Stock-Based Compensation

12 Months Ended

Dec. 31, 2017

12 Stock-Based Compensation

In May 2012, the Company’s shareholders approved the Company’s 2012 Equity Incentive Plan (“2012 Plan”). As of December 31, 2017, the 2012 Plan has 2.7 million shares available for grant in the form of incentive or non-qualified stock options, stock appreciation rights (“SARs”), restricted stock, restricted stock units, performance stock units or other types of awards. The Company issues new shares of common stock upon exercise of stock options, restricted stock unit conversion or performance stock unit conversion. Under the 2012 Plan, the exercise price for stock options may not be less than the fair market value of the underlying stock at the date of grant. The 2012 Plan is scheduled to terminate on May 9, 2022. Options generally will expire no later than ten years after the date on which they are granted and will become exercisable as directed by the Compensation Committee of the Board of Directors and generally vest in equal annual installments over a five-year period. A SAR may be granted alone or in conjunction with an option or other award. Shares of restricted stock, and restricted stock units and performance stock units may be issued under the 2012 Plan for such consideration as is determined by the Compensation Committee of the Board of Directors. As of December 31, 2017, the Company had stock options, restricted stock and restricted and performance stock unit awards outstanding.

In May 2009, the Company’s shareholders approved the 2009 Employee Stock Purchase Plan under which eligible employees may contribute up to 15% of their earnings toward the quarterly purchase of the Company’s common stock. The plan makes available 0.9 million shares of the Company’s common stock, which includes the remaining shares available under the 1996 Employee Stock Purchase Plan. As of December 31, 2017, 1.4 million shares have been issued under both the 2009 and 1996 Employee Stock Purchase Plans. Each plan period lasts three months beginning on January 1, April 1, July 1 and October 1 of each year. The purchase price for each share of stock is the lesser of 90% of the market price on the first day of the plan period or 100% of the market price on the last day of the plan period. Stock-based compensation expense related to this plan was $1 million for each of the years ended December 31, 2017, 2016 and 2015, respectively.

The Company accounts for stock-based compensation costs in accordance with the accounting standards for stock-based compensation, which require that all share-based payments to employees be recognized in the statements of operations based on their grant date fair values. The Company recognizes the expense using the straight-line attribution method. The stock-based compensation expense recognized in the consolidated statements of operations is based on awards that ultimately are expected to vest; therefore, the amount of expense has been reduced for estimated forfeitures. The new stock-based compensation accounting guidance offers the option of recognizing forfeitures as they occur or estimating forfeitures at the time of grant and, if necessary, revising in subsequent periods if actual forfeitures differ from those estimates. The Company has elected to remain consistent with prior periods and estimate forfeitures at the time of grant and, if necessary, revise in subsequent periods in which actual forfeitures differ from those estimates. Forfeitures are estimated based on historical experience. If actual results differ significantly from these estimates, stock-based compensation expense and the Company’s results of operations could be materially impacted. In addition, if the Company employs different assumptions in the application of these standards, the compensation expense that the Company records in the future periods may differ significantly from what the Company has recorded in the current period.

The consolidated statements of operations for the years ended December 31, 2017, 2016 and 2015 include the following stock-based compensation expense related to stock option awards, restricted stock awards, restricted stock unit awards, performance stock unit awards and the employee stock purchase plan (in thousands):

		2017		2016		2015
Cost of sales		$	3,032	$	2,738	$	2,590
Selling and administrative expenses			33,335		34,451		26,431
Research and development expenses			3,069		3,809		4,347
	Total stock-based compensation	$	39,436	$	40,998	$	33,368

During the years ended December 31, 2017 and 2016, the Company recognized $4 million and $7 million, respectively, of stock compensation expense related to the modification of certain stock awards upon the retirement of senior executives.

Stock Options

In determining the fair value of the stock options, the Company makes a variety of assumptions and estimates, including volatility measures, expected yields and expected stock option lives. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model. The Company uses implied volatility on its publicly-traded options as the basis for its estimate of expected volatility. The Company believes that implied volatility is the most appropriate indicator of expected volatility because it is generally reflective of historical volatility and expectations of how future volatility will differ from historical volatility. The expected life assumption for grants is based on historical experience for the population of non-qualified stock option exercises. The risk-free interest rate is the yield currently available on U.S. Treasury zero-coupon issues with a remaining term approximating the expected term used as the input to the Black-Scholes model. The relevant data used to determine the value of the stock options granted during 2017, 2016 and 2015 are as follows:

Options Issued and Significant Assumptions Used to Estimate Option Fair Values	2017	2016	2015
Options issued in thousands	389	324	673
Risk-free interest rate	2.2%	1.9%	1.8%
Expected life in years	6	6	6
Expected volatility	0.227	0.247	0.257
Expected dividends	-	-	-

Weighted-Average Exercise Price and Fair Value of Options on the Date of Grant	2017		2016		2015
Exercise price	$	170.24	$	135.02	$	127.63
Fair value	$	45.73	$	37.44	$	35.84

The following table summarizes stock option activity for the plans for the year ended December 31, 2017 (in thousands, except per share data):

		Number of Shares	Exercise Price per Share					Weighted-Average Exercise Price
Outstanding at December 31, 2016		2,697	$	38.09	to	$	139.51	$	106.55
	Granted	389	$	136.43	to	$	194.26	$	170.24
	Exercised	(972)	$	41.20	to	$	139.51	$	93.49
	Canceled	(75)	$	87.06	to	$	139.51	$	120.59
Outstanding at December 31, 2017		2,039	$	38.09	to	$	194.26	$	124.41

