purchase shares of our common stock at a fixed exercise price. We grant stock options with an exercise price equal to the market price of our stock on the date of the grant. The Details Our stock options generally: • vest over four years of continuous service; and • must be exercised within 10 years of the grant date. Exceptions are that the stock options: • continue to vest following retirement for employees ages 55-61 with at least 10 years of service; and • vest upon retirement for employees age 65 or older, or ages 62-64 with at least 10 years of service. During the second quarter of 2006, we awarded selected executives and other key employees with special stock options that: • vest at the end of two years of continuous service; and • must be exercised within five years of the grant date. Our Accounting We use a Black-Scholes option valuation model to estimate the fair value of every stock option award on its grant date. In our estimates, we use: • historical data – for option exercise time and employee terminations; • a Monte-Carlo simulation – for how long we expect granted options to be outstanding; and • U.S. Treasury yield curve – for the risk-free rate. We use a yield curve over a period matching the expected term of the grant. The expected volatility in our valuation model is based on: • implied volatilities from traded options on our stock; • historical volatility of our stock; and • other factors. Weighted Average Assumptions Used in Estimating the Value of Stock Options Granted in Each of the Last Three Years  Share-based compensation expense for stock options granted in 2006 and after is generally recognized over the vesting period. There are exceptions for stock options awarded to employees who are eligible for retirement or who will become eligible for retirement during the vesting period. In these cases, we recognize the share-based compensation expense over a required service period that is less than the stated four-year vesting period. Activity In our fiscal year 2007, we granted 1.7 million stock options at a weighted average exercise price of $80.62. Stock Option Activity for Our Fiscal Year 2007  The total intrinsic value of stock options exercised during the last three years was: • $131 million in 2007, related to the exercise of 5.6 million options; • $60 million in 2006, related to the exercise of 3.7 million options; and • $43 million in 2005, related to the exercise of 3.1 million options. RESTRICTED STOCK UNITS Through the Plan, we award restricted stock units – grants that entitle the holder to shares of our stock as the award vests. The Details Our restricted stock units generally: • vest over four years of continuous service; and • are forfeited upon termination of employment for any reason, including retirement. Our Accounting The fair value of our restricted stock units is the market price of our stock on the grant date of the awards. We recognize stock compensation expense for restricted stock units over the four-year vesting period. Activity In our fiscal year 2007, we awarded 344,446 restricted stock units at a weighted average fair value of $80.01. The following table shows our restricted stock unit activity for our fiscal year 2007. Summary of Nonvested Restricted Stock Units for Our Fiscal Year 2007  As restricted stock units vest, a portion of the shares awarded is withheld to cover employee taxes. As a result, the number of stock units vested and the number of common shares issued will differ. PERFORMANCE SHARE UNITS Through the Plan, we award performance share units to selected executives and other key employees. These are grants that entitle the holder to shares of our stock if required performance targets are met over a three-year period. The Details Every performance share unit grant has a target number of shares – with the final number of shares to be awarded ranging from 0 to 200 percent of the target, depending upon performance. Performance targets are based on our financial performance ranking among a selected peer group. The financial performance ranking considers: • return on net assets; and • cost of capital. At the end of the performance period, performance share unit payouts will be in shares of our stock, subject to the terms applicable to the awards. Our Accounting Statement 123R requires that certain conditions be met to establish a grant date for accounting purposes. Our performance-based awards do not meet all of these conditions due to discretion the committee has over certain items that are included in the final determination of awards that are granted. In accordance with Statement 123R, we: • remeasure the fair value of the performance share units at every reporting date; • adjust the number of shares expected to be awarded based on the probability of achieving the performance target; and • recognize compensation cost for performance share units over their three-year performance period. The fair value of our performance stock units is the market price of our stock. If the performance goals are met, the cumulative compensation cost will equal the market price of our stock on the date the performance share unit payouts are made times the number of shares of stock that are awarded. If the performance goals are not met, we will: • not recognize any cumulative compensation cost; and • reverse any previously recognized compensation cost. Activity In our fiscal year 2007, we awarded 168,514 performance share units with a weighted average fair value of $80.12 on the date of the awards. Summary of Nonvested Performance Share Units at Target Levels for Our Fiscal Year 2007  STOCK APPRECIATION RIGHTS Through the Plan, we grant cash-settled stock appreciation rights as part of certain compensation awards. The Details Stock appreciation rights are similar to stock options. The benefit comes from the market price of our stock being higher on the exercise date than it was on the date the stock appreciation rights were granted. The differences are that the employee: • receives the benefit as a cash award; and • does not purchase the underlying stock. The vesting conditions and exceptions are the same as for 10-year stock options. Details are in the Stock Options section earlier in this note. Stock appreciation rights are generally issued to employees outside of the U.S. Our Accounting We use a Black-Scholes option valuation model to estimate the fair value of stock appreciation rights on its grant date. The value of a stock appreciation right is equal to the value of a 10-year option on its grant date. Stock appreciation rights are liability classified awards and the fair value is remeasured at every reporting date. The process used to develop our valuation assumptions is the same as for the 10-year stock options we grant. Details are in the Stock Options section earlier in this note. Weighted Average Assumptions Used to Remeasure the Value of Stock Appreciation Rights at Year End  Activity In our fiscal year 2007, we granted 165,727 stock appreciation rights at a weighted average exercise price of $80.66. Summary of Stock Appreciation Rights Activity for Our Fiscal Year 2007  The total intrinsic value of stock appreciation rights settled – which equals the amount of cash used to settle the awards – during the last three years was: • $9 million in 2007; • $4 million in 2006; and • $3 million in 2005. UNRECOGNIZED SHARE-BASED COMPENSATION As of December 30, 2007, our unrecognized share-based compensation cost for all types of share-based awards included: • $47 million related to nonvested equity-classified share-based compensation arrangements – expected to be recognized over a weighted-average period of approximately 2.31 years; and • $2 million related to nonvested liability-classified stock appreciation rights – expected to vest over a weighted-average period of approximately 2.4 years. DEFERRED COMPENSATION STOCK EQUIVALENT UNITS Certain employees and our board of directors can defer compensation into stock equivalent units. The Details The plan works differently for employees and directors. Eligible employees: • may choose to defer all or part of their bonus into stock equivalent units; and • receive a 15 percent premium if the deferral is for at least five years. Our directors: • must have a portion of their annual retainer fee deferred into stock equivalent units; • may choose to defer some or all of the remainder of their annual retainer fee into stock equivalent units; and • do not receive a premium for their deferrals. Employees and directors also choose when the deferrals will be paid out. Our Accounting We settle all deferred compensation accounts in cash. In addition, we credit all stock equivalent accounts with dividend equivalents. Stock equivalent units are: • liability-classified awards; and • are remeasured to fair value at every reporting date. The fair value of a stock equivalent unit is equal to the market price of our stock. Activity The number of stock equivalent units outstanding in our deferred compensation accounts at the end of our last three fiscal years was: • 419,217 as of December 30, 2007; • 397,000 as of December 31, 2006; and • 414,000 as of December 25, 2005. |