Stockholders’ Equity

Performance-based stock awards

We have issued performance-based stock options and performance-based RSUs, the vesting of which is generally contingent upon the achievement of certain performance criteria related to our operating performance, as well as successful and timely development and market acceptance of future product introductions. In addition, certain of the performance RSUs have additional service requirements subsequent to the achievement of the performance criteria. Compensation expense is recognized over the requisite service period, which is defined as the longest explicit, implicit or derived service period based on management’s estimate of the probability of the performance criteria being satisfied, adjusted at each balance sheet date. For awards containing multiple service, performance or market conditions, and all conditions must be satisfied prior to vesting, compensation expense is recognized over the requisite service period, which is defined as the longest explicit, implicit or derived service period, based on management’s estimate of the probability of the performance criteria being satisfied, adjusted at each balance sheet date. For both service-based and performance-based RSUs, we account for forfeitures as they occur as a reduction to stock-based compensation expense and additional paid-in-capital.

For performance-based options with a vesting schedule based entirely on the attainment of both performance and market conditions, stock-based compensation expense is recognized for each pair of performance and market conditions over the longer of the expected achievement period of the performance and market conditions, beginning at the point in time that the relevant performance condition is considered probable of achievement. The fair value of such awards is estimated on the grant date using Monte Carlo simulations.

CEO Performance Award

On May 24, 2018 (the “Grant Date”), our stockholders approved the Board of Directors’ grant of 6,365,856 stock option awards to Patrick W. Smith, our CEO (the “CEO Performance Award”). The CEO Performance Award consists of 12 vesting tranches with a vesting schedule based entirely on the attainment of both operational goals (performance conditions) and market capitalization goals (market conditions), assuming continued employment either as the CEO or as both Executive Chairman and Chief Product Officer and service through each vesting date. Each of the 12 vesting tranches of the CEO Performance Award have a 10-year contractual term and will vest upon certification by the Board of Directors that both (i) the market capitalization goal for such tranche, which begins at $2.5 billion for the first tranche and increases by increments of $1.0 billion thereafter, and (ii) any one of the following eight operational goals focused on revenue or eight operational goals focused on Adjusted EBITDA have been met for the previous four consecutive fiscal quarters. Adjusted EBITDA for purposes of the CEO Performance Award ("Adjusted EBITDA (CEO Performance Award)") is defined as net income (loss) attributable to common stockholders before interest expense, investment interest income, provision (benefit) for income taxes, depreciation and amortization, and stock-based compensation expense.



Eight Separate Revenue Goals ⁽¹⁾ (in thousands)		Eight Separate Adjusted EBITDA (CEO Performance Award) Goals (in thousands)
Goal #1, $710,058		Goal #9, $125,000
Goal #2, $860,058		Goal #10, $155,000
Goal #3, $1,010,058		Goal #11, $175,000
Goal #4, $1,210,058		Goal #12, $190,000
Goal #5, $1,410,058		Goal #13, $200,000
Goal #6, $1,610,058		Goal #14, $210,000
Goal #7, $1,810,058		Goal #15, $220,000
Goal #8, $2,010,058		Goal #16, $230,000

⁽¹⁾In connection with the business acquisition that was completed during the three months ended June 30, 2018, the revenue goals have been adjusted for the acquiree's Target Revenue, as defined in the CEO Performance Award agreement.

As of March 31, 2019, the following operational goals were considered probable of achievement:


•	Total revenue of $710.1 million; and


•	Adjusted EBITDA (CEO Performance Award) of $125.0 million

The first two market capitalization goals have been achieved as of March 31, 2019. However, none of the stock options granted under the CEO Performance Award have vested thus far as the operational goals have not yet been achieved as of March 31, 2019. As there are two operational goals considered probable of achievement, we recorded stock-based compensation expense of $4.7 million related to the CEO Performance Award from the Grant Date through March 31, 2019. The number of stock options that would vest related to the two tranches is approximately 1.1 million shares.

