. 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, 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, restricted stock units ("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.

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



	Three Months Ended
	January 31,
	2015		2014
	(in millions)
Cost of products and services	$	4	$	4
Research and development	4		3
Selling, general and administrative	21		10
Total share-based compensation expense	$	29	$	17

At January 31, 2015 and January 31, 2014, share-based compensation capitalized within inventory was $2 million and $1 million, respectively. The income tax benefit realized from the exercised stock options and similar awards recognized was $3 million and $0 million for the three months ended January 31, 2015 and 2014, respectively. The current period expense includes an expense of $14 million related to special inaugural RSU awards. These awards will vest over three years from the date of grant.

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



	Three Months Ended
	January 31,
	2015		2014
Stock Option Plans:
Weighted average risk-free interest rate	1.6	%	1.7	%
Dividend yield	—	%	1	%
Weighted average volatility	31	%	39	%
Expected life	4.8 years		5.8 years
LTP Program
Volatility of Keysight shares	26	%	—	%
Volatility of selected peer-company shares	17%-67%		—	%
Price-wise correlation with selected peers	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 unit awards is determined based on the market price of Keysight’s common stock on the date of grant adjusted for expected dividend yield. The ESPP allows eligible employees to purchase shares of our common stock at 85 percent of the purchase price and uses the purchase date to establish the fair market value.

As of November 1, 2014, Agilent’s fiscal 2013 LTP Program grants to Keysight executives are classified as liability awards in our condensed 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 mark-to-market adjustment was immaterial for the three months ended January 31, 2015.

For the three months ended January 31, 2015, we used an average of historical volatility of eleven core peer companies to estimate the expected stock price volatility assumption for our employee stock option awards. In reaching to this conclusion, 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 three months ended January 31, 2014, we used historical volatility of Agilent stock to estimate the expected stock price volatility assumption for employee stock option awards. In estimating the expected life of our options granted for three months ended January 31, 2015 and 2014, we considered the historical option exercise behavior of our executives, which we believe is representative of future behavior.