Compensation and Benefits

Share-based Benefit Plans

2005 Incentive Plan. On May 27, 2005, the Company’s stockholders approved the 2005 Stock Incentive Plan, which was amended in May 2006 and renamed the 2005 Incentive Plan (“2005 Plan”). Shares of the Company’s common stock may be issued under the 2005 Plan pursuant to three separate equity incentive programs: (i) the discretionary grant program under which stock options and stock appreciation rights may be granted to officers and other employees, non-employee board members and independent consultants, (ii) the stock issuance program under which shares may be awarded to such individuals through restricted stock or restricted stock unit awards or as a stock bonus for services rendered to the Company, and (iii) an automatic grant program for the non-employee board members pursuant to which such individuals will receive option grants or other stock awards at designated intervals over their period of board service. The 2005 Plan also includes a performance-based cash bonus awards program for executive officers classified under Section 16 of the Securities Exchange Act of 1934, as amended. Grants and awards under the discretionary grant program generally vest as follows: 25% of the shares will vest on the first anniversary of the vesting commencement date and the remaining 75% will vest proportionately each quarter over the next 12 quarters of continued service. Awards under the stock issuance program generally vest in equal annual installments over a 4-year period. Grants under the automatic grant program vest in accordance with the specific vesting provisions set forth in that program. A total of 37,045,436 shares of the Company’s common stock has been reserved for issuance under this plan. The share reserve may increase by up to 10,000,000 shares of common stock to the extent that outstanding options under the 1995 Stock Option Plan and the 1995 Non-Employee Directors Stock Option Plan expire or terminate unexercised, of which 2,345,436 shares of common stock as of January 1, 2012 had been added to the 2005 Plan reserve. All options granted under the 2005 Plan were granted with an exercise price equal to the fair market value of the common stock on the date of grant and will expire seven years from the date of grant.

1995 Stock Option Plan and 1995 Non-Employee Directors Stock Option Plan. Both of these plans terminated on May 27, 2005, and no further option grants were made under the plans after that date. However, options that were outstanding under these plans on May 27, 2005 continue to be governed by their existing terms and may be exercised for shares of the Company’s common stock at any time prior to the expiration of the ten-year option term or any earlier termination of those options in connection with the optionee’s cessation of service with the Company.

2005 Employee Stock Purchase Plan. The 2005 Employee Stock Purchase Plan (“ESPP”) was approved by the stockholders on May 27, 2005. The ESPP consists of two components: a component for employees residing in the U.S. and an international component for employees who are non-U.S. residents. The ESPP allows eligible employees to purchase shares of the Company’s common stock at the end of each six-month offering period at a purchase price equal to 85% of the lower of the fair market value per share on the start date of the offering period or the fair market value per share on the purchase date. The ESPP has 10,000,000 shares reserved for issuance, of which 5,654,199 shares were available to be issued as of January 1, 2012. In fiscal years 2011, 2010 and 2009, a total of 613,452 shares, 966,288 shares and 1,158,909 shares of common stock, respectively, had been issued under this plan.

Pliant Technology, Inc. 2007 Stock Plan. The Pliant Technology, Inc. 2007 Stock Plan was assumed pursuant to the Company’s acquisition of Pliant on May 24, 2011, and no further grants were made under this plan after that date. Unvested stock options that were outstanding under this plan on May 24, 2011 were assumed by the Company and will continue to be governed by the existing terms of the plan and may be exercised for shares of the Company’s common stock at any time prior to the expiration of the ten-year option term or any earlier termination of those options in connection with the optionee’s termination of service with the Company. Stock options granted under this plan generally vest as follows: 25% of the shares vest on the first anniversary of the vesting commencement date and the remaining 75% vest proportionately each month over the next 36 months of continued service. See Note 15, “Business Acquisition.”

msystems Ltd. 1996 Section 102 Stock Option/Stock Purchase Plan and 2003 Stock Option and Restricted Stock Incentive Plan. The msystems Ltd. 1996 Section 102 Stock Option/Stock Purchase Plan and 2003 Stock Option and Restricted Stock Incentive Plan assumed through the Company’s acquisition of msystems Ltd., were terminated on November 19, 2006, and no further grants were made under these plans after that date. However, award grants that were outstanding under these plans on November 19, 2006 continue to be governed by their existing terms and may be exercised for shares of the Company’s common stock at any time prior to the expiration of the ten-year option term or any earlier termination of those options in connection with the optionee’s cessation of service with the Company.

