NOTE 13. EQUITY COMPENSATION PLANS AND SHARE-BASED COMPENSATION

Equity Compensation Plans

Our share-based compensation plans are described below.

2014 Equity Incentive Plan. Our 2014 Equity Incentive Plan (as amended, the “2014 Plan”), which was approved by our shareholders on October 22, 2014, is the successor to and continuation of the 2005 Equity Incentive Plan (the “2005 Plan”). The terms of the 2014 Plan provide for the grant of incentive stock options, nonstatutory stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, other stock awards and performance awards that may be settled in cash, stock or other property. At its October 22, 2014 effective date, the total number of shares of the Company’s common stock available for issuance under the 2014 Plan was 1,712,409 shares, which was equal to the sum of (i) the shares remaining available for issuance pursuant to the exercise of options or issuance or settlement of stock awards that had not previously been granted under the 2005 Plan, as of the effective date of the 2014 Plan and (ii) the Returning Shares (as defined below), as of the effective date of the 2014 Plan. The “Returning Shares” are shares subject to outstanding stock awards granted under the 2005 Plan (the “2005 Available Pool”), as of the effective date of the 2014 Plan, (i) expire or terminate for any reason prior to exercise or settlement, (ii) are forfeited, cancelled or otherwise returned to us because of the failure to meet a contingency or condition required for the vesting of such shares, or (iii) are reacquired or withheld (or not issued) by us to satisfy a tax withholding obligation in connection with a stock award or to satisfy the purchase price or exercise price of a stock award.

On October 26, 2016, our shareholders approved an amendment to the 2014 Plan to, among other things, (i) increase the aggregate number of shares of common stock reserved for issuance under the 2014 Plan by 900,000 shares and (ii) update the means of adjustment when calculating the attainment of performance goals for performance awards under the 2014 Plan for purposes of the requirements of Section 162(m) of the Internal Revenue Code.

2005 Equity Incentive Plan. Our 2005 Plan was originally approved by our shareholders in October 2005 and restated and amended our 1998 Stock Option Plan. Our 2005 Plan allowed for the grant 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. Our 2005 Plan was succeeded by our 2014 Plan upon adoption of our 2014 Plan on October 22, 2014, and no additional awards may be made under our 2005 Plan. However, as described above, the 2005 Available Pool became available for issuance under the 2014 Plan, and Returning Shares may become available under the 2014 Plan, from time to time.

As of December 31, 2016, the 2014 Plan provided for the issuance of a maximum of 2,612,409 shares, of which 1,300,000 shares of common stock were available for future issuance under the 2014 Plan pursuant to stock awards that had not previously been granted. 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 2014 Plan.

We 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

Share-based compensation expense and related restricted stock unit award activity is presented on a consolidated basis, unless otherwise presented as continuing or discontinued operations.

The following table summarizes total share-based compensation expense, net of tax, related to restricted stock units during the three and nine months ended December 31, 2016 and 2015, which is included in our condensed consolidated statements of income (in thousands, except per share data):

	Three Months Ended December 31,						Nine Months Ended December 31,
	2016			2015			2016			2015
Cost of revenues (1)	$	360		$	256		$	1,326		$	950
Research and development		602			484			1,880			1,591
Sales and marketing (2)		797			677			2,218			2,679
General and administrative		673			980			2,893			3,016
Share-based compensation expense before income taxes		2,432			2,397			8,317			8,236
Income tax benefit		(839	)		(845	)		(2,881	)		(2,904	)
Total share-based compensation expense after income taxes	$	1,593		$	1,552		$	5,436		$	5,332
Net impact of share-based compensation on:
Basic net income per share	$	0.07		$	0.07		$	0.24		$	0.24
Diluted net income per share	$	0.07		$	0.07		$	0.24		$	0.23

(1)

Cost of revenues reported in the table include share-based compensation expense from continuing and discontinued operations. During the three months ended December 31, 2016 and 2015, share-based compensation expense included in cost of revenues from continuing operations was $0.4 million and $0.3 million, respectively, and from discontinued operations was $0 and $0, respectively. During the nine months ended December 31, 2016 and 2015, share-based compensation expense included in cost of revenues from continuing operations was $1.3 million and $0.8 million, respectively, and from discontinued operations was $0 and $0.1 million, respectively.

(2)

Sales and marketing expenses reported in the table include share-based compensation expense from continuing and discontinued operations. During the three months ended December 31, 2016 and 2015, share-based compensation expense included in sales and marketing expenses from continuing operations was $0.8 million and $0.7 million, respectively, and from discontinued operations was $0 and $0, respectively. During the nine months ended December 31, 2016 and 2015, share-based compensation expense included in sales and marketing expenses from continuing operations was $2.2 million and $2.5 million, respectively, and from discontinued operations was $0 and $0.2 million, respectively.

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 as of December 31, 2016 and March 31, 2016 were $12,000 and $0.1 million, respectively, which were included in “Inventories” on our condensed consolidated balance sheets.

Cash Flow Impact

Cash flows resulting from excess tax benefits are classified as a part of cash flows from financing activities. Excess tax benefits are realized tax benefits from tax deductions for 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 December 31, 2016 and 2015 were $9,000 and $0.2 million, respectively, and for the nine months ended December 31, 2016 and 2015 were $0.3 million and $1.6 million, 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 were not significant. 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.

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 2014 Plan automatically will also accelerate in full upon a change in control. Beginning in fiscal 2015, 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. Starting in fiscal 2015, we grant “double-trigger” acceleration arrangements to new executive officers, 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.

