Note 14—Stock-based Compensation and Benefit Plans

NOTE 14—STOCK-BASED COMPENSATION AND BENEFIT PLANS

Stock-based Compensation

Going-Private Transaction

In connection with the acquisition of Dell by Denali Holding on October 29, 2013, the board of directors of Denali Holding approved the Denali Holding Inc. 2013 Stock Incentive Plan (the “2013 Stock Incentive Plan”). Immediately prior to the completion of the going-private transaction, Dell had 78 million outstanding options, and subsequent to the going-private transaction, 75 million of these options were settled for a one-time cash payment. In accordance with authoritative guidance, the Company re-valued these options as of the transaction date using the lattice binomial valuation. The difference between the fair value of the canceled awards and the cash payment that pertained to services rendered prior to the transaction date was recognized as additional paid-in capital upon close of the transaction, while $67 million that pertained to services forgone subsequent to the transaction was immediately recognized as stock-based compensation expense in the successor period. In addition, immediately prior to the going-private transaction, Dell had 22 million unvested restricted stock units, 21 million of which were converted to deferred cash awards that continue to have a service period requirement after the completion of the going-private transaction.

Under terms of a new employment agreement effective as of close of the transaction, Michael S. Dell, Chief Executive Officer of the Company, was issued an option to purchase 11 million shares of Series A common stock of Denali Holding at an exercise price of $13.75 per share. The option is service-based and vests ratably over five years on each anniversary of the going-private transaction or will vest fully earlier, upon a change in control of Denali Holding. As of January 29, 2016, the Company expects to incur approximately $49 million of additional compensation-related expense through October 2018 for this option grant.

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DENALI HOLDING INC.

NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS

Description of the 2013 Stock Incentive Plan

The 2013 Stock Incentive Plan provides for the grant of stock-based incentive awards to aid in recruiting and the retention of employees. Denali Holding intends to continue to grant long-term cash incentive awards, but no other type of award, pursuant to the Dell Inc. 2012 Long-Term Incentive Plan (as renamed the Denali Holding Inc. 2012 Long-Term Incentive Plan).

Redeemable Shares—The 2013 Stock Incentive Plan provides for the grant of stock-based incentive awards to the Company’s employees, consultants, and non-employee directors. Equity awards available for issuance under the 2013 Stock Incentive Plan include stock options, stock appreciation rights, restricted stock units, and other equity-based awards. Those awards include certain rights that allow the holder to exercise a put feature for the underlying stock, requiring the Company to purchase the stock at its fair market value. The put feature is subject to a six-month holding period following the issuance of the common stock. Accordingly, these awards are subject to reclassification from equity to temporary equity, and the Company determines the amounts to be classified as temporary equity as follows:

•

For stock options subject to service requirements, the intrinsic value of the option is multiplied by the portion of the option that is vested. Upon exercise of the option, the amount in temporary equity represents the fair value of the Company’s common stock.

•

For stock appreciation rights and restricted stock units, the fair value of each share subject to such awards is multiplied by the portion of the share that is vested.

•

For share-based arrangements that are subject to the occurrence of a contingent event, those amounts are not reclassified as temporary equity until the contingency has been satisfied.

The amount of redeemable shares classified as temporary equity as of January 29, 2016 and January 30, 2015 was $106 million and $53 million, respectively. As of January 29, 2016, redeemable shares was comprised of 0.9 million issued and outstanding common shares, 0.1 million unvested restricted stock units, and 18.6 million outstanding stock options. As of January 30, 2015, redeemable shares was comprised of 0.5 million issued and outstanding common shares, 0.3 million unvested restricted stock units, and 18.8 million outstanding stock options.

As of January 29, 2016 and January 30, 2015, there were approximately 17 million shares of common stock of Denali Holding available for future grants under the 2013 Stock Incentive Plan.

Stock Option Agreements—Stock options granted under the 2013 Stock Incentive Plan include service-based awards and performance-based awards. Service-based stock options typically vest pro-rata at each anniversary of the grant date over a five year period. Performance-based stock options, with a market condition, become exercisable upon achievement of Return on Equity (ROE) metrics up to the seven year anniversary of the going-private transaction date, depending upon the achievement of the market condition. Both service-based and performance-based stock options are granted with option exercise prices equal to the grant date fair market value of Denali common stock, as determined by the Denali Holding board of directors. Generally, common stock issued under both service-based and performance-based awards are subject to liquidity events, such as an initial public offering, change in control, sales of common stock under an annual company liquidity program, and calls and puts resulting upon the occurrence of specified events. Stock options expire ten years after the date of grant. Compensation expense for service-based stock options is recognized on a straight-line basis over the requisite service period, while compensation expense for performance-based stock options, with a market condition, is recognized on a graded accelerated basis net of estimated forfeitures over the requisite service period.

