Note 5 – Shareholders’ Equity and Stock-Based Compensation

Preferred Stock

The Company has five million shares of authorized preferred stock, none of which is issued or outstanding. Under the terms of the Company’s Restated Articles of Incorporation, the Board of Directors is authorized to determine or alter the rights, preferences, privileges and restrictions of the Company’s authorized but unissued shares of preferred stock.

Comprehensive Income

Comprehensive income consists of two components, net income and other comprehensive income. Other comprehensive income refers to revenue, expenses, gains, and losses that under GAAP are recorded as an element of shareholders’ equity but are excluded from net income. The Company’s other comprehensive income consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, unrealized gains and losses on marketable securities categorized as available-for-sale, and net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges.

The following table summarizes the components of total comprehensive income, net of taxes, during the three- and nine-month periods ended June 25, 2011 and June 26, 2010 (in millions):

		September 30,		September 30,			September 30,		September 30,
	Three Months Ended					Nine Months Ended
	June 25, 2011		June 26, 2010			June 25, 2011		June 26, 2010
Net income	$	7,308	$	3,253		$	19,299	$	9,705
Other comprehensive income:
Change in unrecognized gains/losses on derivative instruments		112		13			273		41
Change in foreign currency translation		11		(54	)		101		(43	)
Change in unrealized gains/losses on marketable securities		140		24			61		33

Total comprehensive income	$	7,571	$	3,236		$	19,734	$	9,736

The following table summarizes activity in other comprehensive income related to derivatives, net of taxes, held by the Company during the three- and nine-month periods ended June 25, 2011 and June 26, 2010 (in millions):

		September 30,		September 30,			September 30,			September 30,
	Three Months Ended					Nine Months Ended
	June 25, 2011		June 26, 2010			June 25, 2011			June 26, 2010
Change in fair value of derivatives	$	8	$	55		$	(175	)	$	91
Adjustment for net gains/losses realized and included in income		104		(42	)		448			(50	)

Change in unrecognized gains/losses on derivative instruments	$	112	$	13		$	273		$	41

The following table summarizes the components of AOCI, net of taxes, as of June 25, 2011 and September 25, 2010 (in millions):

		September 30, 2009		September 30, 2009
	June 25, 2011		September 25, 2010
Net unrealized gains/losses on marketable securities	$	232	$	171
Net unrecognized gains/losses on derivative instruments		21		(252	)
Cumulative foreign currency translation		136		35

Accumulated other comprehensive income/(loss)	$	389	$	(46	)

Equity Awards

A summary of the Company’s RSU activity and related information for the nine months ended June 25, 2011, is as follows (in thousands, except per share amounts):

		September 30,			September 30,		September 30,
	Number of Shares			Weighted- Average Grant Date Fair Value		Aggregate Intrinsic Value
Balance at September 25, 2010		13,034		$	165.63
RSUs granted		5,232		$	296.08
RSUs vested		(4,224	)	$	166.49
RSUs cancelled		(609	)	$	183.53

Balance at June 25, 2011		13,433		$	215.35	$	4,383,924

RSUs that vested during the three- and nine-month periods ended June 25, 2011 had a fair value of $637 million and $1.4 billion, respectively, as of the vesting dates. RSUs that vested during the three- and nine-month periods ended June 26, 2010 had a fair value of $353 million and $990 million, respectively, as of the vesting dates.

A summary of the Company’s stock option activity and related information for the nine months ended June 25, 2011, is as follows (in thousands, except per share amounts and contractual term in years):

		September 30,			September 30,		September 30,		September 30,
	Number of Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term		Aggregate Intrinsic Value
Balance at September 25, 2010		21,725		$	90.46
Options granted		1		$	342.62
Options cancelled		(149	)	$	124.71
Options exercised		(7,822	)	$	63.20

Balance at June 25, 2011		13,755		$	105.62		2.54	$	3,036,128

Exercisable at June 25, 2011		12,431		$	99.59		2.43	$	2,818,845
Expected to vest after June 25, 2011		1,324		$	162.24		3.57	$	217,283

Aggregate intrinsic value represents the value of the Company’s closing stock price on the last trading day of the fiscal period in excess of the weighted-average exercise price multiplied by the number of options outstanding or exercisable. The aggregate intrinsic value excludes stock options that have a zero or negative intrinsic value. The total intrinsic value of options at the time of exercise was $248 million and $2.1 billion for the three- and nine-month periods ended June 25, 2011, respectively, and $559 million and $1.6 billion for the three- and nine-month periods ended June 26, 2010, respectively.

