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 July 31, 2016, we had granted stock-based awards pursuant to the Plan representing the right to purchase and/or acquire an aggregate of 7,617,044 shares (net of 3,283,491 expired and canceled awards), of which an aggregate of 5,143,152 have been exercised or converted into common stock, substantially all of which related to stock options.

As of July 31, 2016, the following stock-based awards, by award type, were outstanding:



	July 31, 2016
Stock options	2,256,679
Performance shares	173,852
RSUs and restricted stock	34,858
Share units	8,503
Total	2,473,892

Our ESPP provides for the issuance of 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. In December 2015, our shareholders approved an amendment to increase the number of shares authorized under the ESPP from 675,000 to 800,000. Through July 31, 2016, we have cumulatively issued 634,372 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 Consolidated Statements of Operations:



	Fiscal Years Ended July 31,
	2016			2015		2014
Cost of sales	$	296,000		245,000		252,000
Selling, general and administrative expenses	3,407,000			3,507,000		3,403,000
Research and development expenses	414,000			611,000		608,000
Stock-based compensation expense before income tax benefit	4,117,000			4,363,000		4,263,000
Estimated income tax benefit	(1,434,000		)	(1,523,000	)	(1,550,000	)
Net stock-based compensation expense	$	2,683,000		2,840,000		2,713,000

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. At July 31, 2016, unrecognized stock-based compensation of $6,767,000, net of estimated forfeitures of $680,000, is expected to be recognized over a weighted average period of 2.8 years. Total stock-based compensation capitalized and included in ending inventory at July 31, 2016 and 2015 was $51,000 and $68,000, respectively. There are no liability-classified stock-based awards outstanding as of July 31, 2016 or 2015.

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



	Fiscal Years Ended July 31,
	2016			2015		2014
Stock options	$	2,353,000		2,842,000		2,752,000
Performance shares	1,374,000			890,000		976,000
ESPP	163,000			206,000		184,000
RSUs and restricted stock	227,000			397,000		293,000
Share units	—			28,000		41,000
Equity-classified stock-based compensation expense	4,117,000			4,363,000		4,246,000
Liability-classified stock-based compensation expense (SARs)	—			—		17,000
Stock-based compensation expense before income tax benefit	4,117,000			4,363,000		4,263,000
Estimated income tax benefit	(1,434,000		)	(1,523,000	)	(1,550,000	)
Net stock-based compensation expense	$	2,683,000		2,840,000		2,713,000

ESPP stock-based compensation expense primarily relates to the 15% discount offered to participants 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. Such deferred tax asset was recorded net as part of our non-current deferred tax liability in our Consolidated Balance Sheet as of July 31, 2016 and 2015. 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 Consolidated Statements of Cash Flows:



	Fiscal Years Ended July 31,
	2016		2015	2014
Actual income tax benefit recorded for the tax deductions relating to the settlement of stock-based awards	$	196,000	1,108,000	$	2,339,000
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	168,000		960,000	1,540,000
Excess income tax benefit recorded as an increase to additional paid-in capital	28,000		148,000	799,000
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	—		—	61,000
Excess income tax benefit from settled equity-classified stock-based awards reported as a cash flow from financing activities in our Consolidated Statements of Cash Flows	$	28,000	148,000	738,000

As of July 31, 2016 and 2015, the amount of hypothetical tax benefits related to stock-based awards, recorded as a component of additional paid-in-capital, was $16,937,000 and $17,220,000, respectively. These amounts represent the initial hypothetical tax benefit of $8,593,000 determined upon adoption of FASB ASC 718 (which reflects our estimate of cumulative actual tax deductions for awards issued and settled prior to August 1, 2005), adjusted for actual excess income tax benefits or shortfalls since that date. During fiscal 2016, we recorded a $283,000 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 period. During fiscal 2015 we recorded a $354,000 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 period. During fiscal 2014 we recorded $2,407,000 as a 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 period.

