Stock Based Compensation

Overview

We issue stock-based awards to certain of our employees and our Board of Directors pursuant to our 2000 Stock Incentive Plan, as amended, (the “Plan”) and our 2001 Employee Stock Purchase Plan (the “ESPP”) and recognize related stock-based compensation in our consolidated financial statements. The Plan provides for the granting to employees and consultants of Comtech (including prospective employees and consultants): (i) incentive and non-qualified stock options, (ii) restricted stock units (“RSUs”), (iii) RSUs with performance measures (which we refer to as “performance shares”), (iv) restricted stock, (v) stock units (reserved for issuance to non-employee directors) and share units (reserved for issuance to employees) (collectively, “share units”) and (vi) stock appreciation rights (“SARs”), among other types of awards. Our non-employee directors are eligible to receive non-discretionary grants of stock-based awards, subject to certain limitations. The aggregate number of shares of common stock which may be issued, pursuant to the Plan, may not exceed 8,962,500. Stock options granted may not have a term exceeding ten years or, in the case of an incentive stock award granted to a stockholder who owns stock representing more than 10.0% of the voting power, no more than five years. We expect to settle all outstanding awards under the Plan and ESPP with new shares.

As of April 30, 2015, we had granted stock-based awards pursuant to the Plan representing the right to purchase and/or acquire an aggregate of 7,462,030 shares (net of 2,822,062 expired and canceled awards), of which an aggregate of 5,067,578 have been exercised or converted into common stock, substantially all of which related to stock options.

As of April 30, 2015, the following stock-based awards, by award type, were outstanding:



	April 30, 2015
Stock options	2,164,433
Performance shares	170,841
RSUs and restricted stock	50,675
Share units	8,503
Total	2,394,452

Our ESPP, approved by our stockholders on December 12, 2000, provides for the issuance of 675,000 shares of our common stock. Our ESPP is intended to provide our eligible employees the opportunity to acquire our common stock at 85% of fair market value at the date of issuance. Through April 30, 2015, we have cumulatively issued 580,511 shares of our common stock to participating employees in connection with our ESPP.

Stock-based compensation for awards issued is reflected in the following line items in our Condensed Consolidated Statements of Operations:



	Three months ended April 30,					Nine months ended April 30,
	2015			2014		2015		2014
Cost of sales	$	71,000		57,000		204,000		194,000
Selling, general and administrative expenses	1,005,000			860,000		2,963,000		2,463,000
Research and development expenses	168,000			153,000		475,000		429,000
Stock-based compensation expense before income tax benefit	1,244,000			1,070,000		3,642,000		3,086,000
Estimated income tax benefit	(432,000		)	(394,000	)	(1,283,000	)	(1,143,000	)
Net stock-based compensation expense	$	812,000		676,000		2,359,000		1,943,000

Stock-based compensation for equity-classified awards is measured at the date of grant, based on an estimate of the fair value of the award and is generally expensed over the vesting period of the award. Stock-based compensation for liability-classified awards is determined the same way, except that the fair value of liability-classified awards is re-measured at the end of each reporting period until the award is settled, with changes in fair value recognized pro-rata for the portion of the requisite service period rendered. At April 30, 2015, unrecognized stock-based compensation of $8,786,000, net of estimated forfeitures of $608,000, is expected to be recognized over a weighted average period of 3.0 years. Total stock-based compensation capitalized and included in ending inventory at both April 30, 2015 and July 31, 2014 was $68,000. There were no liability-classified stock-based awards outstanding as of April 30, 2015 and July 31, 2014.

Stock-based compensation expense, by award type, is summarized as follows:



	Three months ended April 30,					Nine months ended April 30,
	2015			2014		2015		2014
Stock options	$	778,000		668,000		2,267,000		2,035,000
Performance shares	308,000			264,000		883,000		671,000
ESPP	52,000			47,000		158,000		135,000
RSUs and restricted stock	106,000			67,000		306,000		203,000
Share units	—			15,000		28,000		27,000
Equity-classified stock-based compensation expense	1,244,000			1,061,000		3,642,000		3,071,000
Liability-classified stock-based compensation expense (SARs)	—			9,000		—		15,000
Stock-based compensation expense before income tax benefit	1,244,000			1,070,000		3,642,000		3,086,000
Estimated income tax benefit	(432,000		)	(394,000	)	(1,283,000	)	(1,143,000	)
Net stock-based compensation expense	$	812,000		676,000		2,359,000		1,943,000

ESPP stock-based compensation expense primarily relates to the 15% discount offered to employees participating in the ESPP.