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DENALI HOLDING INC.

NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS

Stock Option Activity

The following table summarizes stock option activity during the respective periods:

		Number of Options				Weighted- Average Exercise Price				Weighted Average Remaining Contractual Term
		(in millions)				(per share)				(in years)
Predecessor
Options outstanding—February 1, 2013			118			$	22.51
Granted and assumed through acquisitions			—				—
Exercised			(6	)			7.59
Forfeited			(9	)			8.03
Canceled/expired			(101	)			24.46
Converted			(2	)			29.67
Options outstanding—October 28, 2013			—				—
Successor
Options outstanding—October 29, 2013			—				—
Granted and assumed through the going-private transaction (a)			60				14.32
Exercised			—				—
Forfeited			—				—
Canceled/expired			—				—
Options outstanding—January 31, 2014			60				14.32
Granted			2				17.08
Exercised			—				—
Forfeited			(6	)			13.75
Canceled/expired			(1	)			32.22
Options outstanding—January 30, 2015			55				14.11
Granted			2				24.05
Exercised			—				—
Forfeited			(3	)			19.07
Canceled/expired			—				—
Options outstanding—January 29, 2016 (b)			54			$	14.30
Vested and expected to vest (net of estimated forfeitures)—January 29, 2016			49			$	14.27				7.9
Exercisable—January 29, 2016			11			$	13.99				7.6

(a)

In connection with the going-private transaction, Denali Holding assumed 2 million stock options with a weighted-average exercise price per share of $29.67 that were outstanding under an existing Dell stock incentive plan. In addition, one-time awards totaling 58 million stock options with an exercise price of $13.75 per share were granted to certain members of the Company’s management under the 2013 Stock Incentive Plan.

(b)	Of the 54 million stock options outstanding on January 29, 2016, 24 million related to performance-based awards and 30 million related to service-based awards

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DENALI HOLDING INC.

NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS

During the fiscal years ended January 29, 2016 and January 30, 2015 and the successor period ended January 31, 2014, the total fair value of options vested was $42 million, $41 million and immaterial, respectively. For the predecessor period ended October 28, 2013, the total fair value of options vested was $74 million. As of January 29, 2016 and January 30, 2015, there was $183 million and $235 million, respectively, of total unrecognized stock-based compensation expense, net of estimated forfeitures, related to unvested stock options expected to be recognized over a weighted-average period of 3.6 years and 4.0 years, respectively.

Valuation of Service-Based Stock Option Awards

For service-based stock options granted by the successor entity under the 2013 Stock Incentive Plan, Denali Holding utilized the Black-Scholes option pricing model to estimate the fair value of stock options at the grant date. The Black-Scholes option pricing model incorporates various assumptions, including leveraged adjusted volatility of a public peer group, expected term, risk-free interest rates, and dividend yields. The weighted assumptions utilized for valuation of options under this model as well as the weighted-average grant date fair value of stock options granted during the respective periods are presented below. There were no option grants by the predecessor entity in the predecessor period ended October 28, 2013 under previous Dell stock incentive plans.

The expected term of both the successor and predecessor periods shown below is based on historical experience and on the terms and conditions of the stock awards granted to employees. For the predecessor periods shown below, volatility was based on a blend of implied and historical volatility of Dell’s common stock over the most recent period commensurate with the estimated expected term of Dell’s predecessor stock options. For the successor period, option valuations used leverage-adjusted volatility of a peer group and the expected term was based on analysis of Dell historical option settlement experience and on the terms and conditions of the stock awards granted.

Valuation of Performance-Based Stock Option Awards

For performance-based stock options granted under the 2013 Stock Incentive Plan, Denali Holding uses the Monte Carlo valuation model to simulate probabilities of achievement of the market condition and the grant date fair value. The valuation model for performance-based option grants in the fiscal year ended January 29, 2016 used a weighted-average leverage adjusted 7.66 year peer volatility and corresponding risk free interest rate. Upon fulfillment of a ROE condition, a specific portion of the performance options become exercisable. An embedded binomial lattice option pricing model was used to determine the value of these exercisable options using the assumption that each option will be exercised at the midpoint between the date of satisfaction of a ROE condition and the expiration date of such option.

