NOTE 10. EQUITY COMPENSATION PLANS AND SHARE-BASED COMPENSATION

Equity Compensation Plan

As of June 30, 2014, we have one equity incentive plan under which our equity securities are authorized for issuance to our employees, directors and consultants. Our share-based compensation plan is described below.

2005 Equity Incentive Plan. Our 2005 Equity Incentive Plan (the “Equity Incentive Plan”) restated and amended our 1998 Stock Option Plan. The Equity Incentive Plan allows for the awards of stock options, stock appreciation rights, restricted stock awards, restricted stock units, performance cash awards, performance shares, performance units, deferred compensation awards or other share-based awards to employees, directors and consultants. As of June 30, 2014, the Equity Incentive Plan provided for the issuance of a maximum of 6,786,000 shares, of which 894,000 shares of common stock were then available for future issuance. Shares that are canceled or forfeited from an award and shares withheld in satisfaction of tax withholding obligations are again available for issue under the Equity Incentive Plan.

Our current practice is to issue new shares of common stock from our authorized shares for share-based awards upon the exercise of stock options or vesting of restricted stock units.

Share-Based Compensation

The following table summarizes total share-based compensation expense, net of tax, related to restricted stock units during the three months ended June 30, 2014 and 2013, which is included in our condensed consolidated statements of income (in thousands, except per share data):

	Three Months Ended June 30,
	2014			2013
Cost of revenues	$	341		$	254
Research and development		441			367
Sales and marketing		826			706
General and administrative		424			922
Share-based compensation expense before income taxes		2,032			2,249
Income tax benefit		(684	)		(768	)
Total share-based compensation expense after income taxes	$	1,348		$	1,481
Net impact of share-based compensation on:
Basic net income per share	$	0.06		$	0.07
Diluted net income per share	$	0.06		$	0.07

Share-based compensation has been classified in the condensed consolidated statements of income or capitalized on the condensed consolidated balance sheets in the same manner as cash compensation paid to employees. Capitalized share-based compensation costs at June 30, 2014 and March 31, 2014 were $242,000 and $137,000, respectively, which were included in inventories on our condensed consolidated balance sheets.

Cash Flow Impact

The accounting standard with respect to share-based payment requires cash flows resulting from excess tax benefits to be classified as a part of cash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions for exercised stock options and vested restricted stock units in excess of the deferred tax asset attributable to share-based compensation expense for such share-based awards. Excess tax benefits are considered realized when the tax deductions reduce taxes that otherwise would be payable. Excess tax benefits classified as a financing cash inflow for the three months ended June 30, 2014 and 2013 were $100,000 and $1.4 million, respectively.

Stock Options

Prior to fiscal 2007, we granted stock option awards to employees and directors as part of our share-based compensation program. Option awards to consultants were insignificant. Options granted to employees and directors generally expire ten years from the grant date. Options granted to employees generally become exercisable over a period of four years based on cliff-vesting terms and continuous employment. Options granted to non-employee directors generally become exercisable over a period of one year based on monthly vesting terms and continuous service. We have not granted any stock options since the beginning of fiscal 2007. We have recognized compensation expense for stock options granted during the requisite service period of the stock option. As of June 30, 2014, we had no unrecognized compensation expense related to stock options granted.

Stock Option Activity

The following table summarizes information regarding options outstanding and options exercisable at June 30, 2014 and the changes during the three-month period then ended:

	Number of Shares			Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Life (Years)		Aggregate Intrinsic Value (In thousands)
Outstanding at March 31, 2014		2,000		$	13.24
Granted		-			-
Exercised		(200	)		19.45
Canceled or forfeited		-			-
Outstanding at June 30, 2014		1,800		$	12.65		0.63	$	66
Vested and expected to vest at June 30, 2014		1,800		$	12.65		0.63	$	66
Exercisable at June 30, 2014		1,800		$	12.65		0.63	$	66

The aggregate intrinsic value in the table above represents the pre-tax intrinsic value, based on our closing stock price as of June 30, 2014, that would have been received by the option holders had all option holders exercised their stock options as of that date. Total intrinsic value of stock options exercised during the three months ended June 30, 2014 and 2013 was $4,000 and $81,000, respectively. Cash proceeds from stock options exercised during the three months ended June 30, 2014 and 2013 were $4,000 and $17,000, respectively.