The estimated income tax benefit, as shown in the above table, was computed using income tax rates expected to apply when the awards are settled and results in a deferred tax asset which is netted in our long-term deferred tax liability in our Condensed Consolidated Balance Sheet. The actual income tax benefit recognized for tax reporting is based on the fair market value of our common stock at the time of settlement and can significantly differ from the estimated income tax benefit recorded for financial reporting.

The following table reconciles the actual income tax benefit recognized for tax deductions relating to the settlement of stock-based awards to the excess income tax benefit reported as a cash flow from financing activities in our Condensed Consolidated Statements of Cash Flows:



	Nine months ended April 30,
	2015		2014
Actual income tax benefit recorded for the tax deductions relating to the settlement of stock-based awards	$	1,032,000	342,000
Less: Tax benefit initially recognized on settled stock-based awards vesting subsequent to the adoption of accounting standards that require us to expense stock-based awards	892,000		280,000
Excess income tax benefit recorded as an increase to additional paid-in capital	140,000		62,000
Less: Tax benefit initially disclosed but not previously recognized on settled equity-classified stock-based awards vesting prior to the adoption of accounting standards that require us to expense stock-based awards	—		13,000
Excess income tax benefit from settled equity-classified stock-based awards reported as a cash flow from financing activities in our Condensed Consolidated Statements of Cash Flows	$	140,000	49,000

As of April 30, 2015 and July 31, 2014, the amount of hypothetical tax benefits related to stock-based awards, recorded as a component of additional paid-in capital, was $17,314,000 and $17,574,000, respectively. These amounts represent the initial hypothetical tax benefit of $8,593,000 determined upon adoption of ASC 718 (which reflects our estimate of cumulative actual tax deductions for awards issued and settled prior to the August 1, 2005), adjusted for actual excess income tax benefits or shortfalls since that date. During the nine months ended April 30, 2015, we recorded a $260,000 reduction to additional paid-in capital and accumulated hypothetical tax benefits, which primarily represents net income tax shortfalls recognized from the settlement of stock-based awards during the respective period. During the nine months ended April 30, 2014, we recorded a $2,306,000 reduction to additional paid-in capital and accumulated hypothetical tax benefits, which primarily represents the reversal of unrealized deferred tax assets associated with certain vested equity-classified stock-based awards that expired during the respective period.

Stock Options

The following table summarizes the Plan's activity during the nine months ended April 30, 2015:



	Awards (in Shares)		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Outstanding at July 31, 2014	2,132,896		$	28.17
Granted	253,000		33.94
Expired/canceled	(9,900	)	29.10
Exercised	(146,963	)	26.43
Outstanding at October 31, 2014	2,229,033		28.94
Granted	154,025		33.76
Expired/canceled	(10,800	)	29.20
Exercised	(137,525	)	28.06
Outstanding at January 31, 2015	2,234,733		29.32
Granted	3,000		29.31
Expired/canceled	(14,600	)	32.71
Exercised	(58,700	)	28.80
Outstanding at April 30, 2015	2,164,433		$	29.31	7.13	$	1,763,000

Exercisable at April 30, 2015	671,335		$	28.20	5.28	$	537,000

Vested and expected to vest at April 30, 2015	2,021,995		$	29.30	7.09	$	1,621,000

Stock options outstanding as of April 30, 2015 have exercise prices ranging between $24.35 - $33.94. The total intrinsic value relating to stock options exercised during the three months ended April 30, 2015 and 2014 was $265,000 and $533,000, respectively. The total intrinsic value relating to stock options exercised during the nine months ended April 30, 2015 and 2014 was $2,224,000 and $965,000, respectively. Stock options granted during the nine months ended April 30, 2015 and 2014 had exercise prices equal to the fair market value of our common stock on the date of grant, a contractual term of ten years and a vesting period of five years. There were no SARs granted or exercised during the three and nine months ended April 30, 2015 and 2014.

During the nine months ended April 30, 2015 and 2014, at the election of certain holders of vested stock options, 293,988 and 88,755 stock options, respectively, were net settled upon exercise. As a result, 47,532 and 5,488 net shares of our common stock were issued after reduction of shares retained to satisfy the exercise price and minimum statutory tax withholding requirements during the nine months ended April 30, 2015 and 2014, respectively.

