Stock-based Compensation Expense

The Company recognizes share-based payments to employees as compensation expense using the fair value method. The fair value of stock options and shares purchased pursuant to the ESPP is calculated using the Black-Scholes option pricing model. The fair value of restricted stock and restricted stock units typically is based on the intrinsic value on the date of grant. Stock-based compensation, measured at the grant date based on the fair value of the award, is typically recognized as expense ratably over the service period. The expense recognized over the service period includes an estimate of awards that will be forfeited.

The effect of stock-based compensation expense during the three years ended December 31, 2012 was as follows:



	2012		2011		2010
	(in thousands)
Stock-based compensation expense by line item:
Research and development expenses	$	71,533	$	75,574	$	65,198
Sales, general and administrative expenses	42,752		42,652		25,926
Total stock-based compensation expense included in costs and expenses	$	114,285	$	118,226	$	91,124

During 2012 and 2011, the Company capitalized $1.3 million and $1.0 million, respectively, of stock-based compensation expense to inventories, all of which was attributable to employees who supported the Company’s manufacturing operations for the Company's products.

The stock-based compensation expense by type of award during the three years ended December 31, 2012 was as follows:



	2012			2011			2010
	(in thousands)
Stock-based compensation expense by type of award:
Stock options	$	79,047		$	83,098		$	64,005
Restricted stock and restricted stock units	29,194			30,708			22,960
ESPP share issuances	7,298			5,462			4,159
Less stock-based compensation expense capitalized to inventories	(1,254		)	(1,042		)	—
Total stock-based compensation expense included in costs and expenses	$	114,285		$	118,226		$	91,124

The following table sets forth the Company’s unrecognized stock-based compensation expense, net of estimated forfeitures, as of December 31, 2012 by type of award and the weighted-average period over which that expense is expected to be recognized:



	As of December 31, 2012
	Unrecognized Expense Net of Estimated Forfeitures	Weighted-average Recognition Period
	(in thousands)	(in years)
Type of award:
Stock options	$156,225	2.69
Restricted stock and restricted stock units	68,094	2.58
ESPP share issuances	5,661	0.65

Stock Options

The Company issues stock options with service conditions, which are generally the vesting periods of the awards. In 2009, the Company also issued, to certain members of senior management, stock options with performance conditions that vested upon the satisfaction of the performance conditions by the end of the first quarter of 2012. The Company uses the Black-Scholes option pricing model to estimate the fair value of stock options at the grant date. The Black-Scholes option pricing model uses the option exercise price as well as estimates and assumptions related to the expected price volatility of the Company’s stock, the rate of return on risk-free investments, the expected period during which the options will be outstanding, and the expected dividend yield for the Company’s stock to estimate the fair value of a stock option on the grant date. The options granted during 2012, 2011 and 2010 had a weighted-average grant-date fair value per share of $19.72, $20.88 and $18.52, respectively.

The fair value of each option granted during 2012, 2011 and 2010 was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:



	2012		2011		2010
Expected stock price volatility	47.93	%	49.53	%	52.17	%
Risk-free interest rate	0.95	%	2.09	%	2.44	%
Expected term of options (in years)	5.78		5.74		5.71
Expected annual dividends	—		—		—

The weighted-average valuation assumptions were determined as follows:


•	Expected stock price volatility: Options to purchase the Company’s stock with remaining terms of greater than one year are regularly traded in the market. Expected stock price volatility is calculated using the trailing one month average of daily implied volatilities prior to grant date.


•	Risk-free interest rate: The Company bases the risk-free interest rate on the interest rate payable on U.S. Treasury securities in effect at the time of grant for a period that is commensurate with the assumed expected option term.

•

Expected term of options: The expected term of options represents the period of time options are expected to be outstanding. The Company uses historical data to estimate employee exercise and post-vest termination behavior. The Company believes that all groups of employees exhibit similar exercise and post-vest termination behavior and therefore does not stratify employees into multiple groups in determining the expected term of options.


•	Expected annual dividends: The estimate for annual dividends is $0.00 because the Company has not historically paid, and does not intend for the foreseeable future to pay, a dividend.

Restricted Stock and Restricted Stock Units

The Company issues restricted stock and restricted stock units with service conditions, which are generally the vesting periods of the awards. The Company also issues, to certain members of senior management, restricted stock and restricted stock units that vest upon the earlier of the satisfaction of (i) a performance condition or (ii) a service condition.

Employee Stock Purchase Plan

The weighted-average fair value of each purchase right granted during 2012, 2011 and 2010 was $12.90, $9.80 and $10.19, respectively. The following table reflects the weighted-average assumptions used in the Black-Scholes option pricing model for 2012, 2011 and 2010:



	2012		2011		2010
Expected stock price volatility	46.90	%	51.32	%	43.92	%
Risk-free interest rate	0.16	%	0.08	%	0.24	%
Expected term (in years)	0.74		0.72		0.71
Expected annual dividends	—		—		—

The expected stock price volatility for ESPP offerings is based on implied volatility. The Company bases the risk-free interest rate on the interest rate payable on U.S. Treasury securities in effect at the time of grant for a period that is commensurate with the assumed expected term. The expected term represents purchases and purchase periods that take place within the offering period. The expected annual dividends estimate is $0.00 because the Company has not historically paid, and does not for the foreseeable future intend to pay, a dividend.