NOTE 4. SHARE-BASED COMPENSATION

We provide for various forms of share-based compensation awards to our employees and non-employee directors. With the exception of stock options, the fair value of our awards is equal to the closing stock price of IDEXX common stock on the date of grant. We calculate the fair value of our stock option awards using the Black-Scholes-Merton option-pricing model. Share-based compensation expense is recognized net of estimated forfeitures, on a straight-line basis over the requisite service period of the award.

Share-Based Awards

Our share-based compensation plans allow for the issuance of a mix of stock options, restricted stock, stock appreciation rights, employee stock purchase rights and other stock unit awards. Other stock unit awards include restricted stock units (“RSUs”) and deferred stock units (“DSUs”). Stock options permit a holder to buy IDEXX stock upon vesting at the stock’s price on the date the option was granted. An RSU is an agreement to issue shares of IDEXX stock at the time of vesting. DSUs are granted under our Executive Deferred Compensation Plan (the “Executive Plan”) and non-employee Director Deferred Compensation Plan (the “Director Plan”). DSUs may or may not have vesting conditions depending on the plan under which they are issued. We did not issue any restricted stock or stock appreciation rights during the years ended December 31, 2016, 2015 and 2014, nor were any restricted stock or stock appreciation rights outstanding as of those years ended. There were no material modifications to the terms of outstanding options, RSUs or DSUs during the years ended December 31, 2016, 2015 or 2014.

We primarily issue shares of common stock to satisfy stock option exercises and employee stock purchase rights and to settle RSUs and DSUs. We issue shares of treasury stock to settle certain RSUs and upon the exercise of certain stock options, which were not material for the years ended December 31, 2016, 2015 and 2014. The number of shares of common stock and treasury stock issued are equivalent to the number of awards exercised or settled.

With the exception of employee stock purchase rights, equity awards are issued to employees and non-employee directors under the 2009 Stock Incentive Plan (the “2009 Stock Plan”). Our Board of Directors has authorized the issuance of 19,900,000 shares of our common stock under this share-based incentive plan. Any shares that are subject to awards of stock options or stock appreciation rights will be counted against the share limit as one share for every share granted. Any shares that are issued other than stock options and stock appreciation rights will be counted against the share limit as two shares for every share granted. If any shares issued under our prior plans are forfeited, settled for cash or expire, these shares, to the extent of such forfeiture, cash settlement or expiration, will again be available for issuance under the 2009 Stock Plan. As of December 31, 2016, there were 11,711,752 remaining shares available for issuance under the 2009 Stock Plan.

Employee stock purchase rights are issued under the 1997 Employee Stock Purchase Plan, under which we reserved and may issue up to an aggregate of 4,700,000 shares of common stock in periodic offerings. Under this plan, stock is sold to employees at a 15 percent discount off the closing price of the stock on the last day of each quarter. The dollar value of this discount is equal to the fair value of purchase rights recognized as share-based compensation. We issued 85,432, 105,000 and 93,000 shares of common stock in connection with the Employee Stock Purchase Plan during the years ended December 31, 2016, 2015 and 2014, respectively. As of December 31, 2016, there were 1,308,328 remaining shares available for issuance under the 1997 Employee Stock Purchase Plan.

Share-Based Compensation

Share-based compensation costs are classified in our consolidated financial statements consistent with the classification of cash compensation paid to the employees receiving such share-based compensation. The following is a summary of share-based compensation costs and related tax benefits recorded in our consolidated statements of income for the years ended December 31, 2016, 2015 and 2014 (in thousands):



		For the Years Ended December 31,
		2016			2015			2014

Share-based compensation expense included in cost of revenue	$	2,305		$	2,138		$	1,937
Share-based compensation expense included in operating expenses		17,586			17,746			16,162
Total share-based compensation expense included in consolidated statements of income		19,891			19,884			18,099
Income tax benefit resulting from share-based compensation arrangements		(6,143	)		(6,229	)		(6,107	)
Net impact of share-based compensation on net income	$	13,748		$	13,655		$	11,992

Share-based compensation expense is reduced for an estimate of the number of awards that are expected to be forfeited. We use historical data and other factors to estimate expected employee terminations and to evaluate whether particular groups of employees have significantly different forfeiture expectations.

The total unrecognized compensation expense, net of estimated forfeitures, for unvested share-based compensation awards at December 31, 2016, was $38.0 million, which will be recognized over a weighted average period of approximately 1.6 years.

Stock Options

Option awards are granted with an exercise price equal to the closing market price of our common stock on the date of grant. Options granted to employees primarily vest ratably over five years on each anniversary of the date of grant and options granted to non-employee directors vest fully on the first anniversary of the date of grant. Vesting of option awards issued is conditional based on continuous service. Options granted after May 8, 2013 have a contractual term of ten years, options granted between January 1, 2006 and May 8, 2013 have contractual terms of seven years and options granted prior to January 1, 2006 had contractual terms of ten years. Upon any change in control of the company, 25 percent of the unvested stock options then outstanding will vest and become exercisable. However, if the acquiring entity does not assume outstanding options, then all options will vest immediately prior to the change in control.