Restricted Stock Units

Since fiscal 2007, we have granted restricted stock unit awards to employees and directors as part of our share-based compensation program. Restricted stock unit awards to consultants have been insignificant. Awards of restricted stock units are issued at no cost to the recipient and may have time-based vesting criteria, or a combination of time-based and performance-based vesting criteria, as described below. From time to time, restricted stock unit awards granted to employees may be subject to accelerated vesting upon achieving certain performance-based milestones. Additionally, the Compensation Committee of our Board of Directors (the “Compensation Committee”) in its discretion, may provide in the event of a change in control for the acceleration of vesting and/or settlement of the restricted stock unit held by a participant upon such conditions and to such extent as determined by the Compensation Committee. Our Board of Directors has adopted an executive change in control severance plan, which it may terminate or amend at any time, that provides that awards granted to executive officers will accelerate fully on a change of control. The vesting of non-employee director and officer awards granted under the Equity Incentive Plan automatically will also accelerate in full upon a change in control. Beginning in fiscal 2014, the Compensation Committee discontinued the practice of granting such “single trigger” acceleration of vesting benefits to new executive officers pursuant to which an executive officer’s outstanding stock option(s) and other unvested equity-based instruments would accelerate in full upon the occurrence of a change of control. In fiscal 2015, we granted a “double-trigger” acceleration arrangement to an executive officer, which requires both the occurrence of a change of control and the termination by us (or our successor) for any reason other than cause, death or disability within 18 months following such change of control date, with the termination constituting a separation in service and subject to execution of a valid and effective release of claims against us, for the acceleration of vesting of the executive officer’s equity awards in full. See the Executive Employment Agreement, dated as of May 1, 2014, with Craig M. Tockman, our Vice President of Animal Health Sales and Marketing for North America, a copy of which is filed herewith as Exhibit 10.1.

Restricted Stock Unit Awards (Time Vesting)

Restricted stock unit awards with only time-based vesting terms, which we refer to as restricted stock unit awards (time vesting), entitle holders to receive shares of common stock at the end of a specified period of time. For restricted stock unit awards (time vesting), vesting is based on continuous employment or service of the holder. Upon vesting, the equivalent number of common shares are typically issued net of tax withholdings. If the service vesting conditions are not met, unvested restricted stock unit awards (time vesting) will be forfeited. Generally, restricted stock unit awards (time vesting) vest according to one of the following time-based vesting schedules:

Restricted stock unit awards to employees: Four-year time-based vesting as follows: five percent vesting after the first year; additional ten percent after the second year; additional 15 percent after the third year; and the remaining 70 percent after the fourth year of continuous employment with the Company.

·	Restricted stock unit awards to non-employee directors: 100 percent vesting after one year of continuous service to the Company.

The fair value of restricted stock unit awards (time vesting) used in our expense recognition method is measured based on the number of shares granted and the closing market price of our common stock on the date of grant. Such value is recognized as an expense over the corresponding requisite service period. The share-based compensation expense is reduced for an estimate of the restricted stock unit awards that are expected to be forfeited. The forfeiture estimate is based on historical data and other factors. In subsequent periods, if actual forfeitures differ from those estimates, an adjustment to share-based compensation expense will be recognized at that time. As of June 30, 2014, the total unrecognized compensation expense related to restricted stock unit awards (time vesting) granted amounted to $19.1 million, which is expected to be recognized over a weighted average service period of 1.8 years.

Restricted Stock Unit Awards (Performance Vesting)

We also began granting restricted stock unit awards subject to performance vesting criteria, which we refer to as restricted stock unit awards (performance vesting), to our executive officers starting in fiscal 2013. Restricted stock unit awards (performance vesting) consist of the right to receive shares of common stock, subject to achievement of time-based criteria and certain corporate performance-related goals over a specified period, as established by the Compensation Committee. For restricted stock units subject to performance vesting, we recognize any related share-based compensation expense ratably over the service period based on the most probable outcome of the performance condition. The fair value of our restricted stock unit awards (performance vesting) used in our expense recognition method is measured based on the number of shares granted, the closing market price of our common stock on the date of grant and an estimate of the probability of the achievement of the performance goals. The amount of share-based compensation expense recognized in any one period can vary based on the attainment or expected attainment of the performance goals. If such performance goals are not ultimately met, no compensation expense is recognized and any previously recognized compensation expense is reversed.

