SHARE-BASED COMPENSATION

Keysight accounts for share-based awards in accordance with the provisions of the authoritative accounting guidance, which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors, including employee stock option awards, Restricted Stock Units ("RSUs"), employee stock purchases made under our Employee Stock Purchase Plan (“ESPP”) and performance share awards granted to selected members of our senior management under the Long-Term Performance (“LTP”) Program based on estimated fair values.

Prior to the Separation, Keysight employees participated in Agilent’s equity plans. Upon the Separation, outstanding Keysight employee stock options, RSUs and LTP Program awards previously issued under Agilent’s equity plans were adjusted and converted into new Keysight stock-based awards under the Keysight 2014 Equity and Incentive Compensation Plan using a formula designed to preserve the intrinsic value and fair value of the awards immediately prior to the Separation. These adjusted awards retained the vesting schedule and expiration date of the original awards.

Description of Keysight’s Share-Based Plans

Incentive compensation plans. The 2014 Equity and Incentive Compensation Plan (the "2014 Stock Plan") was originally adopted by the Board of Directors ("the Board") on July 16, 2014, subsequently amended and restated by the Board on September 29, 2014 and on January 22, 2015 and became effective as of November 1, 2014 (the “Effective Date”). The Board initially reserved 25 million shares of company common stock that may be issued under the 2014 Stock Plan, plus any shares forfeited or cancelled under the 2014 Stock Plan and subsequently reduced the number to 17 million shares. The 2014 Stock Plan provides for the grant of awards in the form of stock options, SARs, restricted stock, RSUs, performance shares and performance units with performance-based conditions on vesting or exercisability, and cash awards. The 2014 Stock Plan has a term of ten years. As of October 31, 2016, approximately 7 million shares were available for future awards under the 2014 Stock Plan.

Stock options granted under the 2014 Stock Plan may be either "incentive stock options," as defined in Section 422 of the Internal Revenue Code, or non-statutory. Options generally vest at a rate of 25 percent per year over a period of four years from the date of grant and generally have a maximum contractual term of ten years. The exercise price for stock options is generally not less than 100 percent of the fair market value of our common stock on the date the stock award is granted.

Effective November 1, 2014, the Compensation Committee of the Board of Directors approved the Performance awards plan, which is a performance stock award program administered under the 2014 Stock Plan, for the company's executive officers and other key employees. Participants in this program are entitled to receive unrestricted shares of the company's stock after the end of a three-year period, if specified performance targets are met. Performance awards are generally designed to meet the criteria of a performance award with the performance metrics and peer group comparison set at the beginning of the performance period. Based on the performance metrics the final award may vary from zero to 200 percent of the target award. The maximum contractual term for awards under the Performance awards program is three years. We consider the dilutive impact of this program in our diluted net income per share calculation only to the extent that the performance conditions are met.

Restricted stock units under our share-based plans are granted to directors, executives and employees. The estimated fair value of the restricted stock unit awards granted under the 2014 Stock Plan is determined based on the market price of Keysight common stock on the date of grant. Restricted stock units generally vest, with some exceptions, at a rate of 25 percent per year over a period of four years from the date of grant.

Effective November 1, 2014, the company adopted the Employee Stock Purchase Plan. The ESPP allows eligible employees to contribute up to ten percent of their base compensation to purchase shares of Keysight common stock at 85 percent of the closing market price at purchase date. Shares authorized for issuance in connection with the ESPP are subject to an automatic annual increase of the lesser of one percent of the outstanding shares of Keysight common stock on November 1, or an amount determined by the Compensation Committee of our Board of Directors. Under the terms of the ESPP, in no event shall the number of shares issued under the ESPP exceed 75 million shares.

Under our ESPP, employees purchased 1,234,111 shares for $30 million in 2016 and 493,289 shares for $14 million in 2015. As of October 31, 2016, the number of shares of common stock authorized and available for issuance under our ESPP was 23,272,600. The number of securities remaining available for future issuance is before the issuance of shares of common stock to participants in consideration of the aggregate participant contribution totaling $16 million as of October 31, 2016. Under Agilent's ESPP, our employees purchased 878,816 shares of Agilent for $40 million in 2014. The shares purchased by our employees in 2014 include the shares purchased for the second half of 2014 ESPP purchase period. These shares were purchased one month in advance on October 1, 2014, due to separation activities.

Impact of Share-based Compensation Awards

All share-based awards compensation expense has been recognized using a straight-line amortization method and as required by guidance, has been reduced for estimated forfeitures.

The impact on our results for share-based compensation was as follows:



	Year Ended October 31,
	2016		2015		2014
	(in millions)
Cost of products and services	$	11	$	12	$	11
Research and development	8		9		7
Selling, general and administrative	30		34		26
Total share-based compensation expense	$	49	$	55	$	44

At October 31, 2016 and 2015 no share-based compensation expense was capitalized within inventory. The income tax benefit (deficiency) realized from the exercised stock options and similar awards recognized was $(5) million in 2016, $4 million in 2015 and $4 million in 2014. The weighted average grant date fair value of options granted in 2015 and 2014 was $9.20 and $18.73 per share, respectively.

Valuation Assumptions

The following assumptions were used to estimate the fair value of employee stock options and LTP Program grants.



