Cisco 2007 Annual Report Download - page 68

2007 Annual Report 71
Notes to Consolidated Financial Statements
Valuation and Expense Information Under SFAS 123(R) On July 31, 2005, the Company adopted SFAS 123(R), which requires the
measurement and recognition of compensation expense for all share-based payment awards made to the Company’s employees and
directors including employee stock options and employee stock purchase rights, based on estimated fair values. Employee share-based
compensation expense under SFAS 123(R) was as follows (in millions):
Years Ended July 28, 2007 July 29, 2006 July 30, 2005
Cost of sales—product $ 39 $ 50 $ —
Cost of sales—service 104 112 —
Employee share-based compensation expense in cost of sales 143 162 —
Research and development 289 346 —
Sales and marketing 392 427 —
General and administrative 107 115 —
Employee share-based compensation expense in operating expenses 788 888 —
Total employee share-based compensation expense(1) (2) (3) $ 931 $ 1,050 $ —
(1) As of July 28, 2007, total compensation cost related to nonvested share-based awards not yet recognized was $2.8 billion, including share-based compensation
relating to acquisitions and investments, which is expected to be recognized over 3.5 years on a weighted-average basis.
(2) Share-based compensation expense of $34 million, $87 million, and $154 million related to acquisitions and investments for fiscal 2007, 2006, and 2005, respectively,
is disclosed in Note 3 and is not included in the above table.
(3) The income tax benefit for employee share-based compensation expense was $342 million and $294 million for fiscal 2007 and 2006, respectively. The income
tax benefit has been determined using the applicable tax rates in jurisdictions to which this expense relates and for fiscal 2007 included the tax effects resulting from
the reinstatement of the U.S. federal research and development (R&D) tax credit in December 2006 (see Note 11). The tax benefit for fiscal 2006 included the effect of
U.S. tax regulations that require intercompany reimbursement of certain share-based compensation expenses.
Lattice-Binomial Model Upon adoption of SFAS 123(R), the Company began estimating the value of employee stock options and
employee stock purchase rights on the date of grant using a lattice-binomial model. Prior to the adoption of SFAS 123(R), the value of
each employee stock option and employee stock purchase right was estimated on the date of grant using the Black-Scholes model
for the purpose of the pro forma financial information required in accordance with SFAS 123.
The Company’s employee stock options have various restrictions including vesting provisions and restrictions on transfer and hedging,
among others, and are often exercised prior to their contractual maturity. Lattice-binomial models are more capable of incorporating the
features of the Company’s employee stock options than closed-form models such as the Black-Scholes model. The use of a lattice-binomial
model requires extensive actual employee exercise behavior data and a number of complex assumptions including expected volatility,
risk-free interest rate, expected dividends, kurtosis, and skewness. The weighted-average assumptions, using the lattice-binomial model,
the weighted-average expected life and estimated value of employee stock options and employee stock purchase rights are summarized
as follows:
EMPLOYEE STOCK
OPTION PLANS
EMPLOYEE STOCK
PURCHASE PLAN
Years Ended July 28, 2007 July 29, 2006 July 28, 2007 July 29, 2006
Weighted-average assumptions:
Expected volatility 26.0% 23.7% 26.1% 27.5%
Risk-free interest rate 4.6% 4.3% 5.1% 3.4%
Expected dividend 0.0% 0.0% 0.0% 0.0%
Kurtosis 4.5 4.3 N/A N/A
Skewness (0.79) (0.62) N/A N/A
Weighted-average expected life (in years) 6.7 6.6 0.5 0.5
Weighted-average estimated value $ 7.11 $ 5.15 $ 6.46 $ 4.66