Note 15 – Equity Incentive Plans

In 2010, we adopted the 2010 Equity Incentive Plan (the “2010 Plan”). The 2010 Plan provides for the granting of stock options, RSUs and stock purchase rights to our employees, directors and consultants. Stock options granted under the 2010 Plan may be either incentive stock options or nonqualified stock options. Incentive stock options may only be granted to our employees. Nonqualified stock options may be granted to our employees, directors and consultants. Generally, our stock options and RSUs vest over up to four years and are exercisable over a maximum period of 10 years from their grant dates. Vesting typically terminates when the employment or consulting relationship ends. In addition, as a result of our acquisition of SolarCity, we assumed its equity award plans and its outstanding equity awards as of the Acquisition Date. SolarCity’s outstanding equity awards were converted into equity awards to acquire our common stock in share amounts and prices based on the Exchange Ratio, with the equity awards retaining the same vesting and other terms and conditions as in effect immediately prior to the acquisition. The vesting and other terms and conditions of the assumed equity awards are substantially the same as those of the 2010 Plan.

As of December 31, 2017, 7,045,637 shares were reserved and available for issuance under the 2010 Plan.

The following table summarizes our stock option and RSU activity:

	Stock Options								RSUs
						Weighted-						Weighted-
				Weighted-		Average	Aggregate					Average
				Average		Remaining	Intrinsic					Grant
	Number of			Exercise		Contractual	Value		Number			Date Fair
	Options			Price		Life (Years)	(Billions)		of RSUs			Value
Balance, December 31, 2016		12,875,422		$	96.50					4,082,089		$	207.11
Granted		1,163,678		$	310.13					3,073,404		$	308.71
Exercised or released		(2,324,871	)	$	81.04		$	0.54		(1,561,889	)	$	216.46
Cancelled		(833,204	)	$	327.33					(904,294	)	$	233.59
Balance, December 31, 2017		10,881,025		$	105.56	5.3	$	2.30		4,689,310		$	265.43
Vested and expected to vest, December 31, 2017		10,881,025		$	105.56	5.3	$	2.30		4,689,310		$	265.43
Exercisable and vested, December 31, 2017		8,029,228		$	77.56	4.7	$	1.91

The aggregate release date fair value of RSUs in the years ended December 31, 2017, 2016 and 2015 was $491.0 million, $203.9 million and $94.5 million, respectively.

Fair Value Assumptions

We use the fair value method in recognizing stock-based compensation expense. Under the fair value method, we estimate the fair value of each stock option award and the ESPP on the grant date generally using the Black-Scholes option pricing model and the weighted-average assumptions in the following table:

	Year Ended December 31,
	2017			2016			2015
Risk-free interest rate:
Stock options		1.8	%		1.5	%		1.6	%
ESPP		1.1	%		0.6	%		0.3	%
Expected term (in years):
Stock options		5.1			6.2			5.4
ESPP		0.5			0.5			0.5
Expected volatility:
Stock options		42	%		47	%		48	%
ESPP		35	%		41	%		42	%
Dividend yield:
Stock options		0.0	%		0.0	%		0.0	%
ESPP		0.0	%		0.0	%		0.0	%
Grant date fair value per share:
Stock options	$	122.25		$	98.70		$	108.28
ESPP	$	75.05		$	51.31		$	58.77

The fair value of RSUs is measured on the grant date based on the closing fair market value of our common stock. The risk-free interest rate is based on the U.S. Treasury yield for zero-coupon U.S. Treasury notes with maturities approximating each grant’s expected life. Prior to the fourth quarter of 2017, given our then limited history with employee grants, we used the “simplified” method in estimating the expected term of our employee grants; the simplified method utilizes the average of the time-to-vesting and the contractual life of the employee grant. Beginning with the fourth quarter of 2017, we use our historical data in estimating the expected term of our employee grants. The expected volatility is based on the average of the implied volatility of publicly traded options for our common stock and the historical volatility of our common stock.