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DENALI HOLDING INC.

NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS

The assumptions utilized in this model as well as the weighted-average grant date fair value of stock options granted during the successor period are presented below.

		Successor
		Service- Based				Performance- Based				Service- Based				Performance- Based				Service- Based				Performance- Based
		Fiscal Year Ended January 29, 2016				Fiscal Year Ended January 29, 2016				Fiscal Year Ended January 30, 2015				Fiscal Year Ended January 30, 2015				October 29, 2013 through January 31, 2014 (a)				October 29, 2013 through January 31, 2014 (a)
Weighted-average grant date fair value of stock options granted per option		$	10.05			$	10.85			$	8.75			$	9.01			$	7.02			$	5.92
Expected term (in years)			5.1				—				5.2				—				6.9				—
Risk-free rate (U.S. Government Treasury Note)			1.5	%			2.0	%			1.6	%			2.4	%			1.9	%			2.5	%
Volatility			46	%			50	%			62	%			55	%			49	%			48	%
Dividend Yield			—	%			—	%			—	%			—	%			—	%			—	%

(a)	The 11 million options granted to Michael S. Dell by Denali Holding, included in the service-based column for successor above, were valued using an expected term of 10 years and corresponding risk-free interest rate. This resulted in a grant date fair value of $8.22 per option.

Restricted Stock Unit Awards

Non-vested restricted stock unit awards and activities for the respective periods are as follows:

		Number of Shares				Weighted- Average Grant Date Fair Value
		(in millions)				(per share)
Predecessor
Non-vested restricted stock units:
Non-vested restricted stock unit balance as of February 1, 2013			42			$	15.95
Granted			—				—
Vested (a)			(16	)			16.02
Forfeited			(4	)			16.96
Converted			(22	)			15.69
Non-vested restricted stock unit balance as of October 28, 2013			—			$	—

(a)

Upon vesting of restricted stock units, some of the underlying shares were generally sold to cover the required withholding taxes. However, select participants could choose the net shares settlement method to cover withholding tax requirements. Total shares withheld were approximately 320,000 for the predecessor period ended October 28, 2013. Total payments for the employee’s tax obligations to the taxing authorities were $5 million for the predecessor period ended October 28, 2013 and are reflected as a financing activity within the Consolidated Statements of Cash Flows.

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DENALI HOLDING INC.

NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS

In connection with the going-private transaction, the successor entity assumed 0.8 million unvested restricted stock units with a re-measured grant date fair value of $13.75 per share. As of January 29, 2016 and January 30, 2015 there was $1 million and $2 million, respectively, of unrecognized stock-based compensation expense, net of estimated forfeitures, related to these awards expected to be recognized over a weighted-average period of approximately 1.9 years and 2.6 years, respectively.

For the successor periods ended January 29, 2016, January 30, 2015, and January 31, 2014, the total estimated vest date fair value of restricted stock unit awards was not material.

Stock-based Compensation Expense

Stock-based compensation expense was allocated as follows for the respective periods:

		Successor														Predecessor
		Fiscal Year Ended January 29, 2016				Fiscal Year Ended January 30, 2015				October 29, 2013 through January 31, 2014						February 2, 2013 through October 28, 2013
						(in millions)
Stock-based compensation expense:
Cost of net revenue		$	10			$	13			$	5					$	31
Operating expenses			62				59				77						153
Stock-based compensation expense before taxes			72				72				82						184
Income tax benefit			(26	)			(26	)			(24	)					(54	)
Stock-based compensation expense, net of income taxes		$	46			$	46			$	58					$	130

Employee Benefit Plans

401(k) Plan—The Company has a defined contribution retirement plan (the “401(k) Plan”) that complies with Section 401(k) of the Internal Revenue Code. Substantially all employees in the U.S. are eligible to participate in the 401(k) Plan. Effective January 1, 2008, the Company matches 100% of each participant’s voluntary contributions, subject to a maximum contribution of 5% of the participant’s eligible compensation, and participants vest immediately in all contributions to the 401(k) Plan. The Company’s contributions during the successor periods ended January 29, 2016, January 30, 2015, and January 31, 2014 were $169 million, $162 million, and $37 million, respectively, and Dell’s contributions for the predecessor period ended October 28, 2013 were $136 million. The Company’s matching contributions and participants voluntary contributions are invested according to each participant’s elections in the investment options provided under the Plan. Investment options included Dell common stock for a portion of the plan year before the going-private transaction, but neither participant nor Dell contributions were required to be invested in Dell common stock.