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. Options granted under the 2010 Plan may be either incentive options or nonqualified stock options. Incentive stock options may be granted only to our employees including officers and directors. Nonqualified stock options and stock purchase rights may be granted to our employees and consultants. Generally, our stock options and RSUs vest over four years and are exercisable over a period not to exceed the contractual term of ten years from the date the stock options are granted. Continued vesting typically terminates when the employment or consulting relationship ends. In addition, as a result of our acquisition of SolarCity, we have assumed its equity award plans, and its outstanding equity awards as of the Acquisition Date. The equity awards of SolarCity were converted into equity awards to acquire Tesla 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, 2016, 4,698,501 of common shares were reserved and available for future issuance under the 2010 Plan.

The following table summarizes stock option and RSU activity under the 2010 Plan:

	Outstanding Stock Options									Outstanding RSUs
						Weighted-							Weighted-
				Weighted-		Average							Average
				Average		Remaining		*Aggregate					Grant
	Number of			Exercise		Contractual		Intrinsic		Number			Date Fair
	Options			Price		Life (Years)		Value		of RSUs			Value
Balance, December 31, 2015		20,015,180		$	46.14						2,439,674		$	219.90
Assumed through acquisition		1,304,104			283.35						382,611			185.04
Granted		853,960			211.10						2,797,973			202.59
Exercised		(8,735,830	)		12.84						—			—
Cancelled		(561,992	)		218.58						(519,908	)		215.07
Released		—			—						(1,018,261	)		212.96
Balance, December 31, 2016		12,875,422		$	96.50		5.8	$	1.72		4,082,089		$	207.11
Vested and expected to vest, December 31, 2016		12,875,422		$	96.50		5.8	$	1.72		4,082,089
Exercisable and vested, December 31, 2016		7,817,124		$	77.70		5.2	$	1.19		—
*Aggregate intrinsic value in billions

The aggregate intrinsic value represents the total pretax intrinsic value (i.e., the difference between our common stock price and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options. The total intrinsic value of options exercised was $1.68 billion, $395.6 million and $446.9 million for the years ended December 31, 2016, 2015 and 2014.

Fair Value Assumptions

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

	Year Ended December 31,
	2016			2015			2014
Risk-free interest rate:
Stock options		1.5	%		1.6	%		1.9	%
ESPP		0.6	%		0.3	%		0.1	%
Expected term (in years):
Stock options		6.2			5.4			6.0
ESPP		0.5			0.5			0.5
Expected volatility:
Stock options		47	%		48	%		55	%
ESPP		41	%		42	%		46	%
Dividend yield:
Stock options		0.0	%		0.0	%		0.0	%
ESPP		0.0	%		0.0	%		0.0	%

The risk-free interest rate that we use is based on the United States Treasury yield in effect at the time of grant for zero coupon United States Treasury notes with maturities approximating each grant’s expected life. Given our limited history with employee grants, we use the “simplified” method in estimating the expected term for our employee grants. The “simplified” method, as permitted by the SEC Staff, is calculated as the average of the time-to-vesting and the contractual life of the options.

Beginning in 2015, our expected volatility is derived from our implied volatility on publicly traded options of our common stock and the historical volatility of our common stock. Prior to 2015, our expected volatility was derived from our implied volatility on publicly traded options of our common stock and the historical volatilities of several unrelated public companies within industries related to our business, including the automotive OEM, automotive retail, automotive parts and battery technology industries, because we had limited trading history on our common stock. When making the selections of our peer companies within industries related to our business to be used in the volatility calculation, we also considered the stage of development, size and financial leverage of potential comparable companies. Our historical volatility and implied volatility are weighted based on certain qualitative factors and combined to produce a single volatility factor.

The weighted-average grant-date fair value for option awards granted during the years ended December 31, 2016, 2015 and 2014 was $98.7, $108.28 and $94.01 per share. The weighted-average grant-date fair value for ESPP granted during the years ended December 31, 2016, 2015 and 2014 was $51.31, $58.77 and $74.07 per share. The fair value of RSUs is measured on the grant date based on the closing fair market value of our common stock.

2014 Performance-based Stock Options Grants

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 our Company, the Compensation Committee of our Board of Directors granted stock options to certain employees to purchase an aggregate 1,073,000 shares of our common stock. Each such grant consists of four vesting tranches with a vesting schedule based entirely on the attainment of future performance milestones, assuming continued employment and service to us through each vesting date.

