Stock-Based Compensation

Plan Summaries

As of December 30, 2016, the Company had stock-based compensation awards outstanding under the following plans: the 2006 Equity Incentive Plan, the Management Stock Compensation Plan, the Stock Compensation Plan and the 2006 Employee Stock Purchase Plan, as amended ("ESPP"). Leidos issues new shares upon the issuance of stock awards, vesting of stock units or exercise of stock options under these plans.

The 2006 Equity Incentive Plan provides the Company’s and its affiliates' employees, directors and consultants the opportunity to receive various types of stock-based compensation and cash awards. As of December 30, 2016, the Company has issued stock options, restricted stock awards including restricted stock units, performance-based awards and cash awards under this plan. Stock awards granted under the plan prior to fiscal 2015 generally vest or become exercisable 20% a year for the first three years and 40% in the fourth year. In fiscal 2015, the Company began granting awards that generally vest or become exercisable 25% a year over four years. As of December 30, 2016, 5.8 million shares of Leidos' stock were reserved for future issuance under the 2006 Equity Incentive Plan.

The Company has a Management Stock Compensation Plan and a Stock Compensation Plan, together referred to as the Stock Compensation Plans. These plans provide for restricted share units to eligible employees. Benefits from these plans are payable in shares of Leidos' stock that are held in a trust for the purpose of funding shares to the plans' participants. The fair value of the awards granted under the Stock Compensation Plans, which are vesting share unit awards, is based on the fair value of the award on the date of grant. Compensation expense is measured at grant date and generally recognized over the vesting period of four years. Awards granted vest 100% after four years following the date of the award. The Stock Compensation Plans do not provide for a maximum number of shares available for future issuance.

The Company has an ESPP which allows eligible employees to purchase shares of Leidos' stock at a discount of up to 15% of the fair market value on the date of purchase. During fiscal 2016, the 11-month period ended January 1, 2016, and fiscal 2015, the discount was 5% of the fair market value on the date of purchase, thereby resulting in the ESPP being non-compensatory. There are 5 million shares reserved under the Company's Amended and Restated 2006 ESPP, which is subject to stockholder approval at the 2017 annual meeting of stockholders.

Stock-based compensation and related tax benefits recognized under all plans were as follows:



	12 Months Ended		11 Months Ended		12 Months Ended
	December 30, 2016		January 1, 2016		January 30, 2015
	(in millions)
Total stock-based compensation expense	$	35	$	30	$	42
Tax benefits recognized from stock-based compensation	$	14	$	12	$	16

Stock Options

Stock options are granted with exercise prices equal to the fair value of Leidos' common stock on the date of grant and for terms not greater than ten years. Beginning in fiscal 2012, stock options granted under the 2006 Equity Incentive Plan have a term of seven years and a vesting period of four years, except for stock options granted to the Company’s outside directors, which have a vesting period of the earlier of one year from grant date or the next annual meeting of stockholders following grant date.

The fair value of the Company's stock option awards is estimated on the date of grant using the Black-Scholes-Merton option-pricing model. The fair value of the Company’s stock option awards is generally expensed on a straight-line basis over the vesting period of four years, except for stock options granted to the Company's outside directors, which is recognized over the vesting period of one year or less.

During fiscal 2015, the expected term for all stock option awards granted was derived utilizing the "simplified" method due to the lack of historical experience post separation of New SAIC and expected volatility was estimated as of each grant date during fiscal 2015 based on a weighted average historical volatility of a group of publicly-traded peer companies for a period consistent with the expected option term due to lack of historical volatility after the spin-off of New SAIC in fiscal 2014. During the 11-month period ended January 1, 2016, the expected volatility was estimated using a blended volatility method for a period consistent with the expected term based more significantly on the weighted average historical volatility of a group of publicly-traded peer companies and the weighted average implied volatility from traded options on Leidos stock for a time period prior to the grant date.

During fiscal 2016, expected volatility was based on using a blended approach, which included weighted average historical volatility of a group of publicly-traded peer companies, weighted average historical volatility of the Company and the weighted average implied volatility. The Company will continue to use peer group volatility information, until sufficient historical volatility of the Company's common stock is relevant, to measure expected volatility for future option grants. The expected volatility increased from pre-acquisition to post-acquisition of the IS&GS Business in fiscal 2016 due to a higher allocation of peer group volatility used post-acquisition compared to a higher allocation of historical volatility used pre-acquisition. The post-acquisition volatility reflected an updated peer group mix.

