EMPLOYEE STOCK PLANS

Employee Stock Plans

Varian's 2005 Omnibus Stock Plan (the “2005 Plan”) was last amended and restated in December 2017 and approved by VMS’s stockholders at the 2018 Annual Meeting of Stockholders. The 2005 Plan, as amended and restated to date, is referred to as the Fifth Amended 2005 Plan (the “Fifth Amended 2005 Plan”). The Fifth Amended 2005 Plan provides for the grant of equity incentive awards, including stock options, restricted stock, restricted stock units, stock appreciation rights, and performance units and performance shares to officers, employees and consultants, and stock options and restricted stock units to directors. Restricted stock units may have a deferral feature (such units, "deferred stock units"). The maximum number of shares issuable under the Fifth Amended 2005 Plan is (a) 31.0 million, plus (b) the number of shares authorized for issuance, but never issued, under previously approved plans, plus (c) the number of shares subject to awards previously granted under previously approved plans that terminate, expire, or lapse, plus (d) amounts granted in substitution of options in connection with certain transactions.

Stock options granted under the Fifth Amended 2005 Plan have an exercise price equal to the closing market price of a share of VMS common stock on the grant date. Stock options granted to employees under the Fifth Amended 2005 Plan generally are exercisable in the following manner: the first one-third one year from the date of grant, with the remainder vesting monthly during the following two-year period. For grants of non-qualified stock options made on or after November 17, 2005 under the 2005 Plan to employees who retire from the Company within one year of the grant date, generally, the number of shares subject to the stock option shall be adjusted proportionally by the time during such one-year period that the employee remained an employee of the Company (based upon a 365-day year). The revised number of shares subject to the stock option would continue to vest in accordance with the original vesting schedule, and the remaining shares would be cancelled as of the date of retirement. Stock options under the Fifth Amended 2005 Plan have a term of seven years. In addition, in the event of the employee's disability or death, any unvested shares will become fully vested. The Fifth Amended 2005 Plan prohibits the repricing of stock options and stock appreciation rights without the approval of VMS’s stockholders.

Restricted stock awards and restricted stock unit awards generally vest over a period of one to three years from the date of grant. For awards of restricted stock and restricted stock units prior to fiscal year 2010, any unvested awards are generally forfeited at the time of termination. However, restricted stock units granted in fiscal year 2010 and thereafter that are unvested at death become fully vested and unvested restricted stock units will generally continue to vest in accordance with the original vesting schedule if a retirement eligible employee retires one year or more from the grant date. If a retirement eligible employee retires on or after January 1 of the calendar year immediately following the calendar year in which the grant date occurred and such retirement occurs within one year from the grant date, generally the number of restricted stock units shall be adjusted proportionally, subject to local regulations, by the time during such one year period that the employee remained an employee of the Company (based upon a 365-day year). The revised number of restricted stock units would vest in accordance with the original vesting schedule and the remaining restricted stock units would be cancelled as of the date of retirement. In addition, in the event of the employee’s disability, any unvested restricted stock units will generally continue to vest in accordance with the original vesting schedule.

Restricted stock unit awards to non-employee directors vest in full on the earlier of (i) the one-year anniversary of the grant date or (ii) the next Annual Meeting of Stockholders that occurs after the grant date, unless otherwise provided in the grant agreement as determined by VMS’s Board of Directors and payment in shares of VMS common stock will be made upon vesting. Deferred stock unit awards to non-employee directors vest over a period of not less than one year from the date of grant, unless otherwise provided in the grant agreement as determined by VMS’s Board of Directors, and vesting may be pro rata during the vesting period. Payment of deferred stock units generally will be made in shares of VMS common stock upon the earlier of the third anniversary of the grant date or the director’s termination.

In fiscal years 2018, 2017 and 2016, the Company granted performance units and in fiscal year 2018, performance-based options to certain employees under the 2005 Plan. The number of shares of VMS common stock ultimately issued under the performance units and performance-based options at vesting depend on the Company’s business performance and total shareholder return during the performance period, against specified performance targets, both of which are set by the Compensation and Management Development Committee of the Board of Directors at the beginning of the period. The performance units and performance-based options vest at the end of a three-year service period. Performance units granted in fiscal year 2015 have a one-year Company specific performance period and a three-year total shareholder return performance period. Performance unit grants granted in fiscal years 2016 and 2017 have three separate one-year Company specific performance periods and a three-year total shareholder return. Performance units and performance-based options granted in fiscal year 2018 have a three-year Company specific performance period and a three-year total shareholder return. Subject to certain exceptions, any unvested performance unit and performance-based option awards are forfeited at the time of termination. Also, similar to the adjustments discussed above for restricted stock unit awards, the number of performance units that ultimately vest is adjusted in the case of retirement.

