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 three years for restricted stock units/awards. In addition to restricted stock units with a service condition, the Company grants restricted stock units with both a market condition and a service condition (market-based restricted stock units) and in the third quarter of fiscal 2017, granted restricted stock units with both a performance condition and a service condition. The number of shares of the Company's common stock to be issued upon vesting of market-based restricted stock units will range from 0% to 200% of the target amount, based on the comparison of the Company's total shareholder return (TSR) to the median TSR of a specified peer group over a three-year period. TSR is a measure of stock price appreciation plus any dividends paid during the performance period. Determining the amount of stock-based compensation to be recorded for stock options and market-based restricted stock units requires the Company to develop estimates to calculate the grant-date fair value of awards.

Linear Replacement Awards — In connection with the Acquisition, the Company issued equity awards, consisting of restricted stock awards and restricted stock units (replacement awards), to certain Linear employees in replacement of Linear equity awards. The replacement awards consisted of restricted stock awards and restricted stock units for approximately 2.8 million shares of the Company's common stock with a weighted average grant date fair value of $82.20. The terms and intrinsic value of these replacement awards are substantially the same as the converted Linear awards. The fair value of the replacement awards associated with services rendered through the Acquisition Date was recognized as a component of the total preliminary estimated acquisition consideration, and the remaining fair value of the replacement awards associated with post-Acquisition services will be recognized as an expense on a straight-line basis over the remaining vesting period.

Modification of Awards — The Company has from time to time modified the vesting terms of its equity awards to employees and directors. The modifications made to the Company’s equity awards in the first nine months of fiscal 2017 or fiscal 2016 did not result in significant incremental compensation costs, either individually or in the aggregate.

Grant-Date Fair Value — The Company uses the Black-Scholes valuation model to calculate the grant-date fair value of stock option awards and the Monte Carlo simulation model to calculate the grant-date fair value of market-based restricted stock units. The use of these valuation models requires the Company to make estimates and assumptions, such as expected volatility, expected term, risk-free interest rate, expected dividend yield and forfeiture rates. The grant-date fair value of restricted stock units with a service condition and those with both a service and performance condition 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 using the Black-Scholes valuation model granted during the three- and nine-month periods ended July 29, 2017 and July 30, 2016 are as follows:



	Three Months Ended						Nine Months Ended
Stock Options	July 29, 2017			July 30, 2016			July 29, 2017			July 30, 2016
Options granted (in thousands)	98			23			1,474			1,738
Weighted-average exercise price		$79.85			$56.20			$82.97			$54.92
Weighted-average grant-date fair value		$15.75			$10.86			$17.12			$12.77
Assumptions:
Weighted-average expected volatility	26.2		%	29.1		%	26.4		%	34.2		%
Weighted-average expected term (in years)	5.0			5.1			5.1			5.1
Weighted-average risk-free interest rate	1.8		%	1.2		%	2.1		%	1.4		%
Weighted-average expected dividend yield	2.3		%	3.0		%	2.2		%	3.1		%

The Company utilizes the Monte Carlo simulation valuation model to value market-based restricted stock units. The Monte Carlo simulation model utilizes multiple input variables that determine the probability of satisfying the market conditions stipulated in the award grant and calculates the fair market value for the market-based restricted stock units granted. The Monte Carlo simulation model also uses stock price volatility and other variables to estimate the probability of satisfying the market conditions, including the possibility that the market condition may not be satisfied, and the resulting fair value of the award. Information pertaining to the market-based restricted stock units and the related estimated assumptions used to calculate the fair value of the market-based restricted stock units granted during the nine-month periods ended July 29, 2017 and July 30, 2016 using the Monte Carlo simulation model are as follows:



	Nine Months Ended			Nine Months Ended
Market-based Restricted Stock Units	July 29, 2017			July 30, 2016
Units granted (in thousands)	59			102
Grant-date fair value		$94.25			$58.95
Assumptions:
Historical stock price volatility	26.0		%	25.1		%
Risk-free interest rate	1.6		%	1.1		%
Expected dividend yield	2.2		%	3.0		%

The Company did not grant market-based restricted stock units during the three-month periods ended July 29, 2017 or July 30, 2016.