Stock Options

The following table summarizes the Plan's activity (including SARs):



	Awards (in Shares)		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Outstanding at July 31, 2013	3,047,910		$	29.94
Granted	458,110		29.14
Expired/canceled	(492,060	)	42.90
Exercised	(881,064	)	26.55
Outstanding at July 31, 2014	2,132,896		28.17
Granted	416,525		33.78
Expired/canceled	(46,400	)	30.20
Exercised	(383,338	)	27.61
Outstanding at July 31, 2015	2,119,683		29.33
Granted	552,806		27.15
Expired/canceled	(396,610	)	28.99
Exercised	(19,200	)	27.24
Outstanding at July 31, 2016	2,256,679		$	28.87	6.67	$	1,000

Exercisable at July 31, 2016	1,154,882		$	28.60	5.42	$	—

Vested and expected to vest at July 31, 2016	2,174,225		$	28.86	6.62	$	1,000

Stock options outstanding as of July 31, 2016 have exercise prices ranging between $12.43 - $33.94. The total intrinsic value relating to stock options exercised during the fiscal years ended July 31, 2016, 2015 and 2014 was $32,000, $2,279,000 and $6,464,000, respectively. Stock options granted during the fiscal years ended July 31, 2016, 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 five or ten years and a vesting period of three or five years. There were no SARs granted during the prior three fiscal years. There were no SARs exercised during fiscal 2016 and fiscal 2015, and 7,000 SARs were exercised during fiscal 2014.

During fiscal 2016, 2015 and 2014, at the election of certain holders of vested stock options, 19,200, 333,338 and 618,970 stock options, respectively, were net settled upon exercise. As a result, 706, 49,086 and 79,890 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 fiscal years ended July 31, 2016, 2015, and 2014, respectively.

The estimated per-share weighted average grant-date fair value of stock options granted during fiscal 2016, 2015 and 2014 was $5.50, $6.12 and $5.35, respectively, which was determined using the Black-Scholes option pricing model, and included the following weighted average assumptions:



	Fiscal Years Ended July 31,
	2016		2015		2014
Expected dividend yield	4.46	%	3.55	%	3.94	%
Expected volatility	34.44	%	28.19	%	30.36	%
Risk-free interest rate	1.52	%	1.61	%	1.47	%
Expected life (years)	5.15		5.44		5.32

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 fiscal 2016 and 2015. The expected dividend yield was increased from $1.10 per share to $1.20 per share during fiscal 2015 and was $1.10 per share for grants in fiscal 2014. We estimate expected volatility by considering the historical volatility of our stock and the implied volatility of publicly-traded call options on our stock. 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, 2013	102,334		$	25.80
Granted	95,326		26.48
Converted to common stock	(7,857	)	26.18
Forfeited	(9,706	)	24.83
Outstanding at July 31, 2014	180,097		26.20
Granted	66,294		33.96
Converted to common stock	(18,422	)	27.79
Forfeited	(3,804	)	32.47
Outstanding at July 31, 2015	224,165		28.26
Granted	71,605		27.45
Converted to common stock	(16,439	)	26.35
Forfeited	(62,118	)	27.62
Outstanding at July 31, 2016	217,213		$	28.32	$	2,839,000

Vested at July 31, 2016	35,855		$	27.24	$	469,000

Vested and expected to vest at July 31, 2016	209,521		$	28.26	$	2,738,000

The total intrinsic value relating to fully-vested awards converted into our common stock during the fiscal year ended July 31, 2016 was $660,000. 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 July 31, 2016, 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.

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 through 2016 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 fiscal 2016, 2015 and 2014, we accrued $155,000, $224,000 and $113,000, respectively, of dividend equivalents and paid out $23,000, $15,000 and $4,000, respectively. As of July 31, 2016 and 2015, accrued dividend equivalents were $457,000 and $325,000, 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 fiscal years ended July 31, 2016, 2015 and 2014 were $105,000, $473,000 and $1,151,000, respectively, which is reported as a cash outflow from operating activities in our Consolidated Statements of Cash Flows for each respective period.

Subsequent Events

In the first quarter of fiscal 2017, our Board of Directors authorized the issuance of 409,329 stock-based awards of which 137,613 were performance shares, 144,899 were restricted stock and 126,817 were restricted stock units. Total unrecognized compensation expense related to such awards, net of estimated forfeitures and assuming achievement of the pre-established performance goals at a target level, approximated $5,139,000.