The fair value of options granted under the 2005 Plan and the option component of the shares purchased under the Employee Stock Purchase Plan (which is described further below) were estimated at the date of grant using the Black-Scholes model with the following weighted average assumptions:



	Employee Stock Option Plans									Employee Stock Purchase Plans
	Fiscal Years									Fiscal Years
	2018			2017			2016			2018			2017			2016
Expected term (in years)	3.83			3.99			4.13			0.50			0.50			0.50
Risk-free interest rate	2.3		%	1.7		%	1.1		%	1.6		%	0.7		%	0.3		%
Expected volatility	19.1		%	21.3		%	20.1		%	25.2		%	20.3		%	17.6		%
Expected dividend	—		%	—		%	—		%	—		%	—		%	—		%
Weighted average fair value at grant date	$	20.88		$	16.12		$	13.71		$	24.56		$	18.92		$	16.09

The expected term of stock options represents the weighted average period the stock options are expected to remain outstanding. The expected term is based on the observed and expected time to post-vesting exercise and post-vesting cancellations of stock options by Company employees. The Company used a combination of historical and implied volatility of its traded options, or blended volatility, in deriving the expected volatility assumption. The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of VMS’s stock options. The dividend yield assumption is based on the Company’s history and expectation of no dividend payouts.

As share-based compensation expense recognized in the Consolidated Statements of Earnings is based on awards ultimately expected to vest. The Company adopted new accounting guidance in the first quarter of 2018 where it elected to change its accounting policy to account for forfeitures as they occur rather than estimating expected forfeitures. Share-based compensation expense for fiscal years 2017 and 2016 were recorded net of estimated forfeitures.

The table below summarizes the effect of recording share-based compensation expense:



	Fiscal Years
(In millions)	2018			2017			2016
Cost of revenues - Product	$	3.1		$	3.0		$	3.3
Cost of revenues - Service	4.2			4.1			4.1
Research and development	4.8			5.1			5.3
Selling, general and administrative	34.3			27.0			29.5
Total share-based compensation expense	$	46.4		$	39.2		$	42.2
Income tax benefit for share-based compensation	$	(10.5	)	$	(11.5	)	$	(12.8	)

The table below summarizes the effect of recording pre-tax share-based compensation expense for equity incentive awards:



	Fiscal Years
(In millions)	2018		2017		2016
Stock options ⁽¹⁾	$	10.3	$	9.2	$	9.9
Restricted stock units and restricted stock awards ⁽²⁾	31.9		26.2		28.7
Employee stock purchase plan	4.2		3.8		3.6
Total share-based compensation expense	$	46.4	$	39.2	$	42.2


⁽¹⁾	Stock options include performance options awards.


⁽²⁾	Restricted stock units and restricted stock awards include performance units and deferred stock units.

A summary of share-based awards available for grant is as follows:



(In millions)	Shares Available for Grant
Balance at October 2, 2015	6.7
Granted	(2.4	)
Canceled or expired	0.3
Balance at September 30, 2016	4.6
Granted	(1.8	)
Canceled or expired	0.3
Adjustment due to Distribution	(0.6	)
Balance at September 29, 2017	2.5
Authorized ⁽¹⁾	6.0
Granted	(1.9	)
Canceled or expired	0.5
Balance at September 28, 2018	7.1


⁽¹⁾	On February 8, 2018, the Company's stockholders approved its Fifth Amended and Restated 2005 Omnibus Stock Plan ("2005 Plan") to increase the number of shares authorized for issuance by 6.0 million shares.

For purposes of the total number of shares available for grant under the Fifth Amended 2005 Plan, any shares subject to awards of stock options and stock appreciation rights are counted against the available-for-grant limit as one share for every one share subject to the award. Awards other than stock options and stock appreciation rights are counted against the share reserve limit as 2.6 shares for every one share awarded on or after February 9, 2012. The share reserve limit is further adjusted to reflect the maximum payout that could be issued for each performance unit or performance-based option granted. The maximum payouts that could be issued for each performance grant are 2.0 shares for fiscal year 2018 grants, 1.75 shares for fiscal years 2017 and 2016 grants, and 2.0 shares in fiscal year 2015. All awards may be subject to restrictions on transferability and continued employment as determined by the Compensation and Management Development Committee.

