EMPLOYEE STOCK AWARD AND BENEFIT PLANS

Deferred Compensation Plans

Under our deferred compensation plans ("plans"), eligible employees are permitted to make compensation deferrals up to established limits set under the plans and accrue income on these deferrals based on reference to changes in available investment options. While not required by the plan, we choose to invest in insurance contracts and mutual funds in order to approximate the changes in the liability to the employees. These investments and the liability to the employees were as follows (in thousands):



	Fiscal year-end
	2018		2017
Cash surrender value of life insurance contracts	$	15,830	$	13,995
Fair value of mutual and money market funds	22,384		17,870
Total assets	$	38,214	$	31,865

Total assets, included in:
Prepaid expenses and other assets	$	844	$	856
Other assets	37,370		31,009
Total assets	$	38,214	$	31,865



	Fiscal year-end
	2018		2017
Total deferred compensation liability, included in:
Other current liabilities	$	844	$	856
Other long-term liabilities	40,895		34,160
Total deferred compensation liability	$	41,739	$	35,016

Life insurance premiums loads, policy fees and cost of insurance that are paid from the asset investments and gains and losses from the asset investments for these plans are recorded as components of other income or expense; such amounts were a net gain of $4.8 million in fiscal 2018, a net gain of $5.0 million (including a $1.3 million death benefit) in fiscal 2017 and a net gain of $1.7 million in fiscal 2016. Changes in the obligation to plan participants are recorded as a component of operating expenses and cost of sales; such amounts were a loss of $5.2 million in fiscal 2018, a loss of $3.9 million in fiscal 2017 and a loss of $2.1 million in fiscal 2016. Liabilities associated with participant balances under our deferred compensation plans are affected by individual contributions and distributions made, as well as gains and losses on the participant's investment allocation election.

Coherent Employee Retirement and Investment Plan

Under the Coherent Employee Retirement and Investment Plan, we match employee contributions to the plan up to a maximum of 4% of the employee's individual earnings subject to IRS limitations. Employees become eligible for participation and Company matching contributions on their first day of employment. The Company's contributions (net of forfeitures) during fiscal 2018, 2017, and 2016 were $5.6 million, $4.8 million and $4.1 million, respectively.

Employee Stock Purchase Plan

We have an Employee Stock Purchase Plan ("ESPP") whereby eligible employees may authorize payroll deductions of up to 10% of their regular base salary to purchase shares at the lower of 85% of the fair market value of the common stock on the date of commencement of the offering or on the last day of the six-month offering period. During fiscal 2018, 2017 and 2016, a total of 66,099 shares, 95,678 shares and 141,340 shares, respectively, were purchased by and distributed to employees at an average price of $159.97, $81.82 and $46.81 per share, respectively. At fiscal 2018 year-end, we had 358,783 shares of our common stock reserved for future issuance under the plan.

Stock Award Plans

We maintain a stock plan for which employees, service providers and non-employee directors are eligible participants. This plan, the 2011 Equity Incentive Plan (the "2011 Plan"), provides for a number of different equity-based grants, including options, time-based restricted stock units and performance restricted stock units. Under the 2011 Plan, Coherent may grant options and awards (time-based restricted stock units and performance restricted stock units) to purchase up to 6,747,691 shares of common stock, of which 4,780,438 shares remained available for grant at fiscal 2018 year-end. At fiscal 2018 year-end, all outstanding stock options and restricted stock units have been issued under plans approved by our shareholders.

Historically, option grants to employees vested over the four years from the original grant date. Since adoption of the 2011 Plan, no stock options have been granted to employees. Some vested options made to one non-employee director under a prior stock plan remain outstanding.

Non-employee directors are automatically granted time-based restricted stock units upon first joining the Board of Directors and then upon reelection. New non-employee directors initially receive an award of restricted stock units valued at approximately $225,000 which vest over a two year period. The annual grant for non-employee directors is a value of approximately $225,000 in shares of restricted stock units that vest on February 15 of the calendar year following the grant.

Restricted stock awards and restricted stock units are typically subject to vesting restrictions—either time-based or market-based conditions for vesting. Until restricted stock vests, shares (including those issuable upon vesting of the applicable restricted stock unit) are subject to forfeiture if employment or service to the Company terminates prior to the release of restrictions and cannot be transferred.


•	The service based restricted stock awards generally vest within three years from the date of grant.


•	The service based restricted stock unit awards are generally subject to annual vesting over three years from the date of grant, though from time-to-time, depending upon exceptional circumstances, the Company has granted restricted stock unit awards with one or two year vesting.

•

The performance restricted stock unit award grants are generally either subject to annual vesting over three years from the date of grant or subject to a single vest measurement three years from the date of grant, depending upon achievement of performance measurements based on the performance of the Company's total shareholder returns (as defined in the plan) compared with the performance of the Russell 1000 Index (or as otherwise determined by the Compensation and HR Committee).

Fair Value of Stock Compensation

We recognize compensation expense for all share-based payment awards based on the fair value of such awards. The expense is recognized on a straight-line basis per tranche over the respective requisite service period of the awards.

Determining Fair Value

Employee Stock Purchase Plan

Valuation and amortization method—We estimate the fair value of employee stock purchase shares using the Black-Scholes-Merton option-pricing formula. This fair value is then amortized on a straight-line basis over the purchase period.

Expected Term—The expected term represents the period of our employee stock purchase plan.

Expected Volatility—Our process for computing expected volatility considers both historical volatility and market-based implied volatility; however our estimate of expected forfeitures is based on historical employee data and could differ from actual forfeitures.

Risk-Free Interest Rate—The risk-free interest rate used in the Black-Scholes-Merton valuation method is based on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term.