•

1/4th of the shares subject to the options are scheduled to vest upon completion of the first Model X Production Vehicle;

•

1/4th of the shares subject to the options are scheduled to vest upon achieving aggregate vehicle production of 100,000 vehicles in a trailing 12-month period;

•

1/4th of the shares subject to the options are scheduled to vest upon completion of the first Model 3 Production Vehicle; and

•

1/4th of the shares subject to the options are scheduled to vest upon achievement of annualized gross margin of greater than 30.0% in any three years

As of December 31, 2016, the following performance milestone was achieved and approved by our Board of Directors.

•

Completion of the first Model X Production Vehicle

As of December 31, 2016, the following performance milestone was considered probable of achievement.

•

Completion of the first Model 3 Production Vehicle; and

•

Achieving aggregate vehicle production of 100,000 vehicles in a trailing 12-month period

We begin recording stock-based compensation expense as each milestone becomes probable. As of December 31, 2016, we had unrecognized compensation expense of $17.5 million for those performance milestones that were not considered probable of achievement. For the years ended December 31, 2016, 2015 and 2014, we recorded stock-based compensation expense of $25.3 million, $10.4 million and $10.7 million related to this grant.

2012 CEO Grant

In August 2012, our Board of Directors granted 5,274,901 stock options to our CEO (the “2012 CEO Grant”). The 2012 CEO Grant consists of ten vesting tranches with a vesting schedule based entirely on the attainment of both performance conditions and market conditions, assuming continued employment and service to us through each vesting date.

Each of the ten vesting tranches requires a combination of one of the ten pre-determined performance milestones and an incremental increase in our market capitalization of $4.0 billion, as compared to the initial market capitalization of $3.2 billion measured at the time of the 2012 CEO Grant.

As of December 31, 2016, the market conditions for seven vesting tranches and the following five performance milestones were achieved and approved by our Board of Directors:

•

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 vehicle production of 100,000 vehicles; and

•

Successful completion of the Model 3 Alpha Prototype.

As of December 31, 2016, the following performance milestones were considered probable of achievement:

•

Successful completion of the Model 3 Beta Prototype;

•

Completion of the first Model 3 Production Vehicle;

•

Aggregate vehicle production of 200,000 vehicles; and

•

Aggregate vehicle production of 300,000 vehicles.

We expect that the next performance milestone to be achieved will be the successful completion of the Model 3 Beta Prototype, which would be achieved upon the determination by our Board of Directors that an eligible prototype has been completed. Candidates for such prototype are among the vehicles that we are currently building as part of our ongoing testing of our Model 3 vehicle design and manufacturing processes.

We begin recording stock-based compensation expense as each milestone becomes probable. As of December 31, 2016, we had $4.9 million of total unrecognized compensation expense for those performance milestones that were considered probable of achievement and will be recognized over a weighted-average period of 2.3 years. As of December 31, 2016, we had unrecognized compensation expense of $6.1 million for those performance milestones that were not considered probable of achievement. For the years ended December 31, 2016, 2015, and 2014, we recorded stock-based compensation expense of $15.8 million, $10.6 million and $25.0 million.

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 the stock-based compensation expense by line item in the consolidated statements of operations (in thousands):

	Year Ended December 31,
	2016		2015		2014
Cost of sales	$	30,400	$	19,244	$	17,454
Research and development		154,632		89,309		62,601
Selling, general and administrative		149,193		89,446		76,441
Total	$	334,225	$	197,999	$	156,496

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, 2016, we had $772.9 million of total unrecognized compensation expense, net, of estimated forfeitures, related to non-performance awards that will be recognized over a weighted-average period of 2.8 years.

Employee Stock Purchase Plan

Employees are eligible to purchase common stock through payroll deductions of up to 15% of their eligible compensation, subject to any plan limitations. The purchase price of the shares on each purchase date is equal to 85% of the lower of the fair market value of our common stock on the first and last trading days of each six-month offering period. During the years ended December 31, 2016, 2015 and 2014, we issued 321,788, 220,571 and 163,600 shares under the ESPP for $51.7 million, $37.5 million and $28.6 million, respectively. A total of 3,615,749 shares of common stock have been reserved for issuance under the ESPP, and there were 1,794,063 shares available for issuance under the ESPP as of December 31, 2016.