The Company had approximately 53.6 million shares and 62.7 million shares reserved for future issuance under the Company’s stock plans as of June 25, 2011 and September 25, 2010, respectively. RSUs granted are deducted from the shares available for grant under the Company’s stock plans utilizing a factor of two times the number of RSUs granted. Similarly, RSUs cancelled are added back to the shares available for grant under the Company’s stock plans utilizing a factor of two times the number of RSUs cancelled.

Stock-Based Compensation

Stock-based compensation cost for RSUs is measured based on the closing fair market value of the Company’s common stock on the date of grant. Stock-based compensation cost for stock options and employee stock purchase plan rights (“stock purchase rights”) is estimated at the grant date and offering date, respectively, based on the fair-value as calculated using the Black-Scholes Merton (“BSM”) option-pricing model. The BSM option-pricing model incorporates various assumptions including expected volatility, expected life and interest rates. The expected volatility is based on the historical volatility of the Company’s common stock over the most recent period commensurate with the expected life of the Company’s stock options and other relevant factors including implied volatility in market traded options on the Company’s common stock. The Company bases its expected life assumption on its historical experience and on the terms and conditions of the stock awards it grants to employees. The Company recognizes stock-based compensation cost as expense on a straight-line basis over the requisite service period.

The Company did not grant any stock options during the three-month periods ended June 25, 2011 and June 26, 2010. The Company granted 1,370 stock options with a weighted-average grant date fair value of $181.13 per share during the nine months ended June 25, 2011 and granted approximately 34,000 stock options with a weighted-average grant date fair value of $108.58 per share during the nine months ended June 26, 2010.

The Company did not assume any stock options during the three- and nine-month periods ended June 25, 2011. During the three- and nine-month periods ended June 26, 2010, the Company assumed 31,000 and 98,000 stock options, respectively, in conjunction with certain business combinations. The weighted-average fair value of stock options assumed during the three- and nine-month periods ended June 26, 2010 was $256.63 and $216.82, respectively.

The weighted-average fair value of stock purchase rights per share was $72.63 and $67.70 during the three- and nine-month periods ended June 25, 2011, respectively, and was $46.82 and $41.98 during the three- and nine-month periods ended June 26, 2010, respectively.

The following table summarizes the stock-based compensation expense included in the Condensed Consolidated Statements of Operations for the three- and nine-month periods ended June 25, 2011 and June 26, 2010 (in millions):

		September 30,		September 30,		September 30,		September 30,
	Three Months Ended				Nine Months Ended
	June 25, 2011		June 26, 2010		June 25, 2011		June 26, 2010
Cost of sales	$	52	$	38	$	155	$	112
Research and development		119		80		336		240
Selling, general and administrative		113		101		379		303

Total stock-based compensation expense	$	284	$	219	$	870	$	655

The income tax benefit related to stock-based compensation expense was $113 million and $349 million for the three- and nine-month periods ended June 25, 2011, respectively, and $77 million and $238 million for the three- and nine-month periods ended June 26, 2010, respectively. As of June 25, 2011, the total unrecognized compensation cost related to outstanding stock options and RSUs was $2.3 billion, which the Company expects to recognize over a weighted-average period of 2.8 years.

Employee Benefit Plans

Rule 10b5-1 Trading Plans

During the third quarter of 2011, executive officers Timothy D. Cook, Peter Oppenheimer, D. Bruce Sewell and Jeffrey E. Williams, and directors William V. Campbell and Arthur D. Levinson had trading plans pursuant to Rule 10b5-1(c)(1) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). A trading plan is a written document that pre-establishes the amounts, prices and dates (or a formula for determining the amounts, prices and dates) of future purchases or sales of the Company’s stock, including the exercise and sale of employee stock options and shares acquired pursuant to the Company’s employee stock purchase plan and upon vesting of RSUs.