2014 Performance-Based Stock Option Awards

In 2014, to create incentives for continued long-term success beyond the Model S program and to closely align executive pay with our stockholders’ interests in the achievement of significant milestones by us, the Compensation Committee of our Board of Directors granted stock option awards to certain employees (excluding our CEO) to purchase an aggregate of 1,073,000 shares of our common stock. Each award consisted of the following four vesting tranches with the vesting schedule based entirely on the attainment of the future performance milestones, assuming continued employment and service through each vesting date:

•

1/4th of each award vests upon completion of the first Model X production vehicle;

•

1/4th of each award vests upon achieving aggregate production of 100,000 vehicles in a trailing 12-month period;

•

1/4th of each award vests upon completion of the first Model 3 production vehicle; and

•

1/4th of each award vests upon achieving an annualized gross margin of greater than 30% for any three-year period.

As of December 31, 2017, the following performance milestones had been achieved:

•

Completion of the first Model X production vehicle;

•

Completion of the first Model 3 production vehicle; and

•

Aggregate production of 100,000 vehicles in a trailing 12-month period.

We begin recognizing stock-based compensation expense as each performance milestone becomes probable of achievement. As of December 31, 2017, we had unrecognized stock-based compensation expense of $13.1 million for the performance milestone that was considered not probable of achievement. For the years ended December 31, 2017, 2016 and 2015, we recorded stock-based compensation expense of $6.8 million, $25.3 million and $10.4 million, respectively, related to these awards.

2012 CEO Award

In August 2012, our Board of Directors granted 5,274,901 stock option awards to our CEO (the “2012 CEO Grant”). The 2012 CEO Grant consists of 10 vesting tranches with a vesting schedule based entirely on the attainment of both performance conditions and market conditions, assuming continued employment and service through each vesting date. Each vesting tranche requires a combination of a pre-determined performance milestone and an incremental increase in our market capitalization of $4.00 billion, as compared to our initial market capitalization of $3.20 billion at the time of grant. As of December 31, 2017, the market capitalization conditions for all of the vesting tranches and the following performance milestones had been achieved:

•

Successful completion of the Model X alpha prototype;

•

Successful completion of the Model X beta prototype;

•

Completion of the first Model X production vehicle;

•

Aggregate production of 100,000 vehicles;

•

Successful completion of the Model 3 alpha prototype;

•

Successful completion of the Model 3 beta prototype;

•

Completion of the first Model 3 production vehicle; and

•

Aggregate production of 200,000 vehicles.

As of December 31, 2017, the following performance milestone was considered probable of achievement:

•

Aggregate production of 300,000 vehicles.

We begin recognizing stock-based compensation expense as each milestone becomes probable of achievement. As of December 31, 2017, the unrecognized stock-based compensation expense for the performance milestone that was considered probable of achievement was immaterial. As of December 31, 2017, we had unrecognized stock-based compensation expense of $5.7 million for the performance milestone that was considered not probable of achievement. For the years ended December 31, 2017, 2016 and 2015, we recorded stock-based compensation expense of $5.1 million, $15.8 million and $10.6 million, respectively, related to the 2012 CEO Grant.

Our CEO earns a base salary that reflects the currently applicable minimum wage requirements under California law, and he is subject to income taxes based on such base salary. However, he has never accepted and currently does not accept his salary.

Summary Stock-Based Compensation Information

The following table summarizes our stock-based compensation expense by line item in the consolidated statements of operations (in thousands):

	Year Ended December 31,
	2017		2016		2015
Cost of sales	$	43,845	$	30,400	$	19,244
Research and development		217,616		154,632		89,309
Selling, general and administrative		205,299		149,193		89,446
Total	$	466,760	$	334,225	$	197,999

We realized no income tax benefit from stock option exercises in each of the periods presented due to recurring losses and valuation allowances. As of December 31, 2017, we had $1.34 billion of total unrecognized stock-based compensation expense related to non-performance awards, which will be recognized over a weighted-average period of 3.0 years.

ESPP

Our employees are eligible to purchase our common stock through payroll deductions of up to 15% of their eligible compensation, subject to any plan limitations. The purchase price would be 85% of the lower of the fair market value on the first and last trading days of each six-month offering period. During the years ended December 31, 2017, 2016 and 2015, we issued 370,173, 321,788 and 220,571 shares under the ESPP for $71.0 million, $51.7 million and $37.5 million, respectively. There were 1,423,978 shares available for issuance under the ESPP as of December 31, 2017.