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 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 requisite service period. The expense recognized over the requisite 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, 2016 was as follows:



	2016		2015		2014
	(in thousands)
Stock-based compensation expense by line item:
Research and development expenses	$	153,451	$	152,955	$	116,998
Sales, general and administrative expenses	84,254		78,070		60,544
Total stock-based compensation expense included in costs and expenses	$	237,705	$	231,025	$	177,542

The stock-based compensation expense by type of award during the three years ended December 31, 2016 was as follows:



	2016			2015			2014
	(in thousands)
Stock-based compensation expense by type of award:
Stock options	$	114,768		$	129,276		$	99,961
Restricted stock and restricted stock units	118,709			98,811			70,678
ESPP share issuances	7,835			7,025			8,326
Less: stock-based compensation expense capitalized to inventories	(3,607		)	(4,087		)	(1,423		)
Total stock-based compensation expense included in costs and expenses	$	237,705		$	231,025		$	177,542

The Company capitalizes stock-based compensation expense to inventories, all of which is attributable to employees who support the Company’s manufacturing operations for the Company’s products.

The following table sets forth the Company’s unrecognized stock-based compensation expense, net of estimated forfeitures, as of December 31, 2016, by type of award and the weighted-average period over which that expense is expected to be recognized:



	As of December 31, 2016
	Unrecognized Expense Net of Estimated Forfeitures		Weighted-average Recognition Period
	(in thousands)		(in years)
Type of award:
Stock options	$	157,819	2.50
Restricted stock and restricted stock units	$	176,972	2.39
ESPP share issuances	$	4,080	0.58

Stock Options

The Company issues stock options with service conditions, which are generally the vesting periods of the awards. 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 2016, 2015 and 2014 had a weighted-average grant-date fair value per share of $37.93, $52.16 and $39.95, respectively.

The fair value of each option granted during 2016, 2015 and 2014 was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:



	2016		2015		2014
Expected stock price volatility	46.77	%	47.29	%	50.86	%
Risk-free interest rate	1.32	%	1.61	%	1.77	%
Expected term of options (in years)	4.91		5.28		5.47
Expected annual dividends	—		—		—

The weighted-average valuation assumptions were determined as follows:


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


•	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 awards restricted stock and restricted stock units with service conditions, which are generally the vesting periods of the awards. Until 2017, the Company also awarded, to certain members of senior management, on an annual basis restricted stock and restricted stock units that vest upon the earlier of the satisfaction of (i) a performance condition or (ii) a service condition.

In February 2016, the Company began granting performance-based restricted stock units (“PSUs”) to certain members of senior management. Threshold, target and maximum parameters were established for the financial and half on non-financial goals, and will be used to calculate the number of shares that will be issuable when the award vests, which may range from zero to 200% of the target amount. The financial-based PSUs vest in three equal installments over a three-year period and are expensed ratably over that same period based upon an assessment of the likelihood of achievement. The non-financial based PSUs cliff vest at the end of the three-year performance period and are expensed on a straight-line basis over that same period based upon an assessment of the likelihood of achievement.

In addition, in 2015 and 2014, the Company issued, pursuant to a retention program, restricted stock awards to certain members of senior management that will vest upon the satisfaction of both (i) a performance condition and (ii) a service condition.

Employee Stock Purchase Plan

The weighted-average fair value of each purchase right granted during 2016, 2015 and 2014 was $26.86, $37.84 and $29.59, respectively. The following table reflects the weighted-average assumptions used in the Black-Scholes option pricing model for 2016, 2015 and 2014:



	2016		2015		2014
Expected stock price volatility	48.22	%	47.20	%	60.32	%
Risk-free interest rate	0.56	%	0.40	%	0.09	%
Expected term (in years)	0.75		0.72		0.75
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.