Stock-Based Compensation

Stock-based compensation is measured at the grant date based on the grant-date fair value of the awards ultimately expected to vest, and is recognized as an expense on a straight-line basis over the vesting period, which is generally five years for stock options and generally three years for restricted stock units. Determining the amount of stock-based compensation to be recorded requires the Company to develop estimates used in calculating the grant-date fair value of stock options.

Grant-Date Fair Value – The Company uses the Black-Scholes valuation model to calculate the grant-date fair value of stock option awards. The grant-date fair value of restricted stock units represents the value of the Company’s common stock on the date of grant, reduced by the present value of dividends expected to be paid on the Company’s common stock prior to vesting.

Information pertaining to the Company’s stock option awards and the related estimated weighted-average assumptions to calculate the fair value of stock options granted during the three- and nine-month periods ended August 4, 2012 and July 30, 2011 are as follows:



	Three Months Ended						Nine Months Ended
Stock Options	August 4, 2012			July 30, 2011			August 4, 2012			July 30, 2011
Options granted (in thousands)	36			20			2,263			1,980
Weighted-average exercise price		$36.24			$38.50			$39.65			$37.61
Weighted-average grant-date fair value		$6.73			$7.91			$7.49			$8.62
Assumptions:
Weighted-average expected volatility	30.2		%	28.2		%	28.6		%	29.2		%
Weighted-average expected term (in years)	5.3			5.3			5.3			5.3
Weighted-average risk-free interest rate	0.6		%	1.7		%	1.1		%	2.1		%
Weighted-average expected dividend yield	3.3		%	2.6		%	3.0		%	2.3		%

Expected volatility — The Company is responsible for estimating volatility and has considered a number of factors, including third-party estimates, when estimating volatility. The Company currently believes that the exclusive use of implied volatility results in the best estimate of the grant-date fair value of employee stock options because it reflects the market’s current expectations of future volatility. In evaluating the appropriateness of exclusively relying on implied volatility, the Company concluded that: (1) options in the Company’s common stock are actively traded with sufficient volume on several exchanges; (2) the market prices of both the traded options and the underlying shares are measured at a similar point in time to each other and on a date close to the grant date of the employee share options; (3) the traded options have exercise prices that are both near-the-money and close to the exercise price of the employee share options; and (4) the remaining maturities of the traded options used to estimate volatility are at least one year.

Expected term — The Company uses historical employee exercise and option expiration data to estimate the expected term assumption for the Black-Scholes grant-date valuation. The Company believes that this historical data is currently the best estimate of the expected term of a new option, and that generally its employees exhibit similar exercise behavior.

Risk-free interest rate — The yield on zero-coupon U.S. Treasury securities for a period that is commensurate with the expected term assumption is used as the risk-free interest rate.

Expected dividend yield — Expected dividend yield is calculated by annualizing the cash dividend declared by the Company’s Board of Directors for the current quarter and dividing that result by the closing stock price on the date of grant. Until such time as the Company’s Board of Directors declares a cash dividend for an amount that is different from the current quarter’s cash dividend, the current dividend will be used in deriving this assumption. Cash dividends are not paid on options, restricted stock or restricted stock units.

Stock-Based Compensation Expense

The amount of stock-based compensation expense recognized during a period is based on the value of the awards that are ultimately expected to vest. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term “forfeitures” is distinct from “cancellations” or “expirations” and represents only the unvested portion of the surrendered stock-based award. Based on an analysis of its historical forfeitures, the Company has applied an annual forfeiture rate of 4.4% to all unvested stock-based awards as of August 4, 2012. The rate of 4.4% represents the portion that is expected to be forfeited each year over the vesting period. This analysis will be re-evaluated quarterly and the forfeiture rate will be adjusted as necessary. Ultimately, the actual expense recognized over the vesting period will only be for those options that vest.

Additional paid-in-capital (APIC) Pool

The APIC pool represents the excess tax benefits related to share-based compensation that are available to absorb future tax deficiencies. If the amount of future tax deficiencies is greater than the available APIC pool, the Company records the excess as income tax expense in its condensed consolidated statements of income. During the three- and nine-month periods ended July 30, 2011, the Company had a sufficient APIC pool to provide for any tax deficiencies recorded and as a result, these deficiencies did not affect its results of operations. During the three-month period ended February 4, 2012, the Company recognized $1.8 million of income tax expense resulting from tax shortfalls related to share-based compensation in its condensed consolidated statement of income. During the three-month periods ended May 5, 2012 and August 4, 2012, the Company recorded excess tax benefits of $0.3 million and $3.9 million, respectively. The Company applied these excess tax benefits to the income tax expense previously recorded during the three-month period ended February 4, 2012, resulting in no income tax expense related to share-based compensation for the nine month period ended August 4, 2012.