As of March 31, 2019, we had $40.5 million of total unrecognized stock-based compensation expense for the performance goals that were considered probable of achievement, which will be recognized over a weighted-average period of 7.0 years. As of March 31, 2019, we had unrecognized stock-based compensation expense of $200.7 million for the performance goals that were considered not probable of achievement.

eXponential Stock Performance Plan

On February 12, 2019, our shareholders approved the 2019 Stock Incentive Plan (the “2019 Plan”), which was adopted by the Board of Directors to reserve a sufficient number of shares to facilitate our eXponential Stock Performance Plan (“XSPP”) and grants of eXponential Stock Units (“XSUs”) under the plan. Pursuant to the XSPP, all eligible full-time U.S. employees were granted an award of 60 XSUs in January 2019, and certain employees had the opportunity to elect to receive a percentage of the value of their target compensation over the next nine years (2019-2027) in the form of additional XSUs. For employees who elected to receive XSUs, the XSU grants were made as an up front, lump sum grant in January 2019, and are intended to replace that portion of the target compensation they elected to receive in the form of XSUs for the next nine years. Accordingly, their go forward target compensation will be reduced until 2027 by the amount of such compensation that the employees elected to receive in the form of the January 2019 XSU grants. A total of approximately 5.2 million XSUs were granted in the three months ended March 31, 2019.

The XSUs are grants of restricted stock units, each with a term of approximately nine years, that vest in 12 equal tranches. Each of the 12 tranches will vest upon certification by the Compensation Committee of the Board of Directors that both (i) the market capitalization goal for such tranche, which begins at $2.5 billion for the first tranche and increases by increments of $1.0 billion thereafter, and (ii) any one of eight operational goals focused on revenue or eight operational goals focused on Adjusted EBITDA (CEO Performance Award) have been met for the previous four consecutive fiscal quarters.

The XSPP contains an anti-dilution provision, which is used to calculate a maximum number of shares outstanding for purposes of determining achievement of the market capitalization goals whereby the maximum number of shares used to calculate the market capitalization goal is calculated by organically growing the current number of shares outstanding by 3% per year (the "XSU Maximum"). Any shares of Stock issued to Patrick W. Smith upon the exercise of the stock options granted to Mr. Smith under the CEO Performance Award shall increase the XSU Maximum. The XSU Maximum shall also be adjusted for acquisitions, spin-offs or other changes in the number of outstanding shares of common stock, if such changes have a corresponding adjustment on the market capitalization goals.

The market capitalization and operational goals are identical to the CEO Performance Award, except for the number of shares that are used to calculate the market capitalization goals if shares outstanding exceed the XSU Maximum. Additionally, because the grant date is different than that of the CEO Performance Award, the measurement period for market capitalization is not identical.

Stock-based compensation expense associated with XSU awards is recognized over the longer of the expected achievement period for each pair of market capitalization and operational goals, beginning at the point in time when the relevant operational goal is considered probable of being met. The market capitalization goal period and the valuation of each tranche are determined using a Monte Carlo simulation which is also is used as the basis for determining the expected achievement period of the market capitalization goal. The probability of meeting an operational goal and the expected achievement point in time for meeting a probable operational goal are based on a subjective assessment of our forward-looking financial projections, taking into consideration statistical analysis. Even though no tranches of the XSU awards vest unless a market capitalization and a matching operational goal are both achieved, stock-based compensation expense is recognized when an operational goal is considered probable of achievement regardless of whether a market capitalization goal is actually achieved.

The first market capitalization goal has been achieved as of March 31, 2019. However, none of the XSU tranches have vested thus far as the operational goals have not yet been achieved as of March 31, 2019. As there are two operational goals considered probable of achievement, we recorded stock-based compensation expense of $0.7 million related to the XSU awards from their respective grant dates through March 31, 2019. The number of XSU awards that would vest related to the two tranches is approximately 0.9 million shares.

As of March 31, 2019, we had $36.8 million of total unrecognized stock-based compensation expense for the performance goals that were considered probable of achievement, which will be recognized over a weighted-average period of 7 years. As of March 31, 2019, we had unrecognized stock-based compensation expense of $137.0 million for the performance goals that were considered not probable of achievement.

Given the complexity of the awards, we utilized Monte Carlo simulations to simulate a range of possible future market capitalizations for the Company over the term of the awards. The average of all iterations of the simulation was used as the basis for the valuation and market capitalization goal derived service period for each tranche. Additionally, we applied an illiquidity discount of between 10.0% and 16.8% to the valuation of XSUs because the awards specify a post-vest holding period of 2.5 years. Certain of the XSU awards specify a post-vest holding period of the longer of 2.5 years or until the next tranche vests. The illiquidity discounts were estimated using the Finnerty model and reduced by the impact of expected payroll and income taxes due upon vesting of the awards, as the related proportion of shares are expected to be sold to satisfy such obligations. We measured the grant date fair value of the XSU awards with the following assumptions: risk-free interest rate of between 2.47% and 2.62%, expected term of approximately 9 years, expected volatility of between 44.96% and 45.47%, and dividend yield of 0.00%.