The following table details the options outstanding at December 31, 2017 by range of exercise prices (in thousands, except per share data):

								Remaining
					Number		Weighted-	Contractual	Number		Weighted-
					of Shares		Average	Life of Options	of Shares		Average
Exercise Price Range					Outstanding		Exercise Price	Outstanding	Exercisable		Exercise Price
$	38.09	to	$	79.99	157	$	67.58	2.7	157	$	67.58
$	80.00	to	$	113.36	642	$	103.01	6.2	391	$	98.74
$	113.37	to	$	194.26	1,240	$	142.69	8.6	307	$	128.26
		Total			2,039	$	124.41	7.4	855	$	103.63

During 2017, 2016 and 2015, the total intrinsic value of the stock options exercised (i.e., the difference between the market price at exercise and the price paid by the employee to exercise the options) was $76 million, $53 million and $48 million, respectively. The total cash received from the exercise of these stock options was $91 million, $56 million and $47 million for the years ended December 31, 2017, 2016 and 2015, respectively.

The aggregate intrinsic value of the outstanding stock options at December 31, 2017 was $140 million. Options exercisable at December 31, 2017, 2016 and 2015 were 0.9 million, 1.3 million and 1.5 million, respectively. The weighted-average exercise prices of options exercisable at December 31, 2017, 2016 and 2015 were $103.63, $92.26 and $80.71, respectively. The weighted-average remaining contractual life of the exercisable outstanding stock options at December 31, 2017 was 5.6 years.

At December 31, 2017, the Company had 2 million stock options that are vested and expected to vest. The intrinsic value, weighted-average exercise price and remaining contractual life of the vested and expected to vest stock options were $137 million, $124.18 and 7.2 years, respectively, at December 31, 2017.

As of December 31, 2017, there were $42 million of total unrecognized compensation costs related to unvested stock option awards that are expected to vest. These costs are expected to be recognized over a weighted-average period of 3.5 years.

Restricted Stock

During the years ended December 31, 2017, 2016 and 2015, the Company granted 8 thousand, 8 thousand and 10 thousand shares of restricted stock, respectively. The weighted-average fair value per share on the grant date of the restricted stock granted in 2017, 2016 and 2015 was $140.10, $130.35 and $113.88, respectively. The Company has recorded $1 million of compensation expense in each of the years ended December 31, 2017, 2016 and 2015 related to the restricted stock grants. As of December 31, 2017, the Company had 6 thousand unvested shares of restricted stock outstanding, which have been fully expensed.

Restricted Stock Units

The following table summarizes the unvested restricted stock unit award activity for the year ended December 31, 2017 (in thousands, except for per share amounts):

		Shares	Weighted-Average Fair Value
Unvested at December 31, 2016		453	$	110.34
	Granted	107	$	154.60
	Vested	(164)	$	105.02
	Forfeited	(22)	$	119.27
Unvested at December 31, 2017		374	$	124.81

Restricted stock units are generally granted annually in February and vest in equal annual installments over a five-year period. The amount of compensation costs recognized for the years ended December 31, 2017, 2016 and 2015 on the restricted stock units expected to vest were $17 million, $17 million and $16 million, respectively. As of December 31, 2017, there were $32 million of total unrecognized compensation costs related to the restricted stock unit awards that are expected to vest. These costs are expected to be recognized over a weighted-average period of 3.0 years.

Performance Stock Units

During year ended December 31, 2017, the Company issued performance stock units, which are equity compensation awards with a market vesting condition based on the Company’s Total Shareholder Return (“TSR”) relative to the TSR of the components of the S&P Health Care Index. TSR is the change in value of a stock price over time, including the reinvestment of dividends. The vesting schedule ranges from 0% to 200% of the target shares awarded.

In determining the fair value of the performance stock units, the Company makes a variety of assumptions and estimates, including volatility measures, expected yields and expected terms. The fair value of each performance stock unit grant was estimated on the date of grant using the Monte Carlo simulation model. The Company uses implied volatility on its publicly-traded options as the basis for its estimate of expected volatility. The Company believes that implied volatility is the most appropriate indicator of expected volatility because it is generally reflective of historical volatility and expectations of how future volatility will differ from historical volatility. The expected life assumption for grants is based on the performance period of the underlying performance stock units. The risk-free interest rate is the yield currently available on U.S. Treasury zero-coupon issues with a remaining term approximating the expected term used as the input to the Monte Carlo simulation model. The correlation coefficient is used to model the way in which each company in the S&P Health Care Index tends to move in relation to each other during the performance period. The relevant data used to determine the value of the performance stock units granted during 2017 are as follows:

Performance Stock Units Issued and Significant Assumptions Used to Estimate Fair Values		2017
Performance stock units issued in thousands		40
Risk-free interest rate		1.6%
Expected life in years		3.0
Expected volatility		0.209
Average volatility of peer companies		0.256
Correlation Coefficient		0.378
Expected dividends		-

The following table summarizes the unvested performance stock unit award activity for the year ended December 31, 2017 (in thousands, except for per share amounts):

		Shares	Weighted-Average Fair Value
Unvested at December 31, 2016		27	$	171.16
	Granted	40	$	210.25
	Forfeited	(3)	$	156.25
Unvested at December 31, 2017		64	$	196.29

The amount of compensation costs recognized for the years ended December 31, 2017 and 2016 on the performance stock units expected to vest were $2 million and less than $1 million, respectively. As of December 31, 2017, there were $10 million of total unrecognized compensation costs related to the restricted stock unit awards that are expected to vest. These costs are expected to be recognized over a weighted-average period of 2.5 years.