Stock-based Compensation Expense

The Company recognizes share-based payments to employees as compensation expense using the fair value method. The fair value of stock options and shares purchased pursuant to the ESPP is calculated using the Black-Scholes option pricing model. The fair value of restricted stock and restricted stock units typically is based on the intrinsic value on the date of grant. Stock-based compensation, measured at the grant date based on the fair value of the award, is typically recognized as expense ratably over the service period. The expense recognized over the service period includes an estimate of awards that will be forfeited.

The effect of stock-based compensation expense during the three years ended December 31, 2014 was as follows:



	2014		2013		2012
	(in thousands)
Stock-based compensation expense by line item:
Research and development expenses	$	116,998	$	81,183	$	71,243
Sales, general and administrative expenses	60,544		45,652		42,561
Total stock-based compensation expense included in costs and expenses	$	177,542	$	126,835	$	113,804

The stock-based compensation expense by type of award during the three years ended December 31, 2014 was as follows:



	2014			2013			2012
	(in thousands)
Stock-based compensation expense by type of award:
Stock options	$	99,961		$	84,599		$	78,566
Restricted stock and restricted stock units	70,678			36,479			29,194
ESPP share issuances	8,326			6,805			7,298
Less: stock-based compensation expense capitalized to inventories	(1,423		)	(1,048		)	(1,254		)
Total stock-based compensation expense included in costs and expenses	$	177,542		$	126,835		$	113,804

In 2013 and 2012, the Company also recognized stock-based compensation expense recorded to noncontrolling interest (Alios), which is reflected in the Company’s consolidated statements of shareholders equity and noncontrolling interest on the consolidated balance sheet and in discontinued operations attributable to noncontrolling interest as of December 31, 2014.

The Company capitalizes stock-based compensation expense to inventories, all of which is attributable to employees who supported the Company’s manufacturing operations for the Company’s products.

The following table sets forth the Company’s unrecognized stock-based compensation expense, net of estimated forfeitures, as of December 31, 2014, by type of award and the weighted-average period over which that expense is expected to be recognized:



	As of December 31, 2014
	Unrecognized Expense Net of Estimated Forfeitures		Weighted-average Recognition Period
	(in thousands)		(in years)
Type of award:
Stock options	$	156,969	2.13
Restricted stock and restricted stock units	$	148,037	2.79
ESPP share issuances	$	4,262	0.61

Stock Options

The Company issues stock options with service conditions, which are generally the vesting periods of the awards. The Company uses the Black-Scholes option pricing model to estimate the fair value of stock options at the grant date. The Black-Scholes option pricing model uses the option exercise price as well as estimates and assumptions related to the expected price volatility of the Company’s stock, the rate of return on risk-free investments, the expected period during which the options will be outstanding, and the expected dividend yield for the Company’s stock to estimate the fair value of a stock option on the grant date. The options granted during 2014, 2013 and 2012 had a weighted-average grant-date fair value per share of $39.95, $25.79 and $19.72, respectively.

The fair value of each option granted during 2014, 2013 and 2012 was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:



	2014		2013		2012
Expected stock price volatility	50.86	%	46.20	%	47.93	%
Risk-free interest rate	1.77	%	1.25	%	0.95	%
Expected term of options (in years)	5.47		5.81		5.78
Expected annual dividends	—		—		—

The weighted-average valuation assumptions were determined as follows:


•	Expected stock price volatility: Options to purchase the Company’s stock with remaining terms of greater than one year are regularly traded in the market. Expected stock price volatility is calculated using the trailing one month average of daily implied volatilities prior to grant date.


•	Risk-free interest rate: The Company bases the risk-free interest rate on the interest rate payable on U.S. Treasury securities in effect at the time of grant for a period that is commensurate with the assumed expected option term.

•

Expected term of options: The expected term of options represents the period of time options are expected to be outstanding. The Company uses historical data to estimate employee exercise and post-vest termination behavior. The Company believes that all groups of employees exhibit similar exercise and post-vest termination behavior and therefore does not stratify employees into multiple groups in determining the expected term of options.


•	Expected annual dividends: The estimate for annual dividends is $0.00 because the Company has not historically paid, and does not intend for the foreseeable future to pay, a dividend.

Restricted Stock and Restricted Stock Units

The Company issues restricted stock and restricted stock units with service conditions, which are generally the vesting periods of the awards. The Company also issues, to certain members of senior management, on an annual basis restricted stock and restricted stock units that vest upon the earlier of the satisfaction of (i) a performance condition or (ii) a service condition. In addition, in 2014, the Company issued pursuant to a retention program restricted stock awards to certain members of senior management that will vest upon the satisfaction of both (i) a performance condition and (ii) a service condition.

Employee Stock Purchase Plan

The weighted-average fair value of each purchase right granted during 2014, 2013 and 2012 was $29.59, $21.08 and $12.90, respectively. The following table reflects the weighted-average assumptions used in the Black-Scholes option pricing model for 2014, 2013 and 2012:



	2014		2013		2012
Expected stock price volatility	60.32	%	54.69	%	46.90	%
Risk-free interest rate	0.09	%	0.08	%	0.16	%
Expected term (in years)	0.75		0.74		0.74
Expected annual dividends	—		—		—

The expected stock price volatility for ESPP offerings is based on implied volatility. The Company bases the risk-free interest rate on the interest rate payable on U.S. Treasury securities in effect at the time of grant for a period that is commensurate with the assumed expected term. The expected term represents purchases and purchase periods that take place within the offering period. The expected annual dividends estimate is $0.00 because the Company has not historically paid, and does not for the foreseeable future intend to pay, a dividend.