Stock-Based Compensation Expense

The Company’s share-based payments that result in compensation expense consist of stock option and restricted stock award grants. As of September 28, 2014, the Company had 9,901,489 shares available for grant. Generally, stock options are granted with an exercise price equal to the market value of the Company’s common stock at the grant date, vest over four years based upon continuous service, and expire ten years from the grant date. Restricted stock awards are granted with an exercise price equal to the market value of the Company's common stock at the time of grant. Conditions of the award may be based on continuing employment and or achievement of pre-established performance goals and objectives. Vesting for performance-based restricted stock awards and time-based restricted stock awards must be greater than one year and three years, respectively.

The following table summarizes the Company’s stock option activity for the nine-month period ended September 28, 2014:



	Shares (in thousands)		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in thousands)
Outstanding as of December 31, 2013	6,138		$	15.65
Granted	1,412		39.16
Exercised	(1,133	)	13.81
Forfeited or expired	(190	)	21.42
Outstanding as of September 28, 2014	6,227		$	21.14	7.2	$	126,966
Exercisable as of September 28, 2014	2,276		$	13.21	5.4	$	64,411
Options vested or expected to vest at September 28, 2014 (1)	5,657		$	20.34	7.0	$	119,889

(1) In addition to the vested options, the Company expects a portion of the unvested options to vest at some point in the future. Options expected to vest are calculated by applying an estimated forfeiture rate to the unvested options.

The fair values of stock options granted in each period presented were estimated using the following weighted-average assumptions:



	Three-months Ended				Nine-months Ended
	September 28, 2014		September 29, 2013		September 28, 2014		September 29, 2013
Risk-free rate	2.7	%	2.0	%	2.7	%	2.0	%
Expected dividend yield	—	%	—	%	—	%	—	%
Expected volatility	41	%	42	%	41	%	42	%
Expected term (in years)	5.4		5.9		5.4		5.9

Risk-free rate

The risk-free rate was based upon a treasury instrument whose term was consistent with the contractual term of the option.

Expected dividend yield

Generally, the current dividend yield is calculated by annualizing the cash dividend declared by the Company’s Board of Directors and dividing that result by the closing stock price on the grant date. However, in the fourth quarter of 2012, the Company paid the full annual dividends for 2013 and 2014 in advance, and therefore, the dividend yield for those years has been adjusted to zero. At the time of the 2014 valuation, a dividend yield of 0.56% was estimated for future periods from 2015 through the expected life of the option.

Expected volatility

The expected volatility was based upon a combination of historical volatility of the Company’s common stock over the contractual term of the option and implied volatility for traded options of the Company’s stock.

Expected term

The expected term was derived from the binomial lattice model from the impact of events that trigger exercises over time.

The Company stratifies its employee population into two groups: one consisting of senior management and another consisting of all other employees. The Company currently expects that approximately 72% of its stock options granted to senior management and 70% of its options granted to all other employees will actually vest. Therefore, the Company currently applies an estimated annual forfeiture rate of 11% to all unvested options for senior management and a rate of 12% for all other employees. The Company revised its estimated forfeiture rates in the first quarters of 2014 and 2013, resulting in an increase to compensation expense of $288,000 and $300,000, respectively.

The weighted-average grant-date fair values of stock options granted during the three-month periods ended September 28, 2014 and September 29, 2013 were $15.45 and $8.07, respectively. The weighted-average grant-date fair values of stock options granted during the nine-month periods ended September 28, 2014 and September 29, 2013 were $15.35 and $8.07, respectively.

The total intrinsic values of stock options exercised for the three-month periods ended September 28, 2014 and September 29, 2013 were $14,461,000 and $14,422,000, respectively. The total intrinsic values of stock options exercised for the nine-month periods ended September 28, 2014 and September 29, 2013 were $29,104,000 and $28,374,000, respectively. The total fair values of stock options vested for the three-month periods ended September 28, 2014 and September 29, 2013 were $268,000 and $197,000, respectively. The total fair values of stock options vested for the nine-month periods ended September 28, 2014 and September 29, 2013 were $11,251,000 and $9,428,000, respectively.

As of September 28, 2014, total unrecognized compensation expense related to non-vested stock options was $15,716,000, which is expected to be recognized over a weighted-average period of 1.35 years.

The following table summarizes the Company's restricted stock award activity:



	Shares (in thousands)	Weighted-Average Exercise Price		Aggregate Intrinsic Value (in thousands)
Nonvested as of December 31, 2013	—	$	—
Granted	20	34.05
Vested	—	—
Forfeited or expired	—	—
Nonvested as of September 28, 2014	20	$	34.05	$	149

The fair values of restricted stock awards granted were determined based upon the market value of the Company's common stock at the time of grant. The initial cost is then amortized over the period of vesting until the restrictions lapse. These restricted shares will be fully vested in 2018. Participants are entitled to dividends on restricted stock awards, but only receive those amounts if the shares vest. The sale or transfer of these shares is restricted during the vesting period.

The total stock-based compensation expense and the related income tax benefit recognized for the three-month period ended September 28, 2014 were $3,298,000 and $1,098,000, respectively, and for the three-month period ended September 29, 2013 were $2,220,000 and $721,000, respectively. The total stock-based compensation expense and the related income tax benefit recognized for the nine-month period ended September 28, 2014 were $11,258,000 and $3,670,000, respectively, and for the nine-month period ended September 29, 2013 were $8,299,000, and $2,725,000, respectively. No compensation expense was capitalized as of September 28, 2014 or December 31, 2013.

The following table details the stock-based compensation expense by caption for each period presented on the Consolidated Statements of Operations (in thousands):



	Three-months Ended				Nine-months Ended
	September 28, 2014		September 29, 2013		September 28, 2014		September 29, 2013
Product cost of revenue	$	242	$	160	$	795	$	564
Service cost of revenue	31		33		138		143
Research, development, and engineering	856		546		2,900		2,009
Selling, general, and administrative	2,169		1,481		7,425		5,583
	$	3,298	$	2,220	$	11,258	$	8,299