Matrix Semiconductor, Inc. 2005 Stock Incentive Plan, 1999 Stock Plan and 1998 Long-term Incentive Plan. The Matrix Semiconductor, Inc. 2005 Stock Incentive Plan, 1999 Stock Plan and the Rhombus, Inc. 1998 Long-term Incentive Plan (“Matrix Stock Plans”), assumed through the Company’s acquisition of Matrix Semiconductor, Inc., were terminated on January 13, 2006, and no further option grants were made under these plans after that date. However, award grants that were outstanding under these plans on January 13, 2006 continue to be governed by their existing terms and may be exercised for shares of the Company’s common stock at any time prior to the expiration of the ten-year option term or any earlier termination of those options in connection with the optionee’s cessation of service with the Company.

Accounting for Share-based Compensation Expense

For share-based awards expected to vest, compensation cost is based on the grant-date fair value. The Company recognizes compensation expense for the fair values of these awards, which have graded vesting, on a straight-line basis over the requisite service period of each of these awards, net of estimated forfeitures.

The Company estimates the fair value of stock options granted using the Black-Scholes-Merton option-pricing formula and a single-option award approach. The Company’s expected term represents the period that the Company’s share-based awards are expected to be outstanding and was determined based on historical experience regarding similar awards, giving consideration to the contractual terms of the share-based awards. The Company’s expected volatility is based on the implied volatility of its traded options. The Company has historically not paid dividends and has no foreseeable plans to issue dividends. The risk-free interest rate is based on the yield from U.S. Treasury zero-coupon bonds with an equivalent term.

Valuation Assumptions. The fair value of the Company’s stock options granted to employees, officers and non-employee board members and ESPP shares issued to employees, excluding unvested stock options assumed through the acquisition of Pliant, was estimated using the following annual weighted average assumptions:



	Fiscal years ended
	January 1, 2012	January 2, 2011	January 3, 2010
Option Plan Shares
Dividend yield	None	None	None
Expected volatility	0.43	0.50	0.85
Risk-free interest rate	1.49%	1.53%	1.41%
Expected term	4.3 years	3.9 years	3.6 years
Estimated annual forfeiture rate	8.57%	7.32%	9.07%
Weighted average fair value at grant date	$17.37	$12.58	$5.36

Employee Stock Purchase Plan Shares
Dividend yield	None	None	None
Expected volatility	0.43	0.56	0.73
Risk-free interest rate	0.13%	0.18%	0.35%
Expected term	½ year	½ year	½ year
Weighted average fair value at purchase date	$12.17	$9.95	$4.82

Share-based Compensation Plan Activities

Stock Options and SARs. A summary of stock option and stock appreciation rights (“SARs”) activity under all of the Company’s share-based compensation plans as of January 1, 2012 and changes during the three fiscal years ended January 1, 2012 is presented below (in thousands, except exercise price and contractual term):



	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Options and SARs outstanding at December 28, 2008	25,057		$	33.59	4.9	$	5,284
Granted	4,242		9.41
Exercised	(964	)	12.60			5,807
Forfeited	(1,376	)	32.94
Expired	(2,063	)	38.97
Options and SARs outstanding at January 3, 2010	24,896		29.87		4.4	180,834
Granted	3,016		31.67
Exercised	(6,471	)	22.08			137,976
Forfeited	(449	)	24.14
Expired	(599	)	49.15
Options and SARs outstanding at January 2, 2011	20,393		32.18		3.8	393,996
Granted	3,157		44.96
Exercised	(5,310	)	24.81			126,929
Forfeited	(536	)	29.09
Expired	(354	)	51.79
Options assumed through acquisition	209		4.35
Options and SARs outstanding at January 1, 2012	17,559		36.55		3.4	257,251
Options and SARs vested and expected to vest after January 1, 2012, net of forfeitures	16,963		36.50		3.4	250,522
Options and SARs exercisable at January 1, 2012	11,535		37.66		2.4	167,117

At January 1, 2012, the total compensation cost related to stock options granted to employees under the Company’s share-based compensation plans but not yet recognized was approximately $62.0 million, net of estimated forfeitures. This cost will be amortized on a straight-line basis over a weighted average period of approximately 2.5 years. As of January 1, 2012, the Company had fully expensed all of its SARs awards.

