Note 8. Stock-Based Compensation

The following table summarizes stock-based compensation expense by financial statement line item in the Company’s condensed consolidated statements of operations for the three and nine months ended December 31, 2015 and 2014:

	For the Three Months Ended December 31,				For the Nine Months Ended December 31,
		2015		2014		2015		2014
	(in $000's)				(in $000's)
Cost of product revenue	$	216	$	160	$	671	$	517
Research and development		994		840		2,914		2,466
Selling, general and administrative		4,929		3,382		18,146		9,713
	$	6,139	$	4,382	$	21,731	$	12,696

The components of stock-based compensation for the three and nine months ended December 31, 2015 and 2014 were as follows:

	For the Three Months Ended December 31,				For the Nine Months Ended December 31,
		2015		2014		2015		2014
	(in $000's)				(in $000's)
Restricted stock units	$	5,133	$	3,640	$	17,482	$	10,394
Stock options		909		666		3,955		2,089
Employee stock purchase plan		97		76		294		213
	$	6,139	$	4,382	$	21,731	$	12,696

The Company’s former Chief Financial Officer retired effective July 31, 2015 and currently serves as a consultant to the Company through July 31, 2017. In connection with the former Chief Financial Officer’s retirement agreement, his unvested options and restricted stock units were modified such that they will continue to vest and he will be permitted to exercise any vested options until July 31, 2017, including any options that vest after his retirement date, other than such options that expire on the tenth anniversary of the grant date. The Company recorded costs of $2.5 million in stock compensation expense, which is recorded in selling, general and administrative expenses for the nine months ended December 31, 2015.

In June 2015, the Company’s Board of Directors adopted a non-employee director retirement policy that provides for the accelerated vesting of all stock options, restricted stock units and other equity awards held by a non-employee director if he or she permanently ceases his or her service on the Company’s Board of Directors by reason of death, disability, or the non-employee director’s retirement following at least five years of service and so long as his or her age plus service equals or exceeds 65. This retirement policy accelerated the recognition of stock-based compensation because the outstanding unvested restricted stock units held by retirement eligible non-employee directors are able to vest at their decision to retire. The Company recorded costs of $1.4 million in accelerated stock compensation expense, which is recorded in selling, general and administrative expenses for the nine months ended December 31, 2015.

In August 2015, the Company approved the annual equity award grant to non-employee directors in the form of restricted stock units covering 3,900 shares of the Company’s common stock, which vest on the earlier of: (a) the one year anniversary of the grant date; or (b) the next annual meeting of stockholders. In conjunction with the Company’s non-employee director retirement policy, the stock compensation expense for awards to retirement eligible non-employee directors was fully recognized upon grant. The Company recorded costs of $2.0 million in stock compensation expense, which is recorded in selling, general and administrative expenses for the nine months ended December 31, 2015.

Stock Options

The following table summarizes the stock option activity for the nine months ended December 31, 2015:

						Weighted
				Weighted		Average		Aggregate
				Average		Remaining		Intrinsic
	Options			Exercise		Contractual		Value
	(in thousands)			Price		Term (years)		(in thousands)
Outstanding at beginning of period		2,892		$	14.72		5.18
Granted		164			71.15
Exercised		(721	)		11.42
Cancelled and expired		(2	)		13.81
Outstanding at end of period		2,333		$	19.71		5.35	$	164,775
Exercisable at end of period		1,690		$	13.83		4.27	$	129,224
Options vested and expected to vest at end of period		2,273		$	19.33		5.27	$	161,336

The aggregate intrinsic value of options exercised was $50.7 million for the nine months ended December 31, 2015. The total fair value of options that vested during the nine months ended December 31, 2015 was $2.5 million.

The remaining unrecognized stock-based compensation expense for unvested stock option awards at December 31, 2015 was approximately $6.3 million, net of forfeitures, and the weighted-average period over which this cost will be recognized is 2.4 years.

The Company estimates the fair value of each stock option granted at the grant date using the Black-Scholes option valuation model. The weighted average grant-date fair values and weighted average assumptions used in the calculation of fair value of options granted during the three and nine months ended December 31, 2015 and 2014 was as follows:

	For the Three Months Ended December 31,						For the Nine Months Ended December 31,
		2015			2014			2015			2014
Weighted average grant-date fair value	$	34.05		$	15.36		$	28.91		$	9.18

Valuation assumptions:
Risk-free interest rate		1.50	%		1.70	%		1.60	%		1.60	%
Expected option life (years)		4.15			4.17			4.14			4.19
Expected volatility		49.6	%		49.7	%		49.7	%		49.3	%

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for a term consistent with the expected life of the stock options. Volatility assumptions are calculated based on the historical volatility of the Company’s stock and adjustments for factors not reflected in historical volatility that may be more indicative of future volatility. The Company estimates the expected term of options based on historical exercise experience and estimates of future exercises of unexercised options. An expected dividend yield of zero is used in the option valuation model because the Company does not pay cash dividends and does not expect to pay any cash dividends in the foreseeable future. The Company estimates forfeitures based on an analysis of actual historical forfeitures, adjusted to the extent historic forfeitures may not be indicative of forfeitures in the future.

