10. Stock-based Compensation

The Company has stock-based compensation plans under which it grants stock options, restricted stock awards, performance share awards and restricted stock units. Accounting guidance requires all share-based payments to be recognized as an operating expense, based on their fair values, over the requisite service period.

The Company’s stock-based compensation expenses were allocated to the following expense categories:


	Three months ended March 31,				Six months ended March 31,
*(Dollars in thousands)*	2014		2013		2014		2013
Product costs	$	4	$	7	$	8	$	10
Research and development		46		64		98		87
Selling, general and administrative		1,599		775		2,356		1,141

Total	$	1,649	$	846	$	2,462	$	1,238

As of March 31, 2014, approximately $3.9 million of total unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately 2.1 years. The unrecognized compensation costs of $3.9 million above include $1.4 million based on payout levels associated with performance share awards that are currently anticipated to be fully expensed because the performance conditions are expected to be met at or near target levels.

Stock Option Awards

The Company uses the Black-Scholes option pricing model to determine the weighted average grant date fair value of stock options granted. The weighted average per share fair values of stock options granted during the three months ended March 31, 2014 and 2013 were $7.61 and $9.99, respectively. The weighted average per share fair values of stock options granted during the six months ended March 31, 2014 and 2013 were $8.72 and $8.69, respectively. The assumptions used as inputs in the model were as follows:


	Three months ended March 31,						Six months ended March 31,
	2014			2013			2014			2013
Risk-free interest rates		1.2	%		0.7	%		1.2	%		0.6	%
Expected life (years)		4.1			4.8			4.6			4.8
Expected volatility		37.1	%		49.1	%		44.5	%		49.2	%
Dividend yield		0.0	%		0.0	%		0.0	%		0.0	%

The risk-free interest rate assumption was based on the U.S. Treasury’s rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award. The expected life of options granted is determined based on the Company’s experience. Expected volatility is based on the Company’s stock price movement over a period approximating the expected term. Based on management’s judgment, dividend rates are expected to be zero for the expected life of the options. The Company also estimates forfeitures of options granted, which are based on historical experience.

Non-qualified stock options are granted at fair market value on the date of grant. Non-qualified stock options expire in seven to ten years or upon termination of employment or service as a Board member. Non-qualified stock options generally become exercisable with respect to 25% of the shares on each of the first four anniversaries following the grant date with Board member options vesting on a prorated basis within the one-year period following the grant date.

The total pre-tax intrinsic value of options exercised during the three months and six months ended March 31, 2014 was $0.9 million and $1.3 million, respectively. The total pre-tax intrinsic value of options exercised during the three months and six months ended March 31, 2013 was less than $0.1 million in each period. The intrinsic value represents the difference between the exercise price and the fair market value of the Company’s common stock on the last day of the respective fiscal period end.

The Company modified stock option awards granted to Board members in the three months ended March 31, 2014, which resulted in acceleration of the stock option vesting period. The modification changed the vesting period to pro-rata over a 12-month service period and resulted in an increase to stock option related expense of $0.6 million in the three and six months ended March 31, 2014.

Restricted Stock Awards

The Company has entered into restricted stock agreements with certain key employees, covering the issuance of common stock (“Restricted Stock”). Under accounting guidance these shares are considered to be non-vested shares. The Restricted Stock is released to the key employees if they are employed by the Company at the end of the vesting period. Compensation has been recognized for the estimated fair value of the common shares and is being charged to income over the vesting term. The stock-based compensation table above includes Restricted Stock expenses recognized related to these awards, which totaled $0.2 million during the three and six months ended March 31, 2014, respectively, and less than $0.1 million during the three and six months ended March 31, 2013, respectively. During the three months ended on March 31, 2014, the Company granted an award of $0.2 million to the former Chairman of its Board of Directors in connection with his retirement from the Board and in recognition of his contributions to the Company during his years of service.

