Note 19—Stock-Based Compensation

Plan Summaries

As of December 28, 2018, the Company had stock-based compensation awards outstanding under the following plans: the 2017 Omnibus Incentive Plan, 2006 Equity Incentive Plan, as amended, and the 2006 Employee Stock Purchase Plan, as amended ("ESPP"). Leidos issues new shares upon the issuance of the vesting of stock units or exercising of stock options under these plans.

In fiscal 2017, stockholders approved the 2017 Omnibus Incentive Plan which provides the Company and its affiliates' employees, directors and consultants the opportunity to receive various types of stock-based compensation awards, such as stock options, restricted stock units and performance-based awards, as well as cash awards. Service-based awards granted under the plan prior to fiscal 2015 generally vested or became 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 or cliff vest in three years. As of December 28, 2018, 5.0 million shares of Leidos' stock were reserved for future issuance under the 2017 Omnibus Incentive Plan and the 2006 Equity Incentive Plan.

The Company offers eligible employees the opportunity to defer restricted stock units into an equity-based deferred equity compensation plan, the Key Executive Stock Deferral Plan ("KESDP"). Prior to 2013 the Company offered an additional opportunity for deferrals into the Management Stock Compensation Plan ("MSCP"). 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. Restricted stock units deferred under the KESDP are counted against the total shares available for future issuance under the 2017 Omnibus Incentive Plan. All awards under the MSCP are fully vested and the plan does not provide for a maximum number of shares available for future issuance.

The Company's ESPP 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 the first half of fiscal 2018, fiscal 2017 and 2016, the discount was 5% of the fair market value on the date of purchase, thereby resulting in the ESPP being non-compensatory. Effective the second half of fiscal 2018, the Company increased the discount to 10% of the fair market value on the date of purchase, resulting in the ESPP being compensatory. During fiscal 2018 and 2017, $11 million and $10 million, respectively, was received from ESPP plan participants for the issuance of Leidos' stock. A total of 4.6 million shares remain available for future issuance under the ESPP.

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



	Year Ended
	December 28, 2018		December 29, 2017		December 30, 2016
	(in millions)
Total stock-based compensation expense	$	44	$	43	$	35
Tax benefits recognized from stock-based compensation	11		17		14

Stock Options

Stock options are granted with exercise prices equal to the fair market value of Leidos' common stock on the date of grant and for terms not greater than ten years. Stock options 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 to employees are 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 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 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. The post-acquisition volatility reflected an updated peer group mix.

During fiscal 2017, the Company ceased the usage of peer group volatility, as an input into its blended approach to measure expected volatility, and increased the reliance on historical volatility. The revised blended approach includes the Company's weighted average historical and implied volatilities. The Company continued the use of this approach during fiscal 2018.

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. Leidos utilizes the simplified method for the expected term, which represents an appropriate period of time that the options granted are expected to remain outstanding between the weighted-average vesting period and end of the respective contractual term. 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 the periods presented were as follows:



	Year Ended
	December 28, 2018			December 29, 2017			December 30, 2016 (Grants after acquisition)			December 30, 2016 (Grants before acquisition)
Weighted average grant-date fair value	$	13.85		$	11.53		$	10.33		$	9.54
Expected term (in years)	4.7			4.7			4.7			4.8
Expected volatility	26.6		%	29.7		%	37.9		%	29.9		%
Risk-free interest rate	2.6		%	1.9		%	1.2		%	1.3		%
Dividend yield	2.0		%	2.5		%	2.7		%	2.5		%

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 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
Options granted	0.5		53.51
Options forfeited or expired	(0.2	)	35.72
Options exercised	(0.8	)	27.23			23
Outstanding at December 29, 2017	2.8		$	34.38	3.9	$	86
Options granted	0.4		63.75
Options forfeited or expired	(0.2	)	49.65
Options exercised	(0.6	)	30.40			24
Outstanding at December 28, 2018	2.4		39.41		3.8	36
Exercisable at December 28, 2018	1.4		$	31.72	2.8	$	29
Vested and expected to vest in the future as of December 28, 2018	2.4		$	39.15	3.7	$	36

As of December 28, 2018, there was $6 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 2.0 years. Tax benefits from stock options exercised for fiscal 2018, 2017 and 2016 were $6 million, $7 million and $1 million respectively.

Restricted Stock Units and Awards

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

In connection with the Transactions (see "Note 6—Acquisitions"), the Company issued 0.6 million replacement restricted stock units 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 from the date of acquisition.

Restricted stock units and awards 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 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
Awards granted	0.8		53.91
Awards forfeited	(0.3	)	45.89
Awards vested	(1.0	)	41.02
Unvested stock awards at December 29, 2017	2.0		$	44.96
Awards granted	0.6		64.05
Awards forfeited	(0.2	)	42.67
Awards vested	(0.4	)	44.60
Unvested stock awards at December 28, 2018	2.0		$	50.85

As of December 28, 2018, 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 restricted stock units that vested in fiscal 2018, 2017 and 2016, was $22 million, $33 million and $43 million, respectively. In addition, the fair value of dividend equivalents with respect to restricted stock units that vested in fiscal 2018, 2017 and 2016 was $1 million, $13 million and $8 million, respectively.

Performance-Based Stock Awards

Historically, the Company granted performance-based stock awards to certain officers and key employees of the Company under the 2006 Equity Incentive Plan. During fiscal 2017, upon stockholder approval, the Company started granting performance-based stock awards to these individuals under the 2017 Omnibus Incentive Plan. Under both plans, 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 awards granted during fiscal 2018, 2017 and 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 2018, 2017 and 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 1, 2016	0.2		$	43.35
Awards granted	0.2		45.62
Unvested at December 30, 2016	0.4		$	44.44
Awards granted	0.2		57.94
Awards vested	(0.1	)	42.85
Unvested at December 29, 2017	0.5		$	50.34
Awards granted	0.3		61.43
Awards forfeited	(0.1	)	61.81
Awards vested	(0.2	)	44.04
Unvested at December 28, 2018	0.5		$	57.36

The weighted average grant date fair value for performance-based stock, excluding those with a market condition, during fiscal 2018, 2017 and 2016 was $63.76, $53.58 and $45.83, respectively. The weighted average grant date fair value for performance-based stock with market conditions that were granted during fiscal 2018, 2017 and 2016, was $71.50, $62.30 and $45.80, respectively, and was calculated using the Monte Carlo simulation.

The Monte Carlo simulation assumptions used for the periods presented were as follows:



	Year Ended
	December 28, 2018			December 29, 2017			December 30, 2016
Expected volatility	25.37		%	27.19		%	31.73		%
Risk free rate of return	2.35		%	1.53		%	1.01		%
Weighted average grant date stock price	$	65.00		$	53.73		$	46.54

As of December 28, 2018, there was $11 million of unrecognized compensation cost, net of estimated forfeitures, which is expected to be recognized over a weighted average period of 1.7 years. The fair value of performance-based stock awards that vested in fiscal 2018 and 2017 was $13 million and $4 million, respectively. There were no performance-based stock awards that vested in fiscal 2016.