Cisco 2010 Annual Report Download - page 72

Notes to Consolidated Financial Statements
Expense and Valuation Information for Share-Based Awards
Share-Based Compensation Expense
Share-based compensation expense consists primarily of expenses for stock options, stock purchase rights, restricted stock, and
restricted stock units granted to employees. The following table summarizes share-based compensation expense (in millions):
Years Ended July 31, 2010 July 25, 2009 July 26, 2008
Cost of sales—product $57 $46 $40
Cost of sales—service 164 128 108
Share-based compensation expense in cost of sales 221 174 148
Research and development 450 382 339
Sales and marketing 536 441 438
General and administrative 310 234 187
Share-based compensation expense in operating expenses 1,296 1,057 964
Total share-based compensation expense $ 1,517 $ 1,231 $ 1,112
As of July 31, 2010, the total compensation cost related to unvested share-based awards not yet recognized was $3.3 billion,
which is expected to be recognized over approximately 2.5 years on a weighted-average basis. The income tax benefit for share-
based compensation expense was $415 million, $317 million, and $362 million for fiscal 2010, 2009, and 2008, respectively.
Valuation of Employee Stock Options and Employee Stock Purchase Rights
The assumptions related to and the valuation of employee stock options and employee stock purchase rights are summarized as
follows:
EMPLOYEE STOCK OPTIONS EMPLOYEE STOCK PURCHASE RIGHTS
Years Ended July 31, 2010 July 25, 2009 July 26, 2008 July 31, 2010 July 25, 2009 July 26, 2008
Number of options granted (in millions) 49 151 N/A N/A N/A
Weighted-average assumptions:
Expected volatility 30.5% 36.0% 31.0% 30.9% 36.4% 32.6%
Risk-free interest rate 2.3% 3.0% 4.3% 0.5% 0.6% 2.7%
Expected dividend 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Kurtosis 4.1 4.5 4.6 N/A N/A N/A
Skewness 0.20 (0.19) (0.80) N/A N/A N/A
Weighted-average expected life (in years) 5.1 5.9 6.3 1.3 1.1 0.5
Weighted-average estimated grant date fair value (per
option /per share) $ 6.50 $ 6.60 $ 9.60 $ 6.53 $ 5.46 $ 6.12
The Company estimates the value of employee stock options on the date of grant using a lattice-binomial model and estimates the
value of employee stock purchase rights on the date of grant using the Black-Scholes model. The lattice-binomial model is more
capable of incorporating the features of the Company’s employee stock options, such as the vesting provisions and various
restrictions including restrictions on transfer and hedging, among others, and the options are often exercised prior to their
contractual maturity. The use of the lattice-binomial model also requires extensive actual employee exercise behavior data for the
relative probability estimation purpose, and a number of complex assumptions as presented in the preceding table. The probability
estimation of the employees’ exercise behavior is assumed to be a function of two variables: an option’s remaining vested life and
the extent to which the option is in-the-money. Both of these two variables are based on the entire history of exercises and
cancellations on all past option grants made by the Company.
The determination of the fair value of employee stock options and employee stock purchase rights on the date of grant is
impacted by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. The
weighted-average assumptions were determined as follows:
• For employee stock options, the Company used the implied volatility for two-year traded options on the Company’s stock as the
expected volatility assumption required in the lattice-binomial model. For employee stock purchase rights, the Company used the
implied volatility for traded options (with contract terms corresponding to the expected life of the employee stock purchase
rights) on the Company’s stock in the Black-Scholes model. The selection of the implied volatility approach was based upon the
availability of actively traded options on the Company’s stock and the Company’s assessment that implied volatility is more
representative of future stock price trends than historical volatility.
70 Cisco Systems, Inc.