Restricted Stock and Restricted Stock Units

The following table summarizes the activity of restricted stock and restricted stock units for the nine months ended December 31, 2015:

	Number of Shares			Weighted Average Grant Date Fair Value
	(in thousands)			(per share)
Restricted stock and restricted stock units at beginning of period		1,160		$	21.90
Granted		679		$	87.95
Vested		(465	)	$	22.65
Forfeited		(45	)	$	15.44
Restricted stock and restricted stock units at end of period		1,329		$	55.61

The weighted average grant-date fair value for restricted stock units granted, including performance and market-based awards, during the nine months ended December 31, 2015 and 2014 was $87.95 and $22.07 per share, respectively. This includes 322,980 market based awards which were valued at $107.10 per share based on a Monte Carlo simulation that was used to account for the market condition in valuing the award. See details below in “Market Based Awards”.

The total fair value of restricted stock units that vested during the nine months ended December 31, 2015 and 2014 was $10.3 million and $9.5 million, respectively. The remaining unrecognized compensation expense for outstanding restricted stock units, including performance and market-based awards, as of December 31, 2015 was $33.9 million and the weighted-average period over which this cost will be recognized is 2.4 years.

Performance and Market-Based Awards

Included in the restricted stock units activity are certain awards that vest subject to certain performance and market-based criteria. The remaining unrecognized compensation expense for outstanding performance and market-based restricted stock units as of December 31, 2015 was $23.2 million and the weighted-average period over which this cost will be recognized is 2.4 years.

Performance-Based Awards

In May 2015, performance-based awards of restricted stock units for the potential issuance of 183,940 shares of common stock were issued to certain executive officers and employees, all of which vest upon achievement of prescribed service milestones by the award recipients and performance milestones by the Company. As of December 31, 2015, the Company is recognizing compensation expense based on the probable outcome related to the prescribed performance targets on the outstanding awards.

In May 2014, performance-based awards of restricted stock units for the potential issuance of 379,752 shares of common stock were issued to certain executive officers and employees, all of which vest upon achievement of prescribed service milestones by the award recipients and performance milestones by the Company. The Company met the prescribed performance milestones in fiscal 2015. As of December 31, 2015, approximately 200,000 shares of common stock underlying restricted stock units remain unvested and such restricted stock units will vest subject to service requirements for vesting for these employees.

In May 2013, performance-based awards of restricted stock units for the potential issuance of 268,988 shares of common stock were issued to certain executive officers and employees, all of which vest upon achievement of prescribed service milestones by the award recipients and performance milestones by the Company. The Company met the prescribed performance milestones in fiscal 2014. As of December 31, 2015, approximately 70,000 shares of common stock underlying restricted stock units remain unvested and such restricted stock units will vest subject to service requirements for vesting for these employees.

In June 2011, performance-based awards of restricted stock units for the potential issuance of 100,000 shares of common stock was issued to a certain senior executive officer of the Company that would vest upon achievement of prescribed service milestones by the award recipient and performance milestones by the Company. As of December 31, 2015, the Company has met the prescribed milestones for 50,000 shares of this award. The Company modified the performance condition on the 50,000 remaining restricted stock units that were related to this performance award in March 2014 and December 2015, all of which will vest upon achievement of a prescribed service milestone by the award recipients and a performance milestone by the Company. The Company recorded $0.5 million in stock compensation expense related to this accounting modification, which is recorded in selling, general and administrative expenses for the three and nine months ended December 31, 2015. The Company believes that it is probable that the prescribed performance milestones will be met and the compensation expense is being recognized accordingly.

Market-Based Awards

In June 2015, the Company awarded certain executive officers a total of up to 322,980 market-based restricted share units. These restricted stock units will vest and result in the issuance of common stock based on continuing employment and the relative ranking of the total shareholder return (“TSR”) of the Company’s common stock in relation to the TSR of the component companies in the S&P Health Care Equipment Select Industry Index over a three-year performance period based on a comparison of average closing stock prices between June 2015 and June 2018. The actual number of market-based restricted stock units that may be earned can range from 0% to 300% of the target number of shares. One-half of the market-based restricted stock units earned will vest in June 2018 and the remaining restricted stock units will vest one year thereafter.

The Company used a Monte Carlo simulation model to estimate that the grant-date fair value of the restricted stock units. The fair value related to the restricted stock units will be recorded as stock compensation expense over the period from date of grant to June 2019 regardless of the actual TSR outcome achieved.

The table below sets forth the assumptions used to value the awards and the estimated grant-date fair value:

Risk-free interest rate		1.10	%
Dividend yield		0	%
Remaining performance period (years)		2.45
Expected volatility		47.2	%
Estimated grant date fair value (per share)	$	107.10
Target performance (number of shares)		107,660