Stock-Based Compensation

Under the 2004 Amended and Restated Equity Incentive Plan, as amended (the "2004 EIP"), the Company had the ability to grant stock options, stock appreciation rights, restricted stock units, restricted stock awards, performance awards, and deferred stock awards. Effective as of February 20, 2014 and pursuant to its terms, no further awards may be granted under the 2004 EIP; however, that plan continues to govern all awards previously issued under it (many of which remain outstanding). In March 2014, the Compensation Committee (the "Compensation Committee") of the Board of Directors of the Company adopted the 2014 Equity Incentive Plan of NuVasive, Inc. (the "2014 EIP"), which was approved by our stockholders at our 2014 Annual Meeting of Stockholders and provides the Company with the ability to grant various types of equity awards to its workforce. Additionally, the NuVasive, Inc. 2004 Employee Stock Purchase Plan, as amended (the "ESPP"), provides eligible employees with a means of acquiring equity in the Company through accumulated payroll deductions and at a discounted purchase price. Each of the 2004 EIP and the 2014 EIP allow for net share settlement upon vesting of certain equity awards (be it with respect to taxes or strike price owed). The Company accounts for any net share settlement transactions as a treasury share repurchase transaction whereby the cost of repurchasing shares is included in treasury stock and reported as a reduction in total equity when a repurchase occurs, and for tax related withholding obligations.

The Company uses the Black-Scholes option-pricing model (the "Black-Scholes model") to value share-based employee stock option and purchase right awards and Monte Carlo simulations (the "Monte Carlo model") to value performance-based restricted stock units. The Company uses the stock price on the date of grant to value time-based restricted stock units. The determination of fair value of stock-based payment awards using the Black-Scholes model and the Monte Carlo model requires the use of certain estimates and assumptions that affect the reported amount of share-based compensation cost recognized in the condensed consolidated statements of operations. Among these cost-affecting estimates are the expected term of awards, estimated forfeitures, expected volatility of the Company’s stock price, expected dividends and the risk-free interest rate. In addition to these assumptions, performance-based conditions require the assessment of probability of achievement and correlation coefficients. The fair value of equity instruments that are expected to vest are recognized and amortized on an accelerated basis over the requisite service periods.

The compensation cost that has been included in the statement of operations for all stock-based compensation arrangements was as follows (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Sales, marketing and administrative expense	$	8,251	$	8,278	$	15,437	$	14,703
Research and development expense	483		449		947		791
Cost of goods sold	51		34		165		54
Total stock-based compensation expense	$	8,785	$	8,761	$	16,549	$	15,548

At June 30, 2014, there was $42.1 million of unamortized compensation expense for stock options, restricted stock units and performance-based restricted stock units to be recognized over the remaining vesting periods.

Stock Options and Purchase Rights

The weighted average assumptions used to estimate the fair value of stock purchase rights under the ESPP are as follows:



	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
ESPP
Volatility	44	%	57	%	46	%	58	%
Expected term (years)	1.2		1.6		1.2		1.5
Risk free interest rate	0.2	%	0.2	%	0.2	%	0.2	%
Expected dividend yield	—	%	—	%	—	%	—	%

The Company did not grant any stock options during the three and six months ended June 30, 2014 or 2013.

The Company issued approximately 74,000 and 478,000 shares of common stock upon the exercise of stock options during the three and six months ended June 30, 2014, respectively, and issued approximately 177,000 shares of common stock upon the exercise of stock options during the year ended December 31, 2013.

Restricted Stock Units

Time-based restricted stock units ("RSUs") represent a right to receive shares of common stock at a future date determined in accordance with the terms and conditions of a participant's award agreement (issued under either the 2004 EIP or 2014 EIP). No exercise price or other monetary payment are required for receipt of RSUs or the shares issued in settlement of the respective awards (provided the tax withholding obligations nonetheless apply); instead, consideration is furnished in the form of the participant’s services to the Company. Time-based RSUs have graded vesting terms of up to four years. Total compensation cost for these awards is based on the fair value of the award on the date of grant. The Compensation Committee has granted performance-based restricted stock units ("PRSUs") to certain senior Company executives annually since 2012. Pursuant to the terms and conditions of the PRSUs, such executives earned shares in 2012 and 2013 based on the achievement of pre-defined performance criteria. Additionally, in February 2014, the Compensation Committee granted PRSUs (the "2014 PRSUs") with performance criteria measured by the Company’s total shareholder return ("TSR") and total revenue growth over the two-year performance period spanning calendar years 2014 and 2015, with each performance metric being weighted equally and determined independently. The Company’s two-year TSR is measured as the change in the Company’s stock price between the opening stock price for 2014 and December 31, 2015, with the latter price being measured as the fifteen trading-day trailing average of the Company's stock price as of December 31, 2015 (without adjusting for dividends). The target TSR is the median TSR of the companies comprising the Dow Jones Medical Devices Index. Should the Company's two-year TSR over such two-year period be in excess of the 90^th percentile of the index, the eligible executives will earn a number of shares of Company stock equal to 250% of the target amount of the 2014 PRSUs being awarded for this goal. Conversely, no shares would be awarded if the Company’s two-year TSR is below the 30^th percentile of the index; provided, however, that, if the Company’s TSR during the two-year performance period is more than 5%, then, notwithstanding the Company’s percentile ranking, the minimum 25% of the target amount of the 2014 PRSUs would be eligible for award. Revenue growth performance is measured as total revenue growth against the target revenue growth as determined by the Compensation Committee, measured over the two-year performance period spanning fiscal years 2014 and 2015. Should the Company achieve 185.7% of the target revenue growth goal over such two-year period, eligible executives will earn a number of shares of Company stock equal to 250% of the target amount of the 2014 PRSUs being awarded for this goal. Conversely, no shares would be awarded upon achievement of less than 28.6% of the target revenue growth goal. The number of shares achieved with respect to the 2014 PRSUs will be determined in or around January 2016, upon determination of the Company’s two-year TSR and total revenue growth over the two year performance period as compared to the respective targets. Once such number of shares is determined pursuant to the PRSU criteria, half of any such shares will vest on a date shortly after the date the Compensation Committee makes the determination regarding performance, and the remaining half will vest on the one-year anniversary of such determination date (e.g. in 2017), subject, in all cases, to continuous employment through each of the vesting dates and certain, limited vesting acceleration criteria (i.e., in the event of a change of control).

The fair value of the 2014 PRSUs based on the TSR performance metric is measured on the date of grant using a Monte Carlo model and the associated expense is amortized over the three-year period from the date of grant. The fair value of the PRSUs based on the revenue growth performance metric is measured on the date of grant, considering a probability of achieving the specific goals, and expense is amortized over the three-year vesting period. The Company re-evaluates the probability of achieving the specific goals each reporting period and adjusts the related expense and dilution accordingly.

The Company is required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods on a cumulative basis in the period the estimated forfeiture rate changes. The Company considered its historical experience of pre-vesting forfeitures on RSUs by employee ("shareowner") rank as the basis to arrive at its estimated annual pre-vesting forfeiture rate of 0% to 8% per year for the three and six months ended June 30, 2014.

The Company issued approximately 145,000 and 1,355,000 shares of common stock in settlement of RSUs and PRSUs upon their vesting during the three and six months ended June 30, 2014, respectively, and issued approximately 665,000 shares of common stock in settlement of RSUs and PRSUs upon their vesting during the year ended December 31, 2013.