Fiscal 2014 Performance RSUs. In April 2013, the Compensation Committee approved the grant of restricted stock unit awards (performance vesting) for 129,000 shares of common stock to our executive officers that also contained both time-based and performance-based vesting terms (the “FY2014 Performance RSUs”). The aggregate estimated grant date fair value of the FY2014 Performance RSUs was $5.5 million, or $42.43 per share, based on the closing market price of our common stock on the date of grant. The FY2014 Performance RSUs would have vested only if both of the following criteria were satisfied: (1) our consolidated income from operations for the fiscal year ended March 31, 2014, as certified by the Compensation Committee, was in excess of the applicable target amount described below; and (2) the recipient remained in the service of the Company until the applicable vesting date set forth as follows:

·	25% shares issuable upon settlement of FY2014 Performance RSUs upon satisfying 90% of target of consolidated income from operations for the year ending March 31, 2014 and time-based vesting on April 29, 2016;

·	25% shares issuable upon settlement of FY2014 Performance RSUs upon satisfying 90% of target of consolidated income from operations for the year ending March 31, 2014 and time-based vesting on April 29, 2017;

·	25% shares issuable upon settlement of FY2014 Performance RSUs upon satisfying 100% of target of consolidated income from operations for the year ending March 31, 2014 and time-based vesting on April 29, 2016; and

·	25% shares issuable upon settlement of FY2014 Performance RSUs upon satisfying 100% of target of consolidated income from operations for the year ending March 31, 2014 and time-based vesting on April 29, 2017.

As of March 31, 2014, we reviewed each of the underlying performance targets related to the outstanding FY2014 Performance RSUs and determined that it was not probable that the FY2014 Performance RSUs would vest and as a result did not record share-based compensation related to these awards during fiscal 2014. On April 23, 2014, the Compensation Committee determined that the Company’s consolidated income from operations for fiscal 2014 was below 90% of target and, accordingly, the FY2014 Performance RSUs did not vest and were cancelled.

Fiscal 2015 Performance RSUs. In April 2014, the Compensation Committee approved the grant of restricted stock unit awards (performance vesting) for 172,000 shares of common stock to our executive officers that also contained both time-based and performance-based vesting terms (the “FY2015 Performance RSUs”). The aggregate estimated grant date fair value of the FY2015 Performance RSUs was $7.0 million, or $40.82 per share, based on the closing market price of our common stock on the date of grant. The FY2015 Performance RSUs will vest only if both of the following criteria are satisfied: (1) our consolidated income from operations for the fiscal year ending March 31, 2015, as certified by the Compensation Committee, is in excess of the applicable target amount described below; and (2) the recipient remains in the service of the Company until the applicable vesting date set forth as follows:

·	25% shares issuable upon settlement of FY2015 Performance RSUs upon satisfying 90% of target of consolidated income from operations for the year ending March 31, 2015 and time-based vesting on April 28, 2017;

·	25% shares issuable upon settlement of FY2015 Performance RSUs upon satisfying 90% of target of consolidated income from operations for the year ending March 31, 2015 and time-based vesting on April 28, 2018;

·	25% shares issuable upon settlement of FY2015 Performance RSUs upon satisfying 100% of target of consolidated income from operations for the year ending March 31, 2015 and time-based vesting on April 28, 2017; and

·	25% shares issuable upon settlement of FY2015 Performance RSUs upon satisfying 100% of target of consolidated income from operations for the year ending March 31, 2015 and time-based vesting on April 28, 2018.

During the three months ended June 30, 2014, we recorded share-based compensation expense related to the portion of the FY2015 Performance RSUs, as we determined that it was probable that the performance targets would be met. As of June 30, 2014, the total unrecognized compensation expense related to restricted stock unit awards (performance vesting) granted amounted to $4.2 million, which is expected to be recognized over a weighted average service period of 3.3 years.

Restricted Stock Unit Activity

The following table summarizes restricted stock unit activity for the three months ended June 30, 2014:

	Time-Based					Performance-Based
	Restricted Stock Units					Restricted Stock Units
	Number of Shares			Weighted Average Grant Date Fair Value(1)		Number of Shares			Weighted Average Grant Date Fair Value(1)
Nonvested at March 31, 2014		774,000		$	30.98		113,000		$	42.43
Granted		108,000			40.82		172,000			40.82
Vested(2)		(189,000	)		28.70		-			-
Canceled and forfeited		(4,000	)		30.36		(113,000	)		42.43
Nonvested at June 30, 2014		689,000		$	33.15		172,000		$	40.82

(1)	The weighted average grant date fair value of restricted stock units is based on the number of shares and the closing market price of our common stock on the date of grant.

(2)	The number of restricted stock units vested includes shares that we withheld on behalf of our employees to satisfy the statutory tax withholding requirements.

Total intrinsic value of restricted stock units vested during the three months ended June 30, 2014 and 2013 was $7.7 million and $10.5 million, respectively. The total grant date fair value of restricted stock units vested during the three months ended June 30, 2014 and 2013 was $5.4 million and $5.4 million, respectively.