	Year Ended October 31,
	2016	2015	2014
Stock Option Plans:
Weighted average risk-free interest rate	N/A	1.60%	1.69%
Dividend yield	N/A	0%	1%
Weighted average volatility	N/A	31%	39%
Expected life	N/A	4.9 years	5.8 years
LTP Program:
Volatility of Keysight shares	25%	26%	—
Volatility of selected peer-company shares	14%-54%	17%-67%	—
Price-wise correlation with selected peers	38%	38%	—

The fair value of share-based awards for employee stock option awards was estimated using the Black-Scholes option pricing model. Shares granted under the LTP Program were valued using a Monte Carlo simulation model. Both the Black-Scholes and Monte Carlo simulation fair value models require the use of highly subjective and complex assumptions, including the option’s expected life and the price volatility of the underlying stock. The estimated fair value of restricted stock awards is determined based on the market price of Keysight’s common stock on the date of grant. Prior to the Separation, it was determined based on the market price of Agilent’s common stock on the date of grant, adjusted for expected dividend yield.

We did not grant any option awards in 2016. For the year ended October 31, 2015, we used the average historical volatility of eleven peer companies to estimate the volatility for our stock option awards. We considered our ability to find traded options of peer companies in the current market with similar terms and prices to our options. For the year ended October 31, 2014, we used the historical volatility of Agilent stock to estimate the volatility for stock option awards. In estimating the expected life of our options, we considered the historical option exercise behavior of our executives, which we believe is representative of future behavior.

As of November 1, 2014, Agilent’s fiscal 2013 LTP Program grants to Keysight executives are classified as liability awards in our combined and consolidated financial statements as the payout of Keysight shares is dependent upon Agilent Total Shareholder Return (“TSR”) as compared to its peer companies at the end of fiscal 2015. The final payout resulted in reversal of $4 million of expense recorded for those awards.

Share-based Payment Award Activity

Employee Stock Options

The following table summarizes employee stock option award activity made to our employees and directors for 2016:



	Options Outstanding		Weighted Average Exercise Price
	(in thousands)
Outstanding at October 31, 2015	4,025		$	24
Granted	—		$	—
Exercised	(668	)	$	19
Forfeited and expired	(81	)	$	19
Outstanding at October 31, 2016	3,276		$	25

Forfeited and expired options from total cancellations in 2016 were as follows:



	Options Canceled	Weighted Average Exercise Price
	(in thousands)
Forfeited	—	$	—
Expired	81	$	19
Total options canceled during 2016	81	$	19

The options outstanding and exercisable for equity share-based payment awards at October 31, 2016 were as follows:



	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number Outstanding	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Aggregate Intrinsic Value		Number Exercisable	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Aggregate Intrinsic Value
	(in thousands)	(in years)			(in thousands)		(in thousands)	(in years)			(in thousands)
$0 - 25	1,570	4.8	$	19	$	21,589	1,352	4.6	$	19	$	18,815
$25.01 - 30	734	7.1	$	30	2,184		362	7.1	$	30	1,075
$30.01 - 40	972	8.0	$	31	1,745		245	8.0	$	31	438
	3,276	6.3	$	25	$	25,518	1,959	5.5	$	22	$	20,328

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on Keysight's closing stock price of $32.80 at October 31, 2016, which would have been received by award holders had all award holders exercised their awards that were in-the-money as of that date. The total number of in-the-money awards exercisable at October 31, 2016 was approximately 2 million.

The following table summarizes the aggregate intrinsic value of options exercised and the fair value of options granted in 2016, 2015 and 2014:



	Aggregate Intrinsic Value		Weighted Average Exercise Price		Per Share Value Using Black-Scholes Model
	(in thousands)
Options exercised in fiscal 2014	$	39,886	$	30
Black-Scholes per share value of options granted during fiscal 2014					$	19
Options exercised in fiscal 2015	$	15,160	$	16
Black-Scholes per share value of options granted during fiscal 2015					$	9
Options exercised in fiscal 2016	$	5,656	$	19
Black-Scholes per share value of options granted during fiscal 2016					N/A

As of October 31, 2016 the unrecognized share-based compensation costs for outstanding stock option awards, net of expected forfeitures, was approximately $3 million, which is expected to be amortized over a weighted average period of 1.7 years. See Note 6, "Income Taxes," for the tax impact on share-based award exercises.

Non-vested Awards

The following table summarizes non-vested award activity in 2016 primarily for our LTP Program and restricted stock unit awards:



	Shares		Weighted Average Grant Date Fair Value
	(in thousands)
Non-vested at October 31, 2015	3,120		$	29
Granted	1,301		$	32
Vested	(1,077	)	$	27
Forfeited	(54	)	$	30
Change in LTP Program shares vested in the year due to performance conditions	(234	)	$	25
Non-vested at October 31, 2016	3,056		$	30

As of October 31, 2016 the unrecognized share-based compensation cost for non-vested restricted stock awards, net of expected forfeitures, was approximately $32 million, which is expected to be amortized over a weighted average period of 2.1 years. The total fair value of restricted stock awards vested was $33 million for 2016, $36 million for 2015 and $29 million for 2014.