The risk-free rate is derived using the yield curve of a zero-coupon U.S. Treasury bond with a maturity equal to the expected term of the stock option on the grant date. The dividend yield increased from pre-acquisition to post-acquisition due to historical stock price fluctuations. The Company uses historical data to estimate forfeitures and was derived in the same manner as in the prior years presented.

The weighted average grant-date fair value and assumptions used to determine fair value of stock options granted for fiscal 2016, the 11-month period ended January 1, 2016, and fiscal 2015 were as follows:



	12 Months Ended						11 Months Ended			12 Months Ended
	December 30, 2016 (Grants after acquisition)			December 30, 2016 (Grants before acquisition)			January 1, 2016			January 30, 2015
Weighted average grant-date fair value	$	10.33		$	9.54		$	6.72		$	6.15
Expected term (in years)	4.7			4.8			4.7			4.7
Expected volatility	37.9		%	29.9		%	24.5		%	25.1		%
Risk-free interest rate	1.2		%	1.3		%	1.4		%	1.6		%
Dividend yield	2.7		%	2.5		%	2.9		%	2.9		%

Special Dividend Adjustment

As a result of the payment of the special cash dividend to Leidos stockholders in August 2016, Leidos modified all outstanding stock options to preserve their original grant date fair value. The modifications resulted in a reduction in the strike prices of the outstanding stock options by a factor of 0.74 and an increase in the number of shares issuable upon the exercise of each option by a factor of 1.35 between the pre-modification stock price and post-modification stock price. These adjustments did not result in additional stock-based compensation expense, as the fair value of the outstanding options immediately following the payment of the special cash dividend was equal to the fair value immediately prior to such distribution. The modifications resulted in an increase in options outstanding by 0.9 million. The special dividend declared was $993 million. As a result of the special dividend declaration, the Company accrued $29 million of dividend equivalents with respect to outstanding equity awards. The transactions associated with the special cash dividend were recorded to "Additional paid-in capital" in the consolidated balance sheets.

Stock option activity for each of the periods presented was as follows:



	Shares of stock under stock options		Weighted average exercise price		Weighted average remaining contractual term	Aggregate intrinsic value
	(in millions)				(in years)	(in millions)
Outstanding at January 31, 2014	4.5		$	40.32	3.8	$	25
Options granted	0.7		37.25
Options forfeited or expired	(1.5	)	43.90
Options exercised	(0.1	)	34.89			1
Outstanding at January 30, 2015	3.6		$	38.50	4.0	$	14
Options granted	0.6		42.64
Options forfeited or expired	(0.9	)	42.03
Options exercised	(0.9	)	38.53			9
Outstanding at January 1, 2016	2.4		$	38.21	4.5	$	43
Options granted	0.6		43.56
Special dividend adjustments	0.9
Options forfeited or expired	(0.2	)	34.98
Options exercised	(0.4	)	34.11			5
Outstanding at December 30, 2016	3.3		29.77		4.1	70
Exercisable at December 30, 2016	1.6		$	28.19	3.1	$	37
Vested and expected to vest in the future as of December 30, 2016	3.1		$	29.58	4.1	$	67

As of December 30, 2016, there was $5 million of unrecognized compensation cost, net of estimated forfeitures, related to stock options, which is expected to be recognized over a weighted-average period of 2.4 years.

The following table summarizes activity related to exercises of stock options:



	12 Months Ended		11 Months Ended
	December 30, 2016		January 1, 2016
	(in millions)
Tax benefits from stock options exercised	$	1	$	1
Fair value of stock surrendered in payment of the exercise price for stock options exercised	$	4	$	3

The tax benefits from stock options exercised and fair value of stock surrendered in payment of the exercise price for stock options exercised during fiscal 2015 were immaterial. Cash received from exercises of stock options in fiscal 2016, the 11-month period ended January 1, 2016, and fiscal 2015 were immaterial.

Restricted Stock Units and Awards

Compensation expense is measured at the grant date fair value and generally recognized over the vesting period of four years based upon required service conditions and in some cases revenue-based performance conditions.

In connection with the IS&GS Business acquisition (see "Note 2–Acquisitions"), the Company issued 0.6 million replacement RSUs valued at $23 million, of which $9 million was allocated as purchase consideration attributed to pre-acquisition service and the remaining $12 million represents the total remaining stock-based compensation expense, net of estimated forfeitures. This remaining expense will be recognized over three years.

