Stock-Based Compensation

We record stock-based compensation expense for awards of stock options, stock sold pursuant to our ESPP (until October 1, 2013), and the issuance of restricted stock units and unrestricted stock awards. We expense stock-based compensation primarily using the straight-line method over the requisite service period. For the three months ended March 31, stock-based compensation expense and the related tax benefit were as follows:



	Three Months Ended March 31,
	2014		2013
	(in thousands)
Stock options	$	554	$	473
Restricted stock units	3,800		4,235
Unrestricted stock awards	230		197
ESPP	—		191
Total stock-based compensation	$	4,584	$	5,096

Related tax benefit	$	1,287	$	1,364

We issue new shares of common stock upon the exercise of stock options or when vesting conditions on restricted stock units are fully satisfied.

Subject to stock splits, dividends, and other similar events, 3,500,000 shares of common stock are reserved and authorized for issuance under our 2010 Stock Incentive Plan (Stock Incentive Plan). Awards consist of stock options, restricted stock units, and unrestricted stock awards. At March 31, 2014, 72,843 shares were available for grant under the Stock Incentive Plan. The Stock Incentive Plan shares are subject to a fungible share provision such that, with respect to grants made after December 31, 2009, the authorized share reserve is reduced by (i) one share for every one share subject to a stock option or share appreciation right granted under the Plan and (ii) 1.7 shares for every one share of common stock that was subject to an award other than an option or share appreciation right.

Stock Options

Options to purchase our common stock are granted to certain employees, senior management, and members of the Board of Directors with an exercise price equal to the market close price of the stock on the date the Board of Directors approves the grant. Options generally become exercisable in three equal annual installments beginning one year from the date of grant and generally expire 10 years from the date of grant. Compensation expense is recognized only for those options expected to vest, with forfeitures estimated based on our historical experience and future expectations.

The fair values of stock options granted were estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:



	Three Months Ended March 31,
	2014		2013
Dividend yield	0.0	%	0.0	%
Expected volatility	39.8	%	38.1	%
Risk-free interest rate	1.7	%	1.0	%
Expected term (years)	5.5		5.5

Expected volatility is based on a combination of the historical volatility of our common stock and the implied volatility of our traded options for the related expected term. We believe this combined approach is reflective of current and historical market conditions and is an appropriate indicator of expected volatility. The risk-free interest rate is the rate available as of the award date on zero-coupon U.S. government issues with a term equal to the expected life of the award. The expected life is the weighted average expected life of an award based on the period of time between the date the award is granted and the estimated date the award will be fully exercised. Factors considered in estimating the expected life include historical experience of similar awards, contractual terms, vesting schedules, and expectations of future employee behavior. We have not paid dividends in the past and do not plan to pay dividends in the foreseeable future.

A summary of our stock option activity for the three months ended March 31 is as follows:



	Shares		Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value⁽¹⁾		Weighted Average Grant Date Fair Value
	(in thousands)				(years)	(in thousands)
Outstanding, January 1, 2013	1,137		$	54.06	4.8	$	3,815
Granted	129		42.76					$	15.44
Exercised	(11	)	28.92			$	171
Expired	(3	)	48.51
Outstanding, March 31, 2013	1,252		$	53.14	5.1	$	4,805

Outstanding, January 1, 2014	1,180		$	54.79	4.6	$	1,300
Granted	147		35.19					$	13.64
Exercised	(5	)	35.71			$	25
Expired	—		—
Outstanding, March 31, 2014	1,322		$	52.68	5.0	$	613

Exercisable, March 31, 2014	975		$	57.41	3.5	$	562

Expected to vest, March 31, 2014	329		$	39.45	9.2	$	47

⁽¹⁾

The aggregate intrinsic value of outstanding stock options represents amounts that would have been received by the optionees had all in- the-money options been exercised on that date. Specifically, it is the amount by which the market value of Itron’s stock exceeded the exercise price of the outstanding in-the-money options before applicable income taxes, based on our closing stock price on the last business day of the period. The aggregate intrinsic value of stock options exercised during the period is calculated based on our stock price at the date of exercise.

As of March 31, 2014, total unrecognized stock-based compensation expense related to nonvested stock options was approximately $4.5 million, which is expected to be recognized over a weighted average period of approximately 2.2 years.

Restricted Stock Units

Certain employees, senior management, and members of the Board of Directors receive restricted stock units as a component of their total compensation. The fair value of a restricted stock unit is the market close price of our common stock on the date of grant. Restricted stock units generally vest over a three year period. Compensation expense, net of forfeitures, is recognized over the vesting period.

Subsequent to vesting, the restricted stock units are converted into shares of our common stock on a one-for-one basis and issued to employees. We are entitled to an income tax deduction in an amount equal to the taxable income reported by the employees upon vesting of the restricted stock units.