We use the Black-Scholes-Merton option-pricing model to determine the fair value of options granted. Option-pricing models require the input of highly subjective assumptions, particularly for the expected stock price volatility and the expected term of options. Changes in the subjective input assumptions can materially affect the fair value estimate. Our expected stock price volatility assumptions are based on the historical volatility of our stock over periods that are similar to the expected terms of grants and other relevant factors. We derive the expected term based on historical experience and other relevant factors concerning expected employee behavior with regard to option exercise. The risk-free interest rate is based on U.S. Treasury yields for a maturity approximating the expected term calculated at the date of grant. We have never paid any cash dividends on our common stock and we have no intention to pay a dividend at this time; therefore, we assume that no dividends will be paid over the expected terms of option awards.

We determine the assumptions used in the valuation of option awards as of the date of grant. Differences in the expected stock price volatility, expected term or risk-free interest rate may necessitate distinct valuation assumptions at those grant dates. As such, we may use different assumptions for options granted throughout the year. The weighted averages of the valuation assumptions used to determine the fair value of each option award on the date of grant and the weighted average estimated fair values were as follows:



	For the Years Ended December 31,
		2016			2015			2014

Expected stock price volatility		25	%		23	%		28	%
Expected term, in years		5.7			5.6			5.7
Risk-free interest rate		1.2	%		1.5	%		1.5	%

Weighted average fair value of options granted	$	17.87		$	19.72		$	18.07

A summary of the status of options granted under our share-based compensation plans at December 31, 2016, and changes during the year then ended, are presented in the table below:



	Number of Options (000)	Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value ($000)

Outstanding as of December 31, 2015	3,384	$	49.76
Granted	745		69.07
Exercised	(838)		37.04
Forfeited	(115)		59.34
Expired	-		-
Outstanding as of December 31, 2016	3,176	$	57.31	5.3	$	190,424

Fully vested as of December 31, 2016	1,510	$	46.92	3.2	$	106,255

Fully vested and expected to vest as of December 31, 2016	3,034	$	56.78	5.2	$	183,550

The total fair value of options vested was $9.3 million during the year ended December 31, 2016, $8.7 million during the year ended December 31, 2015, and $7.8 million during the year ended December 31, 2014.

Intrinsic value of stock options exercised represents the amount by which the market price of the common stock exceeded the exercise price, before applicable income taxes. The total intrinsic value of stock options exercised was $51.0 million during the year ended December 31, 2016, $35.1 million during the year ended December 31, 2015, and $51.2 million during the year ended December 31, 2014.

Restricted Stock Units

The majority of RSUs granted to employees vest ratably over five years on each anniversary of the date of grant. RSUs granted to non-employee directors vest fully on the first anniversary of the date of grant. Vesting as it relates to RSUs issued is conditional based on continuous service. Upon any change in control of the company, 25 percent of the unvested RSUs then outstanding will vest, provided, however, that if the acquiring entity does not assume the RSUs, then all such units will vest immediately prior to the change in control.

A summary of the status of RSUs granted under our share-based compensation plans at December 31, 2016, and changes during the period then ended, are presented in the table below:



	Number of Units (000)	Weighted Average Grant-Date Fair Value

Nonvested as of December 31, 2015	498	$	58.94
Granted	173		69.14
Vested	(170)		52.60
Forfeited	(33)		60.46
Nonvested as of December 31, 2016	468	$	64.88

Expected to vest as of December 31, 2016	418	$	64.44

The total fair value of RSUs vested was $12.4 million during the year ended December 31, 2016, $15.3 million during the year ended December 31, 2015, and $15.4 million during the year ended December 31 2014. The aggregate intrinsic value of nonvested RSUs as of December 31, 2016, is equal to the fair value of IDEXX’s common stock as of December 31, 2016, multiplied by the number of nonvested units as of December 31, 2016.

Deferred Stock Units

Under our Director Plan, non-employee directors may defer a portion of their cash fees in the form of vested DSUs. Prior to 2014, certain members of our management could elect to defer a portion of their cash compensation in the form of vested deferred stock units under our Executive Plan. Each DSU represents the right to receive one unissued share of our common stock. These recipients receive a number of DSUs equal to the amount of cash fees or compensation deferred divided by the closing sale price of the common stock on the date of deferral. Also under the Director Plan, non-employee directors are awarded annual grants of DSUs that vest fully on the first anniversary of the date of grant. Vesting for these annual DSU grants is conditional based on continuous service. DSUs are exchanged for a fixed number of shares of common stock, upon vesting if vesting criteria apply, subject to the limitations of the Director and Executive Plans and applicable law.

There were approximately 231,000 and 240,000 vested DSUs outstanding under our share-based compensation plans as of December 31, 2016 and 2015, respectively. Unvested DSUs as of December 31, 2016 and 2015, were not material.