Share-Based Compensation

9 Months Ended

Sep. 30, 2011

Share-Based Compensation [Abstract]

Share-Based Compensation

Note 13. Share-Based Compensation

We recognize share-based compensation expense for the portion of awards that are ultimately expected to vest using an accelerated accrual method over the vesting period from the date of grant. We estimate forfeitures at the time of grant. We have applied a forfeiture rate of approximately 12.5% to all unvested share-based awards as of September 30, 2011, which represents the portion that we expect will be forfeited over the vesting period. We reevaluate this estimated rate periodically and adjust the forfeiture rate as necessary. Vesting of share-based awards issued with performance-based vesting criteria must be “probable” before we begin recording share-based compensation expense. At each reporting period, we review the likelihood that these awards will vest and if the vesting is deemed probable, we begin to recognize compensation expense at that time. If ultimately performance goals are not met, for any awards where vesting was previously deemed probable, previously recognized compensation cost will be reversed.

We allocate share-based compensation expense to cost of revenues, selling, general and administrative expense and research and development expense based on the award holders’ employment function. For the three and nine months ended September 30, 2011 and 2010, we recorded share-based compensation expense as follows:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2011		2010		2011		2010
Cost of revenues	$	546,088	$	257,536	$	1,664,950	$	733,456
Selling, general and administrative		1,992,988		1,768,618		5,646,423		6,248,595
Research and development		1,018,700		536,802		2,683,216		1,579,867
	$	3,557,776	$	2,562,956	$	9,994,589	$	8,561,918

No deferred tax benefits were attributed to our share-based compensation expense recorded in the accompanying condensed consolidated financial statements because we are in a net operating loss position and a full valuation allowance is maintained for all net deferred tax assets. We receive a tax deduction for certain stock option exercises during the period the options are exercised, and for the vesting of restricted stock units during the period the restricted stock units vest. For stock options, the amount of the tax deduction is generally equal to the excess of the fair market value of our shares of common stock over the exercise price of the stock options at the date of exercise. For restricted stock units, the amount of the tax deduction is generally equal to the fair market value of our shares of common stock at the vesting date. Excess tax benefits are not included in the accompanying condensed consolidated financial statements because we are in a net operating loss position and a full valuation allowance is maintained for all net deferred tax assets.

Equity Plans

We have issued share-based awards to employees, non-executive directors and outside consultants through various approved plans and outside of any formal plan. New shares are issued upon the exercise of share-based awards.

On August 5, 2008, we adopted the HeartWare International, Inc. 2008 Stock Incentive Plan (“2008 SIP”). The 2008 SIP allows for the issuance of share-based awards to employees, directors and consultants. We have issued options and restricted stock units (“RSU’s”) to employees and directors under the 2008 SIP. The plan allows for the issuance of share-based awards representing up to 13% of the prior fiscal year’s weighted average shares outstanding, less share-based awards outstanding under our other equity plans. At September 30, 2011, there were approximately 605,000 shares available for future awards under the 2008 SIP.

Stock Options

Each option allows the holder to subscribe for and be issued one share of our common stock at a specified price, which is generally the quoted market price of our common stock on the date the option is issued. Options generally vest on a pro-rata basis on each anniversary of the issuance date within four years of the date the option is issued. Options may be exercised after they have vested and prior to the specified expiry date provided applicable exercise conditions are met, if any. The expiry date can be for periods of up to ten years from the date the option is issued.

In 2007 and 2008, we granted options with performance-based vesting criteria. These performance-based options vest in four equal tranches contingent upon the achievement of pre-determined corporate milestones related primarily to the development of our products and the achievement of certain prescribed clinical and regulatory objectives. Any performance-based options that have not vested after five years from the date of grant automatically expire.

The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model using the assumptions established at that time. The following table includes the assumptions used for options issued in the three and nine months ended September 30, 2011 and 2010.