Expected volatility — The Company is responsible for estimating volatility and has considered a number of factors, including third-party estimates. 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. The Company utilizes historical volatility as an input variable of the Monte Carlo simulation to estimate the grant date fair value of market-based restricted stock units. The market performance measure of these awards is based upon the interaction of multiple peer companies. Given the Company is required to use consistent statistical properties in the Monte Carlo simulation and implied volatility is not available across the population, historical volatility must be used.

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 or restricted stock units. In connection with the Acquisition, the Company granted restricted stock awards to replace outstanding restricted stock awards of Linear employees. These restricted stock awards entitle recipients to voting and nonforfeitable dividend rights from the date of grant.

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 4.7% to all unvested stock-based awards as of July 29, 2017. 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 29, 2017 and July 30, 2016, the Company had a sufficient APIC pool to cover any tax deficiencies recorded and as a result, these deficiencies did not affect its results of operations.

Stock-Based Compensation Activity

A summary of the Company’s stock option activity as of July 29, 2017 and changes during the three- and nine-month periods then ended is presented below:



Activity during the Three Months Ended July 29, 2017	Options Outstanding (in thousands)		Weighted- Average Exercise Price Per Share		Weighted- Average Remaining Contractual Term in Years	Aggregate Intrinsic Value
Options outstanding at April 29, 2017	10,530			$50.49
Options granted	98			$79.85
Options exercised	(456	)		$39.42
Options forfeited	(59	)		$59.68
Options expired	(1	)		$48.94
Options outstanding at July 29, 2017	10,112			$51.22	6.3		$288,944
Options exercisable at July 29, 2017	5,602			$41.47	4.7		$211,596
Options vested or expected to vest at July 29, 2017 (1)	9,725			$50.59	6.2		$283,617


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



Activity during the Nine Months Ended July 29, 2017	Options Outstanding (in thousands)		Weighted- Average Exercise Price Per Share
Options outstanding at October 29, 2016	11,704			$44.43
Options granted	1,474			$82.97
Options exercised	(2,724	)		$38.81
Options forfeited	(335	)		$54.71
Options expired	(7	)		$34.10
Options outstanding at July 29, 2017	10,112			$51.22

During the three- and nine-month periods ended July 29, 2017, 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 $19.9 million and $109.0 million, respectively, and the total amount of proceeds received by the Company from the exercise of these options was $18.0 million and $105.2 million, respectively.

During the three- and nine-month periods ended July 30, 2016, 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 $13.0 million and $26.9 million, respectively, and the total amount of proceeds received by the Company from the exercise of these options was $16.6 million and $39.3 million, respectively.

A summary of the Company’s restricted stock unit/award activity as of July 29, 2017 and changes during the three- and nine-month periods then ended is presented below:



Activity during the Three Months Ended July 29, 2017	Restricted Stock Units/Awards Outstanding (in thousands)		Weighted- Average Grant- Date Fair Value Per Share
Restricted stock units/awards outstanding at April 29, 2017	5,313			$70.59
Units/Awards granted	644			$75.59
Restrictions lapsed	(311	)		$79.14
Forfeited	(55	)		$70.94
Restricted stock units/awards outstanding at July 29, 2017	5,591			$70.69



Activity during the Nine Months Ended July 29, 2017	Restricted Stock Units/Awards Outstanding (in thousands)		Weighted- Average Grant- Date Fair Value Per Share
Restricted stock units/awards outstanding at October 29, 2016	2,690			$50.11
Units/Awards granted (a)	4,307			$79.55
Restrictions lapsed	(1,241	)		$58.44
Forfeited	(165	)		$58.71
Restricted stock units/awards outstanding at July 29, 2017	5,591			$70.69

(a) includes replacement awards for 2.8 million shares of the Company's common stock that were granted to certain Linear employees to replace outstanding Linear equity awards.

As of July 29, 2017, there was $369.8 million of total unrecognized compensation cost related to unvested stock-based awards comprised of stock options and restricted stock units/awards. That cost is expected to be recognized over a weighted-average period of 1.9 years. The total grant-date fair value of shares that vested during the three- and nine-month periods ended July 29, 2017 was approximately $28.3 million and $95.2 million, respectively. The total grant-date fair value of shares that vested during the three- and nine-month periods ended July 30, 2016 was approximately $1.7 million and $59.0 million, respectively.