Stock-Based Compensation

Our stock-based compensation expense is associated with stock options, restricted stock units, or RSUs, and performance stock units, or PSUs, and is measured based on the estimated fair value of equity awards at the grant date.

We estimate the fair value of employee stock options on the date of grant using a binomial model and recognize the expense using a straight-line attribution method over the requisite employee service period. We use the closing trading price of our common stock on the date of grant, minus a dividend yield discount, as the fair value of awards of RSUs and PSUs. The compensation expense for the RSUs is recognized using a straight-line attribution method over the requisite employee service period while compensation expense for PSUs is recognized using an accelerated amortization model. We estimate the fair value of shares to be issued under our employee stock purchase plan using the Black-Scholes model at the commencement of an offering period in March and September of each year. Stock-based compensation for our employee stock purchase plan is expensed using an accelerated amortization model.

Our condensed consolidated statements of income include stock-based compensation expense, net of amounts capitalized as inventory, as follows:



	Three Months Ended
	April 27, 2014		April 28, 2013
	(In thousands)
Cost of revenue	$	2,919	$	2,653
Research and development	20,494		21,935
Sales, general and administrative	12,108		8,809
Total	$	35,521	$	33,397

During the three months ended April 27, 2014, we granted 7,800 stock options, with a total grant-date fair value of $35,880 and a weighted average grant-date fair value of $4.60 per option. During the three months ended April 27, 2014, we granted 3.3 million RSUs and PSUs, with a total grant-date fair value of $55.7 million and a weighted average grant-date fair value of $17.13 per share. The PSUs granted during the three months ended April 27, 2014, were granted to our CEO and senior management as approved by our Compensation Committee.

During the three months ended April 28, 2013, we granted 2.8 million stock options, with a total grant-date fair value of $8.7 million and a weighted average grant-date fair value of $3.11 per option. During the three months ended April 28, 2013, we granted 4.9 million RSUs, with a total grant-date fair value of $57.4 million and a weighted average grant-date fair value of $11.72 per RSU.

Of the total grant-date fair value, we estimated that the stock-based compensation expense related to the equity awards that were not expected to vest was $10.0 million and $11.8 million for the three months ended April 27, 2014 and April 28, 2013, respectively. As of April 27, 2014 and January 26, 2014, the aggregate amount of unearned stock-based compensation expense related to our equity awards was $259.6 million and $241.3 million, respectively, adjusted for estimated forfeitures. As of April 27, 2014 and January 26, 2014, we expected to recognize the unearned stock-based compensation expense related to stock options over an estimated weighted average amortization period of 2.3 years and 2.5 years, respectively. As of April 27, 2014 and January 26, 2014, we expected to recognize the unearned stock-based compensation expense related to RSUs and PSUs over an estimated weighted average amortization period of 2.8 years and 2.7 years, respectively.

Valuation Assumptions

We determine the fair value of stock option awards on the date of grant using an option-pricing model that is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, weighted average expected term, risk-free interest rate, expected stock price volatility, dividend yield, actual and projected employee stock option exercise behaviors, vesting schedules and death and disability probabilities. We segregate options into groups of employees with relatively homogeneous exercise behavior in order to calculate the best estimate of fair value using the binomial valuation model.

The expected life of employee stock options is a derived output of our valuation model and is impacted by the underlying assumptions of our company. The risk-free interest rate assumption is based upon observed interest rates on Treasury bills appropriate for the term of our employee stock options. Our management has determined that the use of implied volatility is expected to be more reflective of market conditions and, therefore, can reasonably be expected to be a better indicator of our expected volatility than historical volatility. Dividend yield is based on history and expectation of dividend payouts. Our RSU and PSU awards are not eligible for cash dividends prior to vesting; therefore, the fair value of RSUs and PSUs is discounted by the dividend yield.

We use a dividend yield at grant date based on the per share dividends declared during the most recent quarter. Additionally, for all employee equity awards, we estimate forfeitures annually and revise the estimates of forfeiture in subsequent periods if actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience.

The fair value of stock options granted under our equity incentive plan and shares issued under our employee stock purchase plan have been estimated at the date of grant with the following assumptions:



	Three Months Ended
	April 27, 2014		April 28, 2013
Stock Options	(Using a binomial model)
Expected life (in years)	3.2		3.2 - 3.3
Risk-free interest rate	2.8	%	1.8% - 2.1%
Volatility	31	%	32% - 37%
Dividend yield	1.9	%	2.3% - 2.4%



	Three Months Ended
	April 27, 2014		April 28, 2013
Employee Stock Purchase Plan	(Using a Black-Scholes model)
Expected life (in years)	0.5 - 2.0		0.5 - 2.0
Risk-free interest rate	0.1% - 0.3%		0.1% - 0.3%
Volatility	31	%	37	%
Dividend yield	1.9	%	2.4	%

Equity Award Activity

The following summarizes the stock option, RSU and PSU activity under our equity incentive plans:



	Options Outstanding		Weighted Average Exercise Price
Stock Options	(In thousands)		(Per share)
Balances, January 26, 2014	32,504		$	14.22
Granted	8		$	17.20
Exercised	(4,801	)	$	13.14
Cancelled	(486	)	$	20.31
Balances, April 27, 2014	27,225		$	14.30



	RSUs and PSUs Outstanding		Weighted Average Grant-Date Fair Value
RSUs and PSUs	(In thousands)		(Per share)
Balances, January 26, 2014	18,852		$	13.82
Granted (1)	3,254		$	17.13
Vested	(3,303	)	$	13.31
Cancelled	(367	)	$	13.24
Balances, April 27, 2014	18,436		$	14.51

(1) Includes the total number of PSUs issuable if the maximum corporate financial performance target level for fiscal year 2015 is achieved. Depending on the actual level of achievement of the corporate performance goal at the end of fiscal year 2015, the range of PSUs issued could range from 0 to 2.5 million shares.