Stock-Based Compensation Activity

A summary of the activity under the Company’s stock option plans as of August 4, 2012 and changes during the three- and nine-month periods then ended is presented below:



Activity during the Three Months Ended August 4, 2012	Options Outstanding (in thousands)		Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term in Years	Aggregate Intrinsic Value
Options outstanding May 5, 2012	30,438			$30.88
Options granted	36			$36.24
Options exercised	(1,023	)		$22.95
Options forfeited	(70	)		$28.49
Options expired	(48	)		$36.45
Options outstanding at August 4, 2012	29,333			$31.16	4.7	$	262,212
Options exercisable at August 4, 2012	18,019			$31.52	3.7	$	157,897
Options vested or expected to vest at August 4, 2012 (1)	28,816			$31.09	4.6	$	259,656


(1)	In addition to the vested options, the Company expects a portion of the unvested options to vest at some point in the future. Options expected to vest is calculated by applying an estimated forfeiture rate to the unvested options.



Activity during the Nine Months Ended August 4, 2012	Options Outstanding (in thousands)		Weighted- Average Exercise Price Per Share
Options outstanding October 29, 2011	34,116			$30.27
Options granted	2,263			$39.65
Options exercised	(4,553	)		$24.43
Options forfeited	(358	)		$27.82
Options expired	(2,135	)		$40.94
Options outstanding at August 4, 2012	29,333			$31.16

During the three and nine months ended August 4, 2012, the total intrinsic value of options exercised (i.e. the difference between the market price at exercise and the price paid by the employee to exercise the options) was $15.6 million and $64.9 million, respectively, and the total amount of proceeds received by the Company from exercise of these options was $23.5 million and $111.3 million, respectively. Proceeds from stock option exercises pursuant to employee stock plans in the Company’s statement of cash flows during the nine months ended August 4, 2012 of $110.7 million are net of the value of shares surrendered by employees in certain limited circumstances to satisfy the exercise price of options and employee tax obligations upon vesting of restricted stock units and in connection with the exercise of stock options granted to the Company’s employees under the Company’s equity compensation plans. The withholding amount is based on the Company’s minimum statutory withholding requirement.

During the three and nine months ended July 30, 2011, the total intrinsic value of options exercised (i.e. the difference between the market price at exercise and the price paid by the employee to exercise the options) was $18.9 million and $88.6 million, respectively, and the total amount of proceeds received by the Company from exercise of these options was $41.2 million and $189.4 million, respectively. Proceeds from stock option exercises pursuant to employee stock plans in the Company’s statement of cash flows during the nine months ended July 30, 2011 of $189.2 million are net of the value of shares surrendered by employees in certain limited circumstances to satisfy the exercise price of options and employee tax obligations upon vesting of restricted stock units and in connection with the exercise of stock options granted to the Company’s employees under the Company’s equity compensation plans. The withholding amount is based on the Company’s minimum statutory withholding requirement.

A summary of the Company’s restricted stock unit award activity as of August 4, 2012 and changes during the three- and nine-month periods then ended is presented below:



Activity during the Three Months Ended August 4, 2012	Restricted Stock Units Outstanding (in thousands)		Weighted- Average Grant- Date Fair Value Per Share
Restricted stock units outstanding at May 5, 2012	2,830			$32.71
Units granted	39			$34.10
Restrictions lapsed	(16	)		$27.24
Forfeited	(16	)		$32.65
Restricted stock units outstanding at August 4, 2012	2,837			$32.76



Activity during the Nine Months Ended August 4, 2012	Restricted Stock Units Outstanding (in thousands)		Weighted- Average Grant- Date Fair Value Per Share
Restricted stock units outstanding at October 29, 2011	2,088			$31.10
Units granted	882			$36.10
Restrictions lapsed	(63	)		$27.57
Forfeited	(70	)		$29.89
Restricted stock units outstanding at August 4, 2012	2,837			$32.76

As of August 4, 2012, there was $94.8 million of total unrecognized compensation cost related to unvested share-based awards comprised of stock options and restricted stock units. That cost is expected to be recognized over a weighted-average period of 1.4 years. The total grant-date fair value of shares that vested during the three and nine months ended August 4, 2012 was approximately $0.6 million and $27.4 million, respectively. The total grant-date fair value of shares that vested during the three and nine months ended July 30, 2011 was approximately $0.4 million and $27.4 million, respectively.