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2011			2010			2011			2010
Dividend yield		0	%		0	%		0	%		0	%
Expected volatility		58.00	%		60.26	%		58.23	%		60.94	%
Risk-free interest rate		1.40	%		2.05	%		1.97	%		2.71	%
Estimated holding period (years)		6.25			6.25			6.25			6.25

Information related to options granted under all of our plans at September 30, 2011 and activity in the nine months then ended is as follows (certain amounts in U.S.$ were converted from AU$ at the then period-end spot rate):

						Weighted
				Weighted		Average
				Average		Remaining
				Exercise		Contractual Life		Aggregate
	Shares			Price		(Years)		Intrinsic Value
Outstanding at December 31, 2010		404,366		$	32.87
Granted		18,250			74.53
Exercised		(20,364	)		32.35
Forfeited		(8,991	)		37.26
Expired		—			—
Outstanding at September 30, 2011		393,261		$	33.80		6.09	$	12,039,434
Exercisable at September 30, 2011		276,625		$	32.43		5.45	$	8,846,795

The aggregate intrinsic values at September 30, 2011 noted in the table above represent the closing price of our common stock traded on NASDAQ, less the weighted average exercise price at period end multiplied by the number of options outstanding or exercisable.

At September 30, 2011, 34,283 of the 116,636 options outstanding that are not yet exercisable are subject to performance-based vesting criteria as described above.

The weighted average grant date fair value per share of options issued in the nine months ended September 30, 2011 and 2010 was $41.92 and $28.62 per share, respectively.

The total intrinsic value of options exercised in the nine months ended September 30, 2011 was approximately $1.1 million. Cash received from options exercised in the nine months ended September 30, 2011 was approximately $659,000. The total intrinsic value of options exercised in the nine months ended September 30, 2010 was approximately $3.5 million. Cash received from options exercised in the nine months ended September 30, 2010 was approximately $3.3 million.

At September 30, 2011, there was approximately $1.3 million of unrecognized compensation cost related to non-vested option awards, including performance-based options not yet deemed probable of vesting. The expense is expected to be recognized over a weighted average period of 1.3 years.

Restricted Stock Units

RSU’s issued under the plans vest on a pro-rata basis on each anniversary of the issuance date over three or four years or vest in accordance with performance-based criteria. The RSU’s with performance-based vesting criteria vest in tranches contingent upon the achievement of pre-determined corporate milestones related primarily to the development of our products and the achievement of certain prescribed clinical and regulatory objectives. RSU’s with performance-based vesting criteria not vested after five years from the date of grant automatically expire. There is no consideration payable on the vesting or exercise of RSU’s issued under the plans. Upon vesting, the RSU’s are exercised automatically and settled in shares of our common stock.

Information related to RSU’s at September 30, 2011 and activity in the nine months then ended is as follows:

				Weighted
				Average
				Remaining
				Contractual
	Number of			Life		Aggregate
	Units			(Years)		Intrinsic Value
Outstanding at December 31, 2010		544,865
Granted		75,450
Vested/Exercised		(154,476	)
Forfeited		(18,905	)
Expired		—
Outstanding at September 30, 2011		446,934			1.53	$	28,787,019
Exercisable at September 30, 2011		—			—	$	—

The aggregate intrinsic value at September 30, 2011 noted in the table above represents the closing price of our common stock traded on NASDAQ, multiplied by the number of RSU’s outstanding.

At September 30, 2011, 56,257 of the 446,934 RSU’s outstanding that are not yet exercisable are subject to performance-based vesting criteria as described above.

The total intrinsic value of RSU’s vested in the nine months ended September 30, 2011 and 2010 was approximately $9.6 million and $11.6 million, respectively.

The fair value of each RSU award equals the closing price of our common stock on the date of grant. The weighted average grant date fair value per share of RSU’s granted in the nine months ended September 30, 2011 and 2010 was $76.64 and $55.99, respectively.

At September 30, 2011, we had approximately $13.8 million of unrecognized compensation cost related to non-vested RSU awards, including awards not yet deemed probable of vesting. The expense is expected to be recognized over a weighted average period of 1.4 years.