Eli Lilly 2006 Annual Report Download - page 42

FINANCIALS
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LIBOR over the term of the bonds.
The 6.55 percent Employee Stock Ownership Plan (ESOP) debentures are obligations of the ESOP but are
shown on the consolidated balance sheet because we guarantee them. The principal and interest on the debt are
funded by contributions from us and by dividends received on certain shares held by the ESOP. Because of the am-
ortizing feature of the ESOP debt, bondholders will receive both interest and principal payments each quarter.
The aggregate amounts of maturities on long-term debt for the next fi ve years are as follows: 2007, $210.8 mil-
lion; 2008, $1.40 billion; 2009, $21.5 million; 2010, $19.4 million; and 2011, $16.0 million.
At December 31, 2006 and 2005, short-term borrowings included $8.6 million and $13.4 million, respectively,
of notes payable to banks and commercial paper. At December 31, 2006, we have $1.21 billion of unused commit-
ted bank credit facilities, $1.20 billion of which backs our commercial paper program. Compensating balances
and commitment fees are not material, and there are no conditions that are probable of occurring under which the
lines may be withdrawn.
We have converted substantially all fi xed-rate debt to fl oating rates through the use of interest rate swaps. The
weighted-average effective borrowing rates based on debt obligations and interest rates at December 31, 2006 and
2005, including the effects of interest rate swaps for hedged debt obligations, were 5.89 percent and 4.75 percent,
respectively.
In 2006 and 2005, cash payments of interest on borrowings totaled $299.6 million and $32.0 million, respec-
tively, net of capitalized interest. In 2004, capitalized interest exceeded cash payments of interest on borrowings,
due in large part to certain debt instruments requiring interest payments only at maturity, as previously noted.
In accordance with the requirements of SFAS 133, the portion of our fi xed-rate debt obligations that is hedged
is refl ected in the consolidated balance sheets as an amount equal to the sum of the debt’s carrying value plus the
fair value adjustment representing changes in fair value of the hedged debt attributable to movements in market
interest rates subsequent to the inception of the hedge.
Note 7: Stock Plans
We adopted SFAS 123 (revised 2004), Share-Based Payment (SFAS 123R), effective January 1, 2005. SFAS 123R
requires the recognition of the fair value of stock-based compensation in net income. Stock-based compensation
primarily consists of stock options and performance awards. Stock options are granted to employees at exercise
prices equal to the fair market value of our stock at the dates of grant. Options fully vest three years from the grant
date and have a term of 10 years. Performance awards are granted to offi cers and key employees and are payable
in shares of our common stock. The number of performance award shares actually issued, if any, varies depending
on the achievement of certain earnings-per-share targets. Performance awards fully vest at the end of the fi scal
year of the grant. We recognize the stock-based compensation expense over the requisite service period of the
individual grantees, which generally equals the vesting period. We provide newly issued shares and treasury stock
to satisfy stock option exercises and for the issuance of performance awards.
Prior to January 1, 2005, we followed Accounting Principles Board (APB) Opinion 25, Accounting for Stock Is-
sued to Employees, and related interpretations in accounting for our stock options and performance awards. Under
APB 25, because the exercise price of our employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense was recognized. See Note 1 for a calculation of our net income and
earnings per share if we had applied the fair value recognition provisions of SFAS 123R to stock-based employee
compensation in 2004.
We elected the modifi ed prospective transition method for adopting SFAS 123R. Under this method, the provi-
sions of SFAS 123R apply to all awards granted or modifi ed after the date of adoption. In addition, the unrecognized
expense of awards not yet vested at the date of adoption, determined under the original provisions of SFAS 123,
shall be recognized in net income in the periods after the date of adoption. We recognized stock-based compensa-
tion cost in the amount of $359.3 million, $403.5 million, and $53.0 million, in 2006, 2005, and 2004, respectively,
as well as related tax benefi ts of $115.9 million, $122.9 million, and $18.5 million, respectively. The amounts for
2004 relate only to expenses for performance awards because no expense was recognized for stock options under
APB 25. In addition, after adopting SFAS 123R, we now classify tax benefi ts resulting from tax deductions in excess
of the compensation cost recognized for exercised stock options as a fi nancing cash fl ow in the consolidated state-
ments of cash fl ows rather than an operating cash fl ow as under our previous disclosure.
In connection with the adoption of SFAS 123R, we reassessed the valuation methodology for stock options and
the related input assumptions. As a result, beginning with the 2005 stock option grant, we utilized a lattice-based
option valuation model for estimating the fair value of the stock options. The lattice model allows the use of a range