10. Stock-based Compensation

The Company has stock-based compensation plans under which it grants stock options, restricted stock awards, performance share awards, restricted stock units and deferred stock units. Accounting guidance requires all share-based payments to be recognized as an operating expense, based on their fair values, over the requisite service period.

The Company’s stock-based compensation expenses were allocated to the following expense categories:

	Three Months Ended				Six Months Ended
	March 31,				March 31,
(Dollars in thousands)	2017		2016		2017		2016
Product costs	$	37	$	1	$	50	$	8
Research and development		123		60		248		119
Selling, general and administrative		722		1,154		1,373		1,772
Total	$	882	$	1,215	$	1,671	$	1,899

As of March 31, 2017, approximately $5.8 million of total unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately 2.3 years. The unrecognized compensation costs above include $2.3 million, remaining to be expensed over the life of the awards, based on payout levels associated with performance share awards that are currently anticipated to be fully expensed because the performance conditions are expected to exceed minimum threshold levels.

Stock Option Awards

The Company uses the Black-Scholes option pricing model to determine the weighted average grant date fair value of stock options granted. The weighted average per share fair values of stock options granted during the three months ended March 31, 2017 and 2016 were $7.59 and $6.52, respectively, and $7.59 and $6.85 during the six months ended March 31, 2017 and 2016, respectively. The assumptions used as inputs in the model were as follows:

	Three Months Ended						Six Months Ended
	March 31,						March 31,
	2017			2016			2017			2016
Risk-free interest rates		1.9	%		1.1	%		1.7	%		1.9	%
Expected life (years)		4.7			4.7			4.6			4.6
Expected volatility		34.1	%		37.8	%		34.4	%		36.8	%
Dividend yield		0.0	%		0.0	%		0.0	%		0.0	%

The risk-free interest rate assumption was based on the U.S. Treasury’s rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected term of the award. The expected life of options granted was determined based on the Company’s experience. Expected volatility was based on the Company’s stock price movement over a period approximating the expected term. Based on management’s judgment, dividend yields were expected to be 0.0% for the expected life of the options. The Company also estimated forfeitures of options granted, which were based on historical experience.

Non-qualified stock options are granted at fair market value on the date of grant. Non-qualified stock options expire in seven to ten years or upon termination of employment or service as a Board member. With respect to members of our Board, non-qualified stock options generally become exercisable on a pro-rata basis within the one-year period following the date of grant. With respect to our employees, non-qualified stock options generally become exercisable with respect to 25% of the shares on each of the first four anniversaries following the grant date. The stock-based compensation table above includes stock option expenses recognized related to these awards, which totaled $0.3 million for both the three-month periods ended March 31, 2017 and 2016, respectively, and $0.6 million for both the six-month periods ended March 31, 2017 and 2016, respectively.

The total pre-tax intrinsic value of options exercised during the three and six-month periods ended March 31, 2017 and 2016 was less than $0.1 million in each period. The intrinsic value represents the difference between the average exercise price and the fair market value of the Company’s common stock on the last day of the respective fiscal period end.

Restricted Stock Awards

The Company has entered into restricted stock agreements with certain key employees, covering the issuance of common stock (“Restricted Stock”). Under accounting guidance, these shares are considered to be non-vested shares. The Restricted Stock is released to the key employees if they are employed by the Company at the end of the vesting period. Compensation expense has been recognized for the estimated fair value of the common shares and is being charged to income over the vesting term. The stock-based compensation expense table includes Restricted Stock expenses recognized related to these awards, which totaled $0.1 million for both the three-month periods ended March 31, 2017 and 2016, and $0.3 million and $0.2 million for the six-month periods ended March 31, 2017 and 2016, respectively.