Restricted Stock Unit Awards (Time Vesting)

We grant restricted stock unit awards with only time-based vesting terms, which we refer to as RSUs. The RSUs entitle holders to receive shares of common stock at the end of a specified period of time. For RSUs, 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 RSUs will be forfeited. Generally, RSUs vest according to one of the following time-based vesting schedules:

•	RSU 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.

•	RSU awards to non-employee directors: 100 percent vesting after one year of continuous service to the Company.

The fair value of RSUs 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 RSU awards that are expected to be forfeited. The forfeiture estimate is based on historical data and other factors, and compensation expense is adjusted for actual results. As of December 31, 2016, the total unrecognized compensation expense related to RSU awards granted amounted to $19.4 million, which is expected to be recognized over a weighted average service period of 2.1 years.

Restricted Stock Unit Awards (Performance Vesting)

We grant restricted stock unit awards subject to performance criteria, which we refer to as PSUs to our executive officers and to certain employees. The PSUs vest only if both of the following criteria are satisfied: (1) our consolidated income from operations during the fiscal year in which the grant occurred, as certified by the Compensation Committee, is in excess of the applicable target amount described below; and (2) the recipient remains in the continuous service of the Company until the applicable vesting date set forth as follows for PSUs granted in fiscal 2015, 2016 and 2017 (other than the PSUs granted to our Chief Executive Officer, Mr. Clinton Severson in fiscal 2017).

•	25% of the shares subject to an award vest in full upon achieving 90% of the consolidated income from operations target described above and continuous service until the third anniversary of the date of grant;

•	25% of the shares subject to an award vest in full upon achieving 90% of the consolidated income from operations target described above and continuous service until the fourth anniversary of the date of grant;

•	25% of the shares subject to an award vest in full upon achieving 100% of the consolidated income from operations target described above and continuous service until the third anniversary of the date of grant; and

•	25% of the shares subject to an award vest in full upon achieving 100% of the consolidated income from operations target described above and continuous service until the fourth anniversary of the date of grant.

The PSUs that we granted to Mr. Severson in fiscal 2017 vest as follows:

•	approximately 18% of the shares subject to an award vest in full upon achieving 90% of the consolidated income from operations target described above and continuous service until the third anniversary of the date of grant;

•	approximately 18% of the shares subject to an award vest in full upon achieving 90% of the consolidated income from operations target described above and continuous service until the fourth anniversary of the date of grant;

•	approximately 32% of the shares subject to an award vest in full upon achieving 100% of the consolidated income from operations target described above and continuous service until the third anniversary of the date of grant; and

•	approximately 32% of the shares subject to an award vest in full upon achieving 100% of the consolidated income from operations target described above and continuous service until the fourth anniversary of the date of grant.

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 PSUs 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.

The share-based compensation expense is reduced for an estimate of the PSUs that are expected to be forfeited. The forfeiture estimate is based on historical data and other factors, and compensation expense is adjusted for actual results. If the service vesting conditions are not met, unvested PSUs will be forfeited. Upon vesting on the third and fourth anniversary date of grant of the PSUs, the equivalent number of common shares are typically issued net of tax withholdings.

For the PSUs granted in fiscal 2015 and 2016, we have determined that the performance targets have been met and accordingly, we recorded share-based compensation expense ratably over the vesting terms of the PSUs during the three and nine months ended December 31, 2016.

In April 2016, the Compensation Committee approved the grant of PSUs for an aggregate of 152,000 shares of common stock to our executive officers and to certain of our employees (the “FY2017 PSUs”). As of December 31, 2016, we reviewed each of the underlying performance targets related to the outstanding FY2017 PSUs and determined that it was not probable that the performance targets of the FY2017 PSUs would be met for 84,000 of the 152,000 shares of common stock and consequently, upon our determination of non-achievement of the performance metrics, the related compensation expense was reversed. As of December 31, 2016, we assessed that it was probable that the performance targets of the outstanding FY2017 PSUs would be met for 68,000 of the 152,000 shares of common stock granted and accordingly, we recorded share-based compensation expense ratably over the vesting terms of the PSUs during the three and nine months ended December 31, 2016.

We assess the probability of achievement of the performance targets of the FY2017 PSUs at the end of each quarter. If it becomes probable that the performance targets will be achieved, a cumulative adjustment will be recorded as if ratable share-based compensation expense had been recorded since the grant date. Additional share-based compensation of $0.6 million would have been recorded during the nine months ended December 31, 2016 for FY2017 PSUs with respect to 84,000 shares of common stock had the achievement of performance targets been deemed probable.

As of December 31, 2016, the total unrecognized compensation expense related to PSU awards granted and expected to vest amounted to $6.8 million, which is expected to be recognized over a weighted average service period of 1.7 years.

See Note 19, “Subsequent Events,” for information regarding modifications to the FY2017 PSUs approved by the Compensation Committee after December 31, 2016.

Restricted Stock Unit Activity

The following table summarizes restricted stock unit activity for the nine months ended December 31, 2016.

	Time-Based Restricted Stock Units					Performance-Based 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, 2016		524,000		$	45.37		311,000		$	48.29
Granted		203,000			45.97		152,000			44.54
Vested (2)		(152,000	)		41.54		(24,000	)		40.82
Canceled and forfeited		(29,000	)		46.46		-			-
Nonvested at December 31, 2016		546,000		$	46.60		439,000		$	47.40

(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 December 31, 2016 and 2015 was $0.3 million and $1.1 million, respectively, and during the nine months ended December 31, 2016 and 2015 was $8.1 million and $15.3 million, respectively.

The total grant date fair value of restricted stock units vested during the three months ended December 31, 2016 and 2015 was $0.2 million and $0.7 million, respectively, and during the nine months ended December 31, 2016 and 2015 was $7.3 million and $8.6 million, respectively.