Restricted stock units and award activity for each of the periods presented was as follows:



	Shares of stock under stock awards		Weighted average grant- date fair value
	(in millions)
Unvested stock awards at January 31, 2014	3.7		$	39.58
Awards granted	0.8		37.06
Awards forfeited	(0.5	)	39.05
Awards vested	(1.0	)	41.08
Unvested stock awards at January 30, 2015	3.0		$	38.51
Awards granted	0.5		42.95
Awards forfeited	(0.4	)	40.10
Awards vested	(0.8	)	40.05
Unvested stock awards at January 1, 2016	2.3		$	38.97
Awards granted	1.5		41.45
Awards forfeited	(0.2	)	40.88
Awards vested	(1.1	)	38.91
Unvested stock awards at December 30, 2016	2.5		$	40.39

As of December 30, 2016, there was $37 million of unrecognized compensation cost, net of estimated forfeitures, related to restricted stock units, which is expected to be recognized over a weighted average period of 2.0 years. The fair value of vesting stock awards that vested in fiscal 2016, the 11-month period ended January 1, 2016, and fiscal 2015 was $43 million, $29 million and $34 million, respectively.

Performance-Based Stock Awards

The Company grants performance-based stock awards to certain officers and key employees of the Company under the 2006 Equity Incentive Plan. The Company's performance-based stock awards vest and the stock is issued at the end of a three-year period based upon the achievement of specific performance criteria, with the number of shares ultimately awarded, if any, ranging up to 150% of the specified target awards. If performance is below the threshold level of performance, no shares will be issued.

For the fiscal 2015 awards granted, one-third of the target number of shares of stock granted under the awards will be allocated to each fiscal year over the three-year performance period and the actual number of shares to be issued with respect to each fiscal year will be based upon the achievement of that fiscal year's performance criteria. For awards granted during fiscal 2016 and the 11-month period ended January 1, 2016, the target number of shares of stock granted under the awards will vest and the stock will be issued at the end of a three-year period based on a three-year cycle performance period and the actual number of shares to be issued will be based upon the achievement of the three-year cycle’s performance criteria. Also, during fiscal 2016 and the 11-month period ended January 1, 2016, the Company granted performance-based awards with market conditions. These market conditions grants represent the target number of shares and the actual number of shares to be awarded upon vesting may be higher or lower depending upon the achievement of the relevant market conditions. The target number of shares granted under the market conditions grants will vest and the stock will be issued at the end of a three-year period based on the attainment of certain total shareholder return performance measures and the employee's continued service through the vest date.

Performance-based stock award activity for each of the periods presented was as follows:



	Expected number of shares of stock to be issued under performance-based stock awards			Weighted average grant- date fair value
	(in millions)
Unvested at January 31, 2014	0.1		*	$	36.65	*
Awards granted	0.1			37.64
Awards vested	(0.1	)		36.69
Unvested at January 30, 2015	0.1			$	37.70
Awards granted	0.2			44.30
Awards forfeited	(0.1	)		43.49
Unvested at January 1, 2016	0.2			$	43.35
Awards granted	0.2			45.62
Unvested at December 30, 2016	0.4			$	44.44

*Adjusted for Conversion Ratio of 1.4523 in connection with the spin-off of New SAIC in September 2013

The weighted average grant date fair value for performance-based stock, excluding those with a market condition, during fiscal 2016, the 11-month period ended January 1, 2016, and fiscal 2015 was $45.83, $43.78 and $36.88, respectively. The weighted average grant date fair value for performance-based stock with market conditions that were granted during fiscal 2016 and the 11-month period ended January 1, 2016, was $45.80 and $45.00, respectively, and was calculated using the Monte Carlo simulation. The Monte Carlo simulation in fiscal 2016 used various assumptions including expected volatility of 31.73%, a risk free rate of return of 1.01% and a weighted average grant date stock price of $46.54. For the 11-month period ended January 1, 2016, the Monte Carlo simulation used various assumptions including expected volatility of 27.67%, a risk free rate of return of 0.82% and a weighted average grant date stock price of $42.61.

As of December 30, 2016, there was $7 million of unrecognized compensation cost, net of estimated forfeitures, related to performance-based stock awards granted under the 2006 Equity Incentive Plan, which is expected to be recognized over a weighted average period of 1.6 years. There were no performance-based stock awards that vested in fiscal 2016 and the 11-month period ended January 1, 2016. The fair value of performance-based stock awards that vested in fiscal 2015 was $2 million.