The fair values of shares purchased under the employee stock purchase plan for fiscal 2018, 2017 and 2016 were estimated using the following weighted-average assumptions:



	Employee Stock Purchase Plans
	Fiscal
	2018			2017			2016
Expected life in years	0.5			0.5			0.5
Expected volatility	50.1		%	33.0		%	35.0		%
Risk-free interest rate	1.6		%	0.7		%	0.3		%
Weighted average fair value per share	$	64.39		$	39.40		$	18.59

Time-Based Restricted Stock Units

Time-based restricted stock units are fair valued at the closing market price on the date of grant.

Performance Restricted Stock Units

We grant performance restricted stock units to officers and certain employees. The performance restricted stock unit agreements provide for the award of performance stock units with each unit representing the right to receive one share of our common stock to be issued after the applicable award vesting period. The final number of units awarded, if any, for these performance grants will be determined as of the vesting dates, based upon our total shareholder return over the performance period compared to the applicable Russell Index and could range from no units to a maximum of twice the initial award units. The weighted average fair value for these performance units was determined using a Monte Carlo simulation model incorporating the following weighted average assumptions:



	Fiscal
	2018			2017			2016
Risk-free interest rate	1.7		%	1.3		%	1.2		%
Volatility	37.0		%	31.0		%	27.0		%
Weighted average fair value	$	315.05		$	163.17		$	74.48

We recognize the estimated cost of these awards, as determined under the simulation model, over the related service period of approximately 3 years, with no adjustment in future periods based upon the actual shareholder return over the performance period.

Stock Compensation Expense

The following table shows total stock-based compensation expense and related tax benefits included in the Consolidated Statements of Operations for fiscal 2018, 2017 and 2016 (in thousands):



	Fiscal
	2018			2017			2016
Cost of sales	$	4,403		$	3,541		$	2,558
Research and development	3,247			2,973			2,268
Selling, general and administrative	25,088			23,911			15,331
Income tax benefit	(5,073		)	(7,073		)	(4,896		)
	$	27,665		$	23,352		$	15,261

As a result of our acquisition of Rofin on November 7, 2016, we made a payment of $15.3 million due to the cancellation of options held by employees of Rofin. The payment was allocated between total estimated merger consideration of $11.1 million and post-merger stock-based compensation expense of $4.2 million, recorded in the first quarter of fiscal 2017, based on the portion of the total service period of the underlying options that have not been completed by the merger date.

During fiscal 2018, $4.7 million of stock-based compensation cost was capitalized as part of inventory for all stock plans, $4.4 million was amortized into cost of sales and $1.5 million remained in inventory at September 29, 2018. During fiscal 2017, $3.6 million of stock-based compensation cost was capitalized as part of inventory for all stock plans, $3.3 million was amortized into cost of sales and $1.2 million remained in inventory at September 30, 2017.

At fiscal 2018 year-end, the total compensation cost related to unvested stock-based awards granted to employees under our stock plans but not yet recognized was approximately $36.0 million. We do not estimate forfeitures. This cost will be amortized on a straight-line basis over a weighted-average period of approximately 1.4 years.

The stock option exercise tax benefits, if any, are reported in the statement of cash flows. The tax benefits result from tax deductions in excess of the stock-based compensation cost recognized and are determined on a grant-by-grant basis. During fiscal 2017, we recorded approximately $1.6 million of excess tax benefits as cash flows from financing activities. In fiscal 2016, we did not generate any excess tax benefits as cash flows from financing activities. We adopted the new accounting standard on share-based compensation in the first quarter of fiscal 2018. As a result, we recognized excess tax benefits from stock award exercises and restricted stock unit vesting as a discrete tax benefit, which reduced the provision for income taxes for fiscal 2018 by $12.8 million.

Stock Awards Activity

At fiscal 2018, 2017 and 2016 year-end, we had 24,000, 24,000 and 33,500 shares subject to vested stock options outstanding. The vested stock options at fiscal 2018 are held by one non-employee director.

The following table summarizes the activity of our time-based and performance restricted stock units for fiscal 2018, 2017 and 2016 (in thousands, except per share amounts):



	Time Based Restricted Stock Units				Performance Restricted Stock Units
	Number of Shares		Weighted Average Grant Date Fair Value		Number of Shares		Weighted Average Grant Date Fair Value
Nonvested stock at October 3, 2015	394		$	65.17	199		$	67.09
Granted	270		64.42		65		74.48
Vested ⁽¹⁾	(192	)	61.11		(57	)	48.48
Forfeited	(13	)	63.89		(38	)	48.48
Nonvested stock at October 1, 2016	459		$	66.47	169		$	74.10
Granted	186		131.54		115		163.17
Vested⁽¹⁾	(229	)	66.02		(104	)	77.10
Forfeited	(17	)	84.79		(4	)	70.57
Nonvested stock at September 30, 2017	399		$	118.83	176		$	105.34
Granted	99		254.20		78		315.05
Vested⁽¹⁾	(213	)	88.45		(95	)	70.57
Forfeited	(6	)	119.66		—		—
Nonvested stock at September 29, 2018	279		$	155.24	159		$	155.76

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(1)	Service-based restricted stock units vested during each fiscal year. Performance-based restricted stock units included at 100% of target goal; under the terms of the awards, the recipient may earn between 0% and 200% of the award.

Restricted Stock Units are converted into the right to receive common stock upon vesting; prior to issuance, the Company permits the employee holders to satisfy their tax withholding requirements by net settlement, whereby the Company withholds a portion of the shares to cover the applicable taxes based on the fair market value of the Company's stock at the vesting date. The number of shares withheld to cover tax payments was 131,000 in fiscal 2018, 131,000 in fiscal 2017 and 89,000 in fiscal 2016; tax payments made were $36.3 million, $15.7 million and $5.4 million, respectively.