Restricted Stock Units. Restricted stock units (“RSUs”) are settled in shares of the Company’s common stock upon vesting on a one-for-one basis. Typically, vesting of RSUs is subject to the employee’s continuing service to the Company. The cost of these awards is determined using the fair value of the Company’s common stock on the date of grant, and compensation is recognized on a straight-line basis over the requisite vesting period.

A summary of the changes in RSUs outstanding under the Company’s share-based compensation plan during the three fiscal years ended January 1, 2012 is presented below (in thousands, except for weighted average grant date fair value):



	Shares		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Non-vested share units at December 28, 2008	1,523		$	25.38	$	13,983
Granted	95		15.12
Vested	(559	)	26.40		7,977
Forfeited	(215	)	20.86
Non-vested share units at January 3, 2010	844		24.69		24,476
Granted	1,100		29.39
Vested	(632	)	25.11		24,476
Forfeited	(68	)	24.67
Non-vested share units at January 2, 2011	1,244		28.64		62,007
Granted	1,335		47.56
Vested	(396	)	29.63		19,309
Forfeited	(132	)	37.24
Non-vested share units at January 1, 2012	2,051		40.22		100,913

As of January 1, 2012, the Company had approximately $53.2 million of unrecognized compensation expense, net of estimated forfeitures, related to RSUs, which will be recognized over a weighted average estimated remaining life of 2.7 years.

Employee Stock Purchase Plan. At January 1, 2012, there was approximately $0.8 million of total unrecognized compensation cost related to the Company’s ESPP that is expected to be recognized over a period of approximately 0.1 years.

Share-based Compensation Expense. The following tables set forth the detailed allocation of the share-based compensation expense (in thousands):



	Fiscal years ended
	January 1, 2012			January 2, 2011			January 3, 2010
Share-based compensation expense by caption:
Cost of product revenues	$	4,674		$	5,821		$	12,427
Research and development	34,202			26,292			36,399
Sales and marketing	10,593			10,934			19,247
General and administrative	13,641			34,543			27,487
Total share-based compensation expense	63,110			77,590			95,560
Total tax benefit recognized	(17,008		)	(26,720		)	(23,767		)
Decrease in net income	$	46,102		$	50,870		$	71,793

Share-based compensation expense by type of award:
Stock options and SARs	$	33,684		$	55,821		$	79,859
RSUs	22,355			15,081			11,922
ESPP	7,071			6,688			3,779
Total share-based compensation expense	63,110			77,590			95,560
Total tax benefit recognized	(17,008		)	(26,720		)	(23,767		)
Decrease in net income	$	46,102		$	50,870		$	71,793

Share-based compensation expense of $1.4 million and $0.9 million related to manufacturing personnel was capitalized into inventory as of January 1, 2012 and January 2, 2011, respectively.

The total grant date fair value of options and RSUs vested was as follows (in thousands):



	Fiscal years ended
	January 1, 2012		January 2, 2011		January 3, 2010
Fair value of options vested	$	33,868	$	40,509	$	59,207
Fair value of RSUs vested	11,747		15,868		14,755
Total fair value of options and RSUs vested	$	45,615	$	56,377	$	73,962

Modification of Stock Awards and Other Adjustments. In fiscal year 2010, the Company recognized $17.3 million of expense related to the modification of stock awards, pursuant to the retirement agreement with the Company’s former Chief Executive Officer.

In fiscal year 2009, the Company identified that its third-party equity software contained a feature that resulted in incorrect share-based compensation expense. This software feature affected the Company’s share-based compensation expense reported for the nine months ended September 27, 2009 and the three fiscal years ended December 28, 2008. The Company determined that the impact of the underreported share-based compensation expense was not material to any of the previously issued financial statements. Accordingly, fiscal year 2009 included a cumulative non-cash adjustment of $16.2 million to increase share-based compensation, allocated to multiple expense categories. The Company has modified its implementation of the software to prevent this error going forward.