Restricted Stock Units

The following table summarizes RSU activity for the three months ended March 31, 2019 (number of units and aggregate intrinsic value in thousands):



	Number of Units		Weighted Average Grant-Date Fair Value		Aggregate Intrinsic Value
Units outstanding, beginning of year	1,655		$	28.34
Granted	5,667		34.32
Released	(290	)	20.91
Forfeited	(46	)	34.43
Units outstanding, end of period	6,986		33.47		$	380,123

Aggregate intrinsic value represents our closing stock price on the last trading day of the period, which was $54.41 per share, multiplied by the number of RSUs outstanding. As of March 31, 2019, there was $84.9 million in unrecognized compensation costs related to RSUs under our stock plans for shares that are expected to vest. We expect to recognize the cost related to the RSUs over a weighted average period of 4.59 years. RSUs are released when vesting requirements are met.

During the three months ended March 31, 2019, we granted 5.7 million RSUs, consisting of 0.3 million service-based RSUs and 5.4 million performance-based RSUs, including 5.2 million XSUs. As of March 31, 2019, the performance criteria had been met for approximately five thousand of the 5.7 million performance-based RSUs outstanding. Certain of the performance-based RSUs outstanding as of March 31, 2019 can vest with a range of shares earned being between 0% and 200% of the targeted shares granted, depending on the final achievement of pre-determined performance criteria as of the vesting date. The amount of RSUs included in the table above related to such grants is the target level. The maximum additional number of performance-based RSUs that could be earned is 0.3 million, which are not included in the table above.

Certain RSUs that vested in the three months ended March 31, 2019 were net-share settled such that we withheld shares with value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. Total shares withheld related to RSUs were approximately 15 thousand and had a value of $1.3 million on their respective vesting dates as determined by the closing stock price on such dates. Payments for the employees’ tax obligations are reflected as a financing activity within the condensed consolidated statements of cash flows. We record a liability for the tax withholding to be paid by us as a reduction to additional paid-in capital.

Stock Option Activity

The following table summarizes stock option activity for the three months ended March 31, 2019 (number of units and aggregate intrinsic value in thousands):



	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value
Options outstanding, beginning of year	6,458		$	28.24
Granted	—		—
Exercised	(24	)	4.20
Expired / terminated	—		—
Options outstanding, end of period	6,434		28.33		8.83	$	167,827
Options exercisable, end of period	68		4.54		1.69	3,397

Aggregate intrinsic value represents the difference between the exercise price of the underlying stock option awards and the closing market price of our common stock of $54.41 on March 31, 2019. The intrinsic value of options exercised for the three months ended March 31, 2019 and 2018 was $1.0 million and $2.0 million, respectively. As of March 31, 2019, total options outstanding included 6.4 million unvested performance-based stock options. Of this total, 1.1 million options relate to tranches of the CEO Performance Award considered probable of achievement.

Stock-based Compensation Expense

The following table summarizes the composition of stock-based compensation for the three months ended March 31, 2019 and 2018 (in thousands):



	Three Months Ended March 31,
	2019		2018
Cost of products sold and services delivered	$	226	$	141
Sales, general and administrative expenses	4,681		2,304
Research and development expenses	2,998		1,648
Total stock-based compensation	$	7,905	$	4,093

Stock Incentive Plan

In February 2019, our shareholders approved the 2019 Plan authorizing an additional 6.0 million shares, plus remaining available shares under prior plans, for issuance under the new plan. Combined with the legacy stock incentive plans, there are 2.2 million shares available for grant as of March 31, 2019.

Stock Repurchase Plan

In February 2016, our Board of Directors authorized a stock repurchase program to acquire up to $50.0 million of our outstanding common stock subject to stock market conditions and corporate considerations. During the three months ended March 31, 2019 and 2018, no common shares were purchased under the program. As of March 31, 2019, $16.3 million remains available under the plan for future purchases. Any future purchases will be discretionary.