Share-Based Compensation

On October 7, 2008, the Company’s stockholders approved the Kansas City Southern 2008 Stock Option and Performance Award Plan (the “2008 Plan”). The 2008 plan became effective on October 14, 2008 and replaced the Kansas City Southern 1991 Amended and Restated Stock Option and Performance Award Plan. The 2008 Plan provides for the granting of up to 2.3 million shares of the Company’s common stock to eligible persons as defined in the 2008 Plan.

Stock Options. The exercise price for options granted under the 2008 Plan equals the closing market price of the Company’s stock on the date of grant. Options generally have a 3 year vesting period and are exercisable over the 10 year contractual term, except that options outstanding become immediately exercisable upon certain defined circumstances constituting a change in control of the Company. The grant date fair value, less estimated forfeitures, is recorded to expense on a straight-line basis over the vesting period.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model. The weighted-average assumptions used were as follows:



	2014			2013			2012
Expected dividend yield	1.19		%	0.88		%	0		%
Expected volatility	45.57		%	46.12		%	46.59		%
Risk-free interest rate	1.96		%	1.11		%	0.46		%
Expected term (years)	6.0			6.0			6.0
Weighted-average grant date fair value of stock options granted	$	38.31		$	40.05		$	29.45

The expected dividend yield is calculated as the ratio of dividends paid per share of common stock to the stock price on the date of grant. The expected dividend yield for 2012 was 0% as all stock options were granted prior to the initial dividend declaration on March 30, 2012. The expected volatility is based on the historical volatility of the Company’s stock price over a term equal to the estimated life of the options. The risk-free interest rate is determined based on U.S. Treasury rates for instruments with terms approximating the expected life of the options granted, which represents the period of time the awards are expected to be outstanding and is based on the historical experience of similar awards.

A summary of stock option activity is as follows:



	Number of Shares		Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
					In years	In millions
Options outstanding at December 31, 2013	362,759		$	54.94
Granted	53,021		94.23
Exercised	(46,100	)	43.93
Forfeited or expired	(13,582	)	91.32
Options outstanding at December 31, 2014	356,098		$	60.83	6.58	$	21.8
Vested and expected to vest at December 31, 2014	353,769		$	60.64	6.57	$	21.7
Exercisable at December 31, 2014	256,888		$	49.62	5.88	$	18.6

Compensation cost of $1.7 million, $2.4 million, and $1.8 million was recognized for stock option awards for the years ended December 31, 2014, 2013, and 2012, respectively. The total income tax benefit recognized in the consolidated statements of income was $0.7 million, $0.9 million, and $0.7 million for the years ended December 31, 2014, 2013 and 2012, respectively.

Additional information regarding stock option exercises appears in the table below (in millions):



	2014		2013		2012
Aggregate grant-date fair value of stock options vested	$	2.3	$	1.8	$	1.3
Intrinsic value of stock options exercised	3.3		5.0		12.1
Cash received from option exercises	2.0		1.5		1.9
Tax benefit realized from options exercised during the annual period	1.3		1.9		4.6

As of December 31, 2014, $1.0 million of unrecognized compensation cost relating to nonvested stock options is expected to be recognized over a weighted-average period of 1.0 year. At December 31, 2014, there were 1,059,927 shares available for future grants under the 2008 Plan.

Nonvested Stock. The 2008 Plan provides for the granting of nonvested stock awards to officers and other designated employees. The grant date fair value is based on the closing market price on the date of the grant. These awards are subject to forfeiture if employment terminates during the vesting period, which is generally 3 year or 5 year vesting for employees. Awards granted to the Company’s directors vest immediately on date of grant. The grant date fair value of nonvested shares, less estimated forfeitures, is recorded to compensation expense on a straight-line basis over the vesting period.

A summary of nonvested stock activity is as follows:



	Number of Shares		Weighted- Average Grant Date Fair Value		Aggregate Intrinsic Value
					In millions
Nonvested stock at December 31, 2013	202,060		$	63.00
Granted	75,541		105.04
Vested	(82,642	)	54.53
Forfeited	(38,266	)	66.45
Nonvested stock at December 31, 2014	156,693		$	86.89	$	19.1

The fair value (at vest date) of shares vested during the years ended December 31, 2014, 2013, and 2012 was $8.5 million, $12.2 million, and $7.8 million, respectively.

The weighted-average grant date fair value of nonvested stock granted during 2014, 2013, and 2012 was $105.04, $103.38 and $70.98, respectively. Compensation cost for nonvested stock was $4.0 million, $5.6 million, and $4.4 million for the years ended December 31, 2014, 2013, and 2012, respectively. The total income tax benefit recognized in the consolidated statements of income was $1.5 million, $2.1 million, and $1.6 million for the years ended December 31, 2014, 2013, and 2012, respectively.

