4. SHARE-BASED COMPENSATION

Agilent accounts for share-based awards in accordance with the provisions of the 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 ESPP and performance share awards granted to selected members of our senior management under the LTPP based on estimated fair values.

Description of Share-Based Plans

Employee stock purchase plan. Effective November 1, 2000, we adopted the ESPP. The ESPP allows eligible employees to contribute up to ten percent of their base compensation to purchase shares of our 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 common stock of Agilent 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 696,178 shares for $23 million in 2016, 346,472 shares for $12 million in 2015 and 1,604,406 shares for $73 million in 2014. As of October 31, 2016, the number of shares of common stock authorized and available for issuance under our ESPP was 45,168,192.

Incentive compensation plans. On November 19, 2008 and March 11, 2009, the Compensation Committee of Board of Directors and the stockholders, respectively, approved the Agilent Technologies, Inc. 2009 Stock Plan (the "2009 Stock Plan") to replace the Company's 1999 Stock Plan and 1999 Stock Non-Employee Director Stock Plan and subsequently reserved 25 million shares of Company common stock that may be issued under the 2009 Plan, plus any shares forfeited or cancelled under the 1999 Stock Plan. The 2009 Stock Plan provides for the grant of awards in the form of stock options, stock appreciation rights ("SARs"), restricted stock, restricted stock units ("RSUs"), performance shares and performance units with performance-based conditions on vesting or exercisability, and cash awards. The 2009 Plan has a term of ten years. As of October 31, 2016, 10,316,082 shares were available for future awards under the 2009 Stock Plan.

Stock options granted under the 2009 Stock Plans 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. No options were granted during the year ended October 31, 2016.

Effective November 1, 2003, the Compensation Committee of the Board of Directors approved the LTPP, which is a performance stock award program administered under the 2009 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. Certain LTPP awards are generally designed to meet the criteria of a performance award with the performance metrics and peer group comparison based on the Total Stockholders’ Return (“TSR”) set at the beginning of the performance period. Effective November 1, 2015, the Compensation Committee of the Board of Directors approved another type of performance stock award, for the company's executive officers and other key employees. Participants in this program are also entitled to receive unrestricted shares of the company's stock after the end of a three-year period, if specified performance targets based on Operating Margin (“OM”) over the three-year period are met. All LTPP awards granted after November 1, 2015, are subject to a one-year post-vest holding period.

Based on the performance metrics the final LTPP award may vary from zero to 200 percent of the target award. The maximum contractual term for awards under the LTPP program is three years and the maximum award value cannot exceed 300 percent of the grant date target value. We consider the dilutive impact of these programs in our diluted net income per share calculation only to the extent that the performance conditions are expected to be met.

We also issue restricted stock units under our share-based plans. The estimated fair value of the restricted stock unit awards granted under the Stock Plans is determined based on the market price of Agilent's common stock on the date of grant adjusted for expected dividend yield. 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.

In connection with the separation of Keysight Technologies on November 1, 2014 and in accordance with the Employee Matters Agreement we made certain adjustments to the exercise price and number of our share-based compensation awards with the intention of preserving the intrinsic value of the awards prior to the separation. Exercisable and non-exercisable stock options converted to those of the entity where the employee is working post-separation. Restricted stock units awards and long-term performance plan grants were adjusted to provide holders restricted stock units and long-term performance plan grants in the company that employs such employee following the separation. These adjustments to our stock-based compensation awards did not have a material impact on compensation expense.

Impact of Share-based Compensation Awards

We have recognized compensation expense based on the estimated grant date fair value method under the authoritative guidance. For all share-based awards we have recognized compensation expense using a straight-line amortization method. As the guidance requires that share-based compensation expense be based on awards that are ultimately expected to vest, estimated share-based compensation has been reduced for estimated forfeitures.

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



	Years Ended October 31,
	2016		2015		2014
	(in millions)
Cost of products and services	$	14	$	11	$	13
Research and development	6		5		7
Selling, general and administrative	40		39		39
Share-based compensation expense in continuing operations	60		55		59
Share-based compensation expense in discontinued operations	—		—		39
Total share-based compensation expense	$	60	$	55	$	98

At October 31, 2016 and 2015 there was no share-based compensation capitalized within inventory. The weighted average grant date fair value of options, granted in 2015 and 2014 was $10.58 and $18.73 per share, respectively. No stock options were granted in 2016.

Included in the 2016, 2015 and 2014 expense is incremental expense for acceleration of share-based compensation related to the announced workforce reduction plan of zero, $2 million and $1 million, respectively. Upon termination of the employees impacted by workforce reduction, the non-vested Agilent awards held by these employees immediately vests. Employees have a period of up to three months in which to exercise the Agilent options before such options are cancelled.