The estimated per-share weighted average grant-date fair value of stock options granted during the three and nine months ended April 30, 2015 was $4.53 and $6.13, respectively, and $5.91 and $5.51, respectively, during the three and nine months ended April 30, 2014, which was determined using the Black-Scholes option pricing model, and included the following weighted average assumptions:



	Three months ended April 30,				Nine months ended April 30,
	2015		2014		2015		2014
Expected dividend yield	4.09	%	3.98	%	3.55	%	4.03	%
Expected volatility	27.00	%	32.00	%	28.12	%	32.83	%
Risk-free interest rate	1.37	%	1.49	%	1.61	%	1.39	%
Expected life (years)	5.22		5.31		5.45		5.43

Expected dividend yield is the expected annual dividend as a percentage of the fair market value of our common stock on the date of grant, based on our Board's annual dividend target at the time of grant, which was $1.20 per share for grants in the three and nine months ended April 30, 2015. We estimate expected volatility by considering the historical volatility of our stock, the implied volatility of publicly-traded call options on our stock and our expectations of volatility for the expected life of stock options. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant for an instrument which closely approximates the expected term. The expected term is the number of years we estimate that awards will be outstanding prior to exercise and is determined by employee groups with sufficiently distinct behavior patterns. Assumptions used in computing the fair value of stock-based awards reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by recipients of stock-based awards.

Performance Shares, RSUs, Restricted Stock and Share Unit Awards

The following table summarizes the Plan's activity relating to performance shares, RSUs, restricted stock and share units:



	Awards (in Shares)		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Outstanding at July 31, 2014	180,097		$	26.20
Granted	60,378		33.97
Converted to common stock	(13,376	)	27.75
Forfeited	(248	)	31.44
Outstanding at October 31, 2014	226,851		28.17
Granted	5,916		33.94
Converted to common stock	—		—
Forfeited	(248	)	31.44
Outstanding at January 31, 2015	232,519		28.31
Granted	—		—
Converted to common stock	—		—
Forfeited	(2,500	)	33.94
Outstanding at April 30, 2015	230,019		$	28.25	$	6,648,000

Vested at April 30, 2015	23,308		$	27.09	$	674,000

Vested and expected to vest at April 30, 2015	202,491		$	28.26	$	5,852,000

The total intrinsic value relating to fully-vested awards converted into our common stock during the nine months ended April 30, 2015 and 2014 was $504,000 and $110,000, respectively. Performance shares granted to employees prior to fiscal 2014 vest over a 5.3 year period, beginning on the date of grant if pre-established performance goals are attained, and are convertible into shares of our common stock generally at the time of vesting, on a one-for-one basis for no cash consideration. The performance shares granted to employees since fiscal 2014 principally vest over a three year performance period, if pre-established performance goals are attained or as specified pursuant to the Plan and related agreements. As of April 30, 2015, the number of outstanding performance shares included in the above table, and the related compensation expense prior to consideration of estimated pre-vesting forfeitures, assume achievement of the pre-established goals at a target level. During the nine months ended April 30, 2015, our Board of Directors determined that the pre-established performance goals for performance shares granted in fiscal 2013 had been attained, and as a result, the first tranche of 5,568 performance shares vested and converted into 4,149 shares of our common stock, after reduction of shares retained to satisfy deferral requirements.

RSUs and restricted stock granted to non-employee directors have a vesting period of three years and are convertible into shares of our common stock generally at the time of termination, on a one-for-one basis for no cash consideration, or earlier under certain circumstances. RSUs granted to employees have a vesting period of five years and are convertible into shares of our common stock generally at the time of vesting, on a one-for-one basis for no cash consideration.

Share units are vested when issued and are convertible into shares of our common stock generally at the time of termination, on a one-for-one basis for no cash consideration, or earlier under certain circumstances. No share units granted to date have been converted into common stock.

The fair value of performance shares, RSUs, restricted stock and share units is determined using the closing market price of our common stock on the date of grant, less the present value of any estimated future dividend equivalents such awards are not entitled to receive. RSUs and performance shares granted in fiscal 2012 are not entitled to dividend equivalents. RSUs, performance shares and restricted stock granted in fiscal 2013, 2014 and 2015 are entitled to dividend equivalents unless forfeited before vesting occurs; however, performance shares granted in fiscal 2013 were not entitled to such dividend equivalents until our Board of Directors determined that the pre-established performance goals were met. Share units granted prior to fiscal 2014 are not entitled to dividend equivalents. Share units granted in fiscal 2014 and thereafter are entitled to dividend equivalents while the underlying shares are unissued.

Dividend equivalents are subject to forfeiture, similar to the terms of the underlying stock-based awards, and are payable in cash generally at the time of conversion of the underlying shares into our common stock. During the nine months ended April 30, 2015, we accrued $169,000 of dividend equivalents and paid out $5,000. As of April 30, 2015 and July 31, 2014, accrued dividend equivalents were $280,000 and $116,000, respectively. Such amounts were recorded as a reduction to retained earnings.

Cash payments to remit employees' minimum statutory tax withholding requirements related to the net settlement of stock-based awards for the nine months ended April 30, 2015 and 2014 were $420,000 and $122,000, respectively, which is reported as a cash outflow from operating activities in our Condensed Consolidated Statements of Cash Flows for each respective period.