Beginning in 2013, the performance-based restricted stock units to be issued under the Long-Term Performance Restricted Stock Unit Award Agreement (Performance Award Agreement) are determined based on (1) our achievement of specified non-GAAP EPS targets, as established by the Board at the beginning of each year for each of the calendar years contained in the performance periods (2-year and 3-year awards in 2013 and 3-year awards in subsequent years) (the performance condition) and (2) our total shareholder return (TSR) relative to the TSR attained by companies that are included in the Russell 3000 Index during the performance periods (the market condition). Compensation expense, net of forfeitures, is recognized on a straight-line basis, and the units vest upon achievement of the performance condition, provided participants are employed by Itron at the end of the respective performance periods. For U.S. participants who retire during the performance period, a pro-rated number of restricted stock units (based on the number of days of employment during the performance period) immediately vest based on the attainment of the performance goals as assessed after the end of the performance period.

Depending on the level of achievement of the performance condition, the actual number of shares to be earned ranges between 0% and 160% of the awards originally granted. At the end of the performance periods, if the performance conditions are achieved at or above threshold, the number of shares earned is further adjusted by a TSR multiplier payout percentage, which ranges between 75% and 125%, based on the market condition. Therefore, based on the attainment of the performance and market conditions, the actual number of shares that vest may range from 0% to 200% of the awards originally granted. Due to the presence of the TSR multiplier market condition, we utilize a Monte Carlo valuation model to determine the fair value of the awards at the grant date. This pricing model uses multiple simulations to evaluate the probability of our achievement of various stock price levels to determine our expected TSR performance ranking. The weighted-average assumptions used to estimate the fair value of performance-based restricted stock units awarded and the resulting weighted average fair-value are as follows:



	Three Months Ended March 31,
	2014			2013
Dividend yield	0.0		%	0.0		%
Expected volatility	30.9		%	31.9		%
Risk-free interest rate	0.2		%	0.3		%
Expected term (years)	1.4			2.5

Weighted-average fair value	$	28.88		$	44.93

Expected volatility is based on the historical volatility of our common stock for the related expected term. We believe this approach is reflective of current and historical market conditions and is an appropriate indicator of expected volatility. The risk-free interest rate is the rate available as of the award date on zero-coupon U.S. government issues with a term equal to the expected term of the award. The expected term is the term of an award based on the period of time between the date of the award and the date the award is expected to vest. The expected term assumption is based upon the plan's performance period as of the date of the award. We have not paid dividends in the past and do not plan to pay dividends in the foreseeable future.

The following table summarizes restricted stock unit activity for the three months ended March 31:



	Number of Restricted Stock Units		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value⁽¹⁾
	(in thousands)				(in thousands)
Outstanding, January 1, 2013	774
Granted ⁽²⁾	237		$	42.13
Released	(224	)			$	12,084
Forfeited	(7	)
Outstanding, March 31, 2013	780

Outstanding, January 1, 2014	658
Granted ⁽²⁾	308		$	35.38
Released	(236	)			$	11,666
Forfeited	(3	)
Outstanding, March 31, 2014	727

Vested but not released, March 31, 2014	8				$	300

Expected to vest, March 31, 2014	605				$	21,503


⁽¹⁾	The aggregate intrinsic value is the market value of the stock, before applicable income taxes, based on the closing price on the stock release dates or at the end of the period for restricted stock units expected to vest.


⁽²⁾	Restricted stock units granted in 2013 and 2014 do not include awards under the Performance Award Agreement for the respective years, as these awards are not granted until attainment of annual performance goals has been determined at the conclusion of the performance period, which had not occurred as of March 31, 2013 and 2014, respectively.

At March 31, 2014, unrecognized compensation expense on restricted stock units was $23.5 million, which is expected to be recognized over a weighted average period of approximately 2.1 years.

Unrestricted Stock Awards

We grant unrestricted stock awards to members of our Board of Directors as part of their compensation. Awards are fully vested and expensed when granted. The fair value of unrestricted stock awards is the market close price of our common stock on the date of grant.

The following table summarizes unrestricted stock award activity for the three months ended March 31:



	Three Months Ended March 31,
	2014		2013
	(in thousands, except per share data)
Shares of unrestricted stock granted	6		4

Weighted average grant date fair value per share	$	40.63	$	45.43

Employee Stock Purchase Plan

Under the terms of the ESPP, employees can deduct up to 10% of their regular cash compensation to purchase our common stock at a discount from the fair market value of the stock at the end of each fiscal quarter, subject to other limitations under the plan. The sale of the stock to the employees occurs at the beginning of the subsequent quarter. Effective October 1, 2013, we changed the terms of the ESPP to reduce the discount from 15% to 5% from the fair market value of the stock at the end of each fiscal quarter. As a result of this change, the ESPP is no longer considered compensatory, and no compensation expense is recognized for future sales of our common stock to employees. Prior to October 1, 2013, the plan was considered compensatory.

The following table summarizes ESPP activity for the three months ended March 31:



	Three Months Ended March 31,
	2014		2013
	(in thousands, except per share data)
Shares of stock sold to employees⁽¹⁾	14		20

Weighted average fair value per ESPP award⁽²⁾	$	—	$	6.96


⁽¹⁾	Stock sold to employees during each fiscal quarter under the ESPP is associated with the offering period ending on the last day of the previous fiscal quarter.


⁽²⁾	Effective October 1, 2013, the ESPP is no longer compensatory, and therefore the weighted average fair value per award is not applicable for the three months ended March 31, 2014.

There were approximately 492,000 shares of common stock available for future issuance under the ESPP at March 31, 2014.