Valuation Assumptions

For all periods presented, the fair value of share based awards for employee stock option awards was estimated using the Black-Scholes option pricing model. For all periods presented, shares granted under the LTPP (TSR) were valued using a Monte Carlo simulation. The ESPP allows eligible employees to purchase shares of our common stock at 85 percent of the fair market value at the purchase date.

The estimated fair value of restricted stock unit awards and LTPP (OM) was determined based on the market price of Agilent's common stock on the date of grant adjusted for expected dividend yield and as appropriate, a discount related to the one-year post vesting. The compensation cost for LTPP (OM) reflects the cost of awards that are probable to vest at the end of the performance period.

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



	Years Ended October 31,
	2016	2015	2014
Stock Option Plans:
Weighted average risk-free interest rate	—	1.75%	1.69%
Dividend yield	—	1%	1%
Weighted average volatility	—	28%	39%
Expected life	—	5.5 years	5.8 years
LTPP:
Volatility of Agilent shares	24%	25%	36%
Volatility of selected peer-company shares	14%-50%	12%-57%	13%-57%
Price-wise correlation with selected peers	35%	37%	47%

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. Due to the separation of Keysight on November 1, 2014, expected volatility for grants of options in 2015 was based on a 5.5 year average historical stock price volatility of a group of our peer companies. For the volatility of our 2016 and 2015 LTPP (TSR) grants, we used the 3-year average historical stock price volatility of a group of our peer companies. We believe our historical volatility prior to the separation of Keysight is no longer relevant to use. For the grants of options and LTPP (TSR) prior to November 1, 2014, the expected stock price volatility assumption was determined using the historical volatility of Agilent’s stock over the most recent historical period equivalent to the expected life of the stock options and LTPP (TSR).

All LTPP awards granted in 2016 to our senior management employees have a one-year post-vest holding restriction. The estimated discount associated with post-vest holding restrictions is calculated using the Finnerty model. The model calculates the potential lost value if the employee were able to sell the shares during the lack of marketability period, instead of being required to hold the shares. The model used the 3-year average historical stock price volatility of a group of our peer companies and an expected dividend yield to compute the discount. The grants made during 2016 have a discount of 5.5 percent while computing the fair value.

Share-based Payment Award Activity

Employee Stock Options

The following table summarizes employee stock option award activity of our employees and directors for 2016.



	Options Outstanding		Weighted Average Exercise Price
	(in thousands)
Outstanding at October 31, 2015	5,712		$	31
Granted	—		$	—
Exercised	(1,547	)	$	25
Cancelled/Forfeited/Expired	(59	)	$	33
Outstanding at October 31, 2016	4,106		$	33

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



	Options Cancelled	Weighted Average Exercise Price
	(in thousands)
Forfeited	31	$	38
Expired	28	$	28
Total Options Cancelled during 2016	59	$	33

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	361	2.4	$	18	$	9,268	361	2.4	$	18	$	9,268
$25.01 - 30	1,633	5.0	$	26	28,095		1,324	4.7	$	26	22,741
$30.01 - 40	898	7.1	$	39	3,995		439	7.1	$	39	1,957
$40.01 - over	1,214	8.0	$	41	3,259		302	8.0	$	41	815
	4,106	6.1	$	33	$	44,617	2,426	5.2	$	29	$	34,781

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the company's closing stock price of $43.57 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 2.4 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	$	98,075	$	30
Black-Scholes per share value of options granted during fiscal 2014					$	19
Options exercised in fiscal 2015	$	33,258	$	24
Black-Scholes per share value of options granted during fiscal 2015					$	11
Options exercised in fiscal 2016	$	26,913	$	25
Black-Scholes per share value of options granted during fiscal 2016					$	—

As of October 31, 2016, the unrecognized share-based compensation costs for outstanding stock option awards, net of expected forfeitures, was approximately $2 million which is expected to be amortized over a weighted average period of 1.7 years. The amount of cash received from the exercise of share-based awards granted was $62 million in 2016, $58 million in 2015 and $188 million in 2014. See Note 5, "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 LTPP and restricted stock unit awards.



	Shares		Weighted Average Grant Price
	(in thousands)
Non-vested at October 31, 2015	2,417		$	36
Granted	1,732		$	40
Vested	(607	)	$	35
Forfeited	(94	)	$	39
Change in LTPP shares in the year due to not meeting performance conditions	(386	)	$	28
Non-vested at October 31, 2016	3,062		$	40

As of October 31, 2016, the unrecognized share-based compensation costs for non-vested restricted stock awards, net of expected forfeitures, was approximately $45 million which is expected to be amortized over a weighted average period of 2.5 years. The total fair value of restricted stock awards vested was $21 million for 2016, $31 million for 2015 and $54 million for 2014.

In the third quarter of fiscal year 2016, the company elected to early adopt new guidance that changes the accounting for certain aspects of share-based payments to employees. For additional details related to the new guidance see Note 2, "New Accounting Pronouncements."