Performance Share Awards

The Company has entered into performance share agreements with certain key employees and executives, covering the issuance of common stock (“Performance Shares”). Performance Shares vest upon the achievement of all or a portion of certain performance objectives (which may include financial or project objectives), which must be achieved during the performance period. The Organization and Compensation Committee of the Board of Directors (the “Committee”) approves the performance objectives used for our executive compensation programs, which objectives were cumulative revenue and cumulative earnings before interest, income taxes, depreciation and amortization (“EBITDA”) for the three-year performance periods for awards granted in fiscal 2015 (2015 – 2017), fiscal 2016 (2016 – 2018) and fiscal 2017 (2017 – 2019). The fiscal 2017 awards also include performance objectives related to achievement of the Company’s strategic initiatives. Assuming that the minimum performance level is attained, the number of shares that may actually vest will vary based on performance from 20% (minimum) to 200% (maximum) of the target number of shares. Shares will be issued to participants as soon as practicable following the end of each performance period, subject to Committee approval and verification of results. Awards granted in fiscal 2014 were finalized in the six months ended March 31, 2017 and resulted in the issuance of 38,505 shares (maximum was 78,606 shares) based on the performance objectives relative to actual results achieved during the performance period. The per share compensation cost for each award is fixed on the grant date. Compensation expense is recognized in each period based on management’s best estimate of the achievement level of actual and forecasted results, as appropriate, compared with the specified performance objectives and the related impact on the number of Performance Shares expected to vest. The stock-based compensation expense table includes the Performance Shares expenses recognized related to these awards, which totaled $0.4 million and $0.7 million for the three-month periods ended March 31, 2017 and 2016, respectively, and $0.6 million and $1.0 million for the six-month periods ended March 31, 2017 and 2016, respectively.

The fair values of the Performance Shares, at target, were $1.2 million, $1.3 million and $0.9 million in each fiscal year for awards granted in fiscal 2017, 2016 and 2015, respectively.

The aggregate number of shares that could be awarded to our executives if the minimum, target and maximum performance goals are met, based on the fair value at the date of grant is as follows:

Performance Period	Minimum Shares		Target Shares		Maximum Shares
Fiscal 2015 – 2017		8,440		42,199		84,398
Fiscal 2016 – 2018		13,268		66,338		132,676
Fiscal 2017 – 2019		10,437		52,185		104,370

1999 Employee Stock Purchase Plan

Under the 1999 Employee Stock Purchase Plan (“Stock Purchase Plan”), the Company is authorized to issue up to 600,000 shares of common stock. All full-time and part-time U.S. employees can choose to have up to 10% of their annual compensation withheld, with a limit of $25,000, to purchase the Company’s common stock at purchase prices defined within the provisions of the Stock Purchase Plan. As of March 31, 2017 and September 30, 2016, there was less than $0.1 million of employee contributions included in accrued liabilities in the condensed consolidated balance sheets. Stock compensation expense recognized related to the Stock Purchase Plan for the three and six-month periods ended March 31, 2017 and 2016 totaled less than $0.1 million in each respective period. The stock-based compensation table includes the Stock Purchase Plan expenses.

Restricted Stock and Deferred Stock Units

During the six months ended March 31, 2017 and 2016, the Company awarded 14,728 and 8,916 restricted stock units (“RSUs”), respectively, under the 2009 Equity Incentive Plan to non-employee directors and certain key employees in foreign jurisdictions. Forfeiture of 446 RSUs occurred during the six months ended March 31, 2017. As of March 31, 2017 and September 30, 2016, 43,164 and 32,101 RSUs were outstanding, respectively, with an estimated fair market value of $1.0 million and $0.9 million, respectively. RSU awards are not considered issued or outstanding common stock of the Company until they vest. The estimated fair value of the RSUs was calculated based on the closing market price of Surmodics’ common stock on the date of grant. Compensation expense has been recognized for the estimated fair value of the common shares and is being charged to income over the vesting term. The stock-based compensation table includes RSU expenses recognized related to these awards, which totaled less than $0.1 million for both the three-month periods ended March 31, 2017 and 2016, and $0.1 million both for the six-month periods ended March 31, 2017 and 2016.

Directors can also elect to receive their annual fees for services to the Board in deferred stock units (“DSUs”). Certain directors elected this option beginning on January 1, 2013 with deferral elections made annually. During the six months ended March 31, 2017 and 2016, 2,501 and 4,512 units, respectively, were issued with a total fair value of less than $0.1 million in each period. As of March 31, 2017 and September 30, 2016, outstanding DSUs totaled 23,578 and 21,077, respectively, with an estimated fair value of $0.6 million for both periods. These DSUs are fully vested. Stock-based compensation expense related to DSU awards, totaled less than $0.1 million for both the three-month periods ended March 31, 2017 and 2016, and $0.1 million for both the six-month periods ended March 31, 2017 and 2016.