Activity under the Company’s employee stock plans related to stock options is presented below:



	Options Outstanding
(In millions, except per share amounts)	Number of Shares		Weighted Average Exercise Price
Balance at September 29, 2017 (1.2 million options exercisable at a weighted average exercise price of $71.37)	2.3		$	74.08
Granted	0.7		111.54
Canceled, expired or forfeited	(0.1	)	84.90
Exercised	(0.6	)	71.02
Balance at September 28, 2018	2.3		$	85.82

The total pre-tax intrinsic value of stock options exercised was $28.3 million, $25.6 million and $23.8 million in fiscal years 2018, 2017 and 2016, respectively. The total fair value of stock options vested was $9.6 million, $9.7 million and $10.2 million in fiscal years 2018, 2017 and 2016, respectively.

The following table summarizes information related to stock options outstanding and exercisable under the Company’s employee stock plans at September 28, 2018:



	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number of Shares	Weighted Average Remaining Contractual Term (in years)	Weighted Average Exercise Price		Aggregate Intrinsic Value ⁽¹⁾		Number of Shares	Weighted Average Remaining Contractual Term (in years)	Weighted Average Exercise Price		Aggregate Intrinsic Value ⁽¹⁾
(In millions, except years and per-share amounts)
$51.23 - $67.12	0.6	3.6	$	65.72	$	28.4	0.5	3.5	$	65.43	$	23.7
$71.47 - $77.49	0.2	2.6	74.45		6.5		0.2	2.6	74.47		6.4
$80.40 - $99.26	0.8	4.6	82.38		24.8		0.5	4.2	82.20		16.2
$109.03 - $118.27	0.7	6.3	111.51		0.7		—	—	—		—
Total	2.3	4.7	$	85.82	$	60.4	1.2	3.7	$	74.14	$	46.3

⁽¹⁾

The aggregate intrinsic value represents the total pre-tax intrinsic value, which is computed based on the difference between the exercise price and the closing price of VMS common stock of $111.93 as of September 28, 2018, the last trading date of fiscal year 2018, and which represents the amount that would have been received by the option holders had all option holders exercised their options and sold the shares received upon exercise as of that date.

As of September 28, 2018, there was $14.9 million of total unrecognized compensation expense related to stock options granted under the Company’s employee stock plans. This unrecognized compensation expense is expected to be recognized over a weighted average period of 1.9 years.

The activity for restricted stock, restricted stock units, deferred stock units and performance units is summarized as follows:



(In millions, except per share amounts)	Number of Shares		Weighted Average Grant-Date Fair Value
Balance at September 29, 2017	0.9		$	75.37
Granted	0.3		111.84
Vested	(0.3	)	76.80
Canceled or expired	(0.1	)	87.23
Balance at September 28, 2018	0.8		$	89.17

The total grant-date fair value of restricted stock units, deferred stock units and performance units was $33.7 million, $31.4 million and $38.4 million in fiscal years 2018, 2017 and 2016, respectively. The total fair value of restricted stock, restricted stock units, deferred stock units and performance units that vested was $36.9 million, $29.8 million and $31.7 million in fiscal years 2018, 2017 and 2016, respectively.

As of September 28, 2018, unrecognized compensation expense totaling $36.4 million was related to restricted stock, restricted stock units, deferred stock units and performance units granted under the Company’s employee stock plans. This unrecognized share-based compensation expense is expected to be recognized over a weighted average period of 1.8 years. The Company withheld 0.1 million shares with a fair value of $11.6 million for employees’ minimum withholding taxes at vesting of such awards in fiscal year 2018.

Employee Stock Purchase Plan

In February 2010, VMS’s stockholders approved the 2010 Employee Stock Purchase Plan (the “2010 ESPP”). The 2010 ESPP provides eligible employees with an opportunity to purchase shares of VMS common stock at 85% of the lower of its fair market value at the start and end of a six-month purchase period. The 2010 ESPP provides for the purchase of up to seven million shares of VMS common stock.

VMS issued approximately 0.2 million shares for $15.7 million in fiscal year 2018 and approximately 0.2 million shares for $16.2 million in fiscal year 2017. At September 28, 2018, 5.2 million shares were available for issuance under the 2010 ESPP.