As of December 31, 2014, $7.2 million of unrecognized compensation costs related to nonvested stock is expected to be recognized over a weighted-average period of 1.9 years.

Performance Based Awards. The Company granted performance based nonvested stock awards during 2014 (the “2014 Awards”), 2013 (the “2013 Awards”) and 2012 (the “2012 Awards”). The awards granted provide a target number of shares that generally vest at the end of a 3 year requisite service period following the grant date. In addition to the service condition, the number of nonvested shares to be received depends on the attainment of defined Company-wide performance goals based on operating ratio and return on invested capital over a three-year performance period. The number of nonvested shares ultimately earned will range between zero to 200% of the target award.

A summary of performance based nonvested stock activity at target is as follows:



	Target Number of Shares *		Weighted-Average Grant Date Fair Value
Nonvested stock, at December 31, 2013	178,886		$	69.19
Granted	43,110		94.23
Vested	(72,900	)	52.66
Forfeited	(17,031	)	86.59
Nonvested stock, at December 31, 2014	132,065		$	84.24

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* For the 2014 Awards and the 2013 Awards, participants in the aggregate can earn up to a maximum of 74,298 and 52,838 shares, respectively. For the 2012 Awards, the performance shares earned were 45,000.

The weighted-average grant date fair value of performance based nonvested stock granted during 2014, 2013 and 2012 was $94.23, $82.34 and $62.81, respectively. The Company expenses the grant date fair value of the awards which are probable of being earned over the performance periods. Compensation cost on performance based awards was $3.7 million, $5.1 million and $4.0 million for the years ended December 31, 2014, 2013 and 2012, respectively. Total income tax benefit recognized in the consolidated statements of income for performance based awards was $1.3 million, $1.9 million and $1.5 million for the years ended December 31, 2014, 2013 and 2012, respectively.

As of December 31, 2014, $4.0 million of unrecognized compensation cost related to performance based awards is expected to be recognized over a weighted-average period of 0.9 year. The fair value (at vest date) of shares vested for the year ended December 31, 2014 was $6.8 million.

Employee Stock Purchase Plan. The employee stock purchase plan (“ESPP”) provides substantially all full-time employees of the Company, certain subsidiaries and certain other affiliated entities, with the right to subscribe to an aggregate of 4.0 million shares of common stock of the Company.

Prior to January 1. 2015, eligible employees could contribute, through payroll deductions, up to 5% of their regular base compensation during six-month purchase periods.

The purchase price for shares was equal to 90% of the closing market price on either the exercise date or the offering date, whichever was lower. Effective January 1, 2015, the ESPP plan was amended to allow eligible employees to contribute up to 10% of their regular base compensation during six-month purchase periods at a purchase price equal to 85% of the closing market price on either the exercise date or the offering date, whichever is lower.

At the end of each purchase period, the accumulated deductions are applied toward the purchase of the Company’s common stock. Both the discount in grant price and the share option purchase price are valued to derive the award’s fair value. The awards vest and the expense is recognized ratably over the offering period.

The following table summarizes activity related to the various ESPP offerings:



	Exercise Date				Received from Employees(i)
	Date Issued	Purchase Price		Shares Issued	Received from Employees(i)
					In millions
July 2014 offering	January 9, 2015	$	96.48	17,639	$	1.7
January 2014 offering	July 10, 2014	96.76		17,026	1.6
July 2013 offering	January 13, 2014	97.58		16,376	1.6
January 2013 offering	July 12, 2013	77.53		19,292	1.5
July 2012 offering	January 14, 2013	61.73		23,099	1.4
January 2012 offering	July 13, 2012	61.84		21,559	1.3

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(i)	Represents amounts received from employees through payroll deductions for share purchases under applicable offering.

The fair value of the ESPP stock purchase rights is estimated on the date of grant using the Black-Scholes option pricing model. The weighted-average assumptions used for each of the respective periods were as follows:



	Year Ended December 31,
	2014			2013			2012
Expected dividend yield	0.99		%	0.90		%	0.59		%
Expected volatility	19.03		%	18.30		%	28.97		%
Risk-free interest rate	0.10		%	0.13		%	0.14		%
Expected term (years)	0.5			0.5			0.5
Weighted-average grant date fair value	$	17.13		$	14.48		$	12.40

Compensation expense of $0.6 million, $0.5 million, and $0.5 million was recognized for ESPP option awards for the years ended December 31, 2014, 2013, and 2012, respectively. At December 31, 2014, there were 3.8 million remaining shares available for future ESPP offerings under the plan.