Performance Share Awards

The Company has entered into performance share agreements with certain key employees, covering the issuance of common stock (“Performance Shares”). The Performance Shares vest upon the achievement of all or a portion of certain performance objectives, which must be achieved during the performance period. Performance objectives selected by the Organization and Compensation Committee of the Board of Directors (the “Committee”) were cumulative earnings per share and cumulative revenue for the three-year performance periods for fiscal 2011 (2011 – 2013), fiscal 2012 (2012 – 2014), fiscal 2013 (2013 – 2015) and fiscal 2014 (2014 – 2016). Assuming that the minimum performance level is attained, the number of shares that may actually vest will vary based on performance from 20% (minimum) to 200% (maximum). Shares will be issued to participants as soon as practicable following the end of the performance periods subject to Committee approval and verification of results. The fiscal 2011 awards were finalized in the three months ended December 31, 2013 and resulted in issuance of 122,053 shares (maximum was 137,066 shares) based on the performance objective results. The compensation cost related to the number of shares to be granted under each performance period is fixed on the grant date, which is the date the performance period begins. Compensation is recognized in each period based on management’s best estimate of the achievement level of the specified performance objectives for Performance Shares. For the three and six months ended March 31, 2014, the Company recognized expenses of $0.3 million and $0.5 million, respectively, in each period. For the three and six months ended March 31, 2013, the Company recognized expenses of $0.4 million and $0.6 million, respectively. The stock-based compensation table above includes the Performance Shares expenses.

The fair values of the Performance Shares, at target, were $0.9 million, $0.9 million and $0.8 million for grants awarded in fiscal 2014, 2013 and 2012, respectively.

The aggregate number of shares that could be awarded to key employees if the minimum, target and maximum performance goals are met, based upon the fair value at the date of grant is as follows:


Performance Period	Minimum Shares		Target Shares		Maximum Shares
Fiscal 2012 - 2014		12,499		62,497		124,994
Fiscal 2013 - 2015		8,551		42,753		85,506
Fiscal 2014 - 2016		7,861		39,303		78,606

1999 Employee Stock Purchase Plan

Under the 1999 Employee Stock Purchase Plan (“Stock Purchase Plan”), the Company is authorized to issue up to 400,000 shares of common stock. All full-time and part-time employees can choose to have up to 10% of their annual compensation withheld, with a limit of $25,000, to purchase the Company’s common stock at purchase prices defined within the provisions of the Stock Purchase Plan. As of March 31, 2014 and 2013, there were less than $0.1 million of employee contributions in each period included in accrued liabilities in the condensed consolidated balance sheets. Stock compensation expense recognized related to the Stock Purchase Plan for the three and six months ended March 31, 2014 and 2013 totaled less than $0.1 million in each period. The stock-based compensation table above includes the Stock Purchase Plan expenses.

Restricted Stock Units

The Company has awarded 24,834 restricted stock units (“RSU”) in fiscal 2014 and 2013 under the 2009 Equity Incentive Plan to non-employee directors with forfeiture of 3,417 RSU’s in the three months ended March 31, 2014. The RSU awards were modified in the second quarter of fiscal 2014 to vest pro-rata over a 12-month service period. This modification resulted in a total expense of $0.2 million in the three and six months ended March 31, 2014. RSU awards are not considered issued or outstanding common stock of the Company until they vest. The estimated fair value of the RSU awards was calculated based on the closing market price of SurModics’ common stock on the date of grant. Compensation has been recognized for the estimated fair value of the common shares and is being charged to income over the vesting term. Directors can also elect to receive their cash retainers for services to the Board of Directors and its committees in the form of deferred stock units (“DSU”). Certain directors elected this option beginning on January 1, 2013 which has resulted in 9,349 DSUs issued with a total value of $219,000. The DSUs are fully vested. The stock-based compensation table above includes RSU and DSU expenses recognized related to these awards, which totaled $0.3 million and $0.4 million during the three months and six months ended March 31, 2014, respectively, and less than $0.1 million in each period during the three and six months ended March 31, 2013.