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 condensed 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 9,462,500. 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 the issuance of new shares of our common stock.

As of April 30, 2017, we had granted stock-based awards pursuant to the Plan representing the right to purchase and/or acquire an aggregate of 7,671,924 shares (net of 3,670,231 expired and canceled awards), of which an aggregate of 5,206,985 have been exercised or converted into common stock.

As of April 30, 2017, the following stock-based awards, by award type, were outstanding:



Stock options	1,900,975
Performance shares	252,089
RSUs and restricted stock	304,116
Share units	7,759
Total	2,464,939

Our ESPP provides for the issuance of up to 800,000 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, 2017, we have cumulatively issued 684,066 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,
	2017			2016		2017		2016
Cost of sales	$	56,000		70,000		162,000		233,000
Selling, general and administrative expenses	862,000			875,000		2,591,000		2,630,000
Research and development expenses	73,000			96,000		227,000		303,000
Stock-based compensation expense before income tax benefit	991,000			1,041,000		2,980,000		3,166,000
Estimated income tax benefit	(349,000		)	(391,000	)	(1,051,000	)	(1,103,000	)
Net stock-based compensation expense	$	642,000		650,000		1,929,000		2,063,000

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 April 30, 2017, unrecognized stock-based compensation of $7,756,000, net of estimated forfeitures of $705,000, is expected to be recognized over a weighted average period of 2.9 years. Total stock-based compensation capitalized and included in ending inventory at both April 30, 2017 and July 31, 2016 was $51,000. There are no liability-classified stock-based awards outstanding as of April 30, 2017 or July 31, 2016.

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



	Three months ended April 30,					Nine months ended April 30,
	2017			2016		2017		2016
Stock options	$	368,000		591,000		1,000,000		1,803,000
Performance shares	361,000			369,000		1,227,000		1,093,000
RSUs and restricted stock	221,000			46,000		633,000		152,000
ESPP	41,000			35,000		120,000		118,000
Stock-based compensation expense before income tax benefit	991,000			1,041,000		2,980,000		3,166,000
Estimated income tax benefit	(349,000		)	(391,000	)	(1,051,000	)	(1,103,000	)
Net stock-based compensation expense	$	642,000		650,000		1,929,000		2,063,000

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 Condensed Consolidated Balance Sheet as of April 30, 2017. 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,
	2017		2016
Actual income tax benefit recorded for the tax deductions relating to the settlement of stock-based awards	$	352,000	150,000
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	274,000		127,000
Excess income tax benefit from settled equity-classified stock-based awards recorded as an increase to additional paid-in capital and reported as a cash inflow from financing activities in our Condensed Consolidated Statements of Cash Flows	$	78,000	23,000

As of April 30, 2017 and July 31, 2016, the amount of hypothetical tax benefits related to stock-based awards, recorded as a component of additional paid-in capital, was $16,347,000 and $16,937,000, 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 the nine months ended April 30, 2017 and 2016, we recorded $590,000 and $81,000, respectively, of a reduction to additional paid-in capital and accumulated hypothetical tax benefits, which represent net income tax shortfalls recognized from the settlement of stock-based awards and the reversal of unrealized deferred tax assets associated with certain vested equity-classified stock-based awards that expired during each of the respective periods.

Stock Options

The following table summarizes the Plan's activity during the nine months ended April 30, 2017:



	Awards (in Shares)		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Outstanding at July 31, 2016	2,256,679		$	28.87
Expired/canceled	(118,505	)	27.34
Outstanding at October 31, 2016	2,138,174		28.96
Expired/canceled	(227,598	)	32.06
Outstanding at January 31, 2017	1,910,576		28.59
Expired/canceled	(9,601	)	26.11
Outstanding at April 30, 2017	1,900,975		$	28.60	5.76	$	—

Exercisable at April 30, 2017	1,173,564		$	28.54	4.96	$	—

Vested and expected to vest at April 30, 2017	1,847,340		$	28.60	5.72	$	—

Stock options outstanding as of April 30, 2017 have exercise prices ranging from $20.90 to $33.94. There were no stock options granted or exercised during the nine months ended April 30, 2017. Stock options granted during the three and nine months ended April 30, 2016 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. The total intrinsic value relating to stock options exercised during the nine months ended April 30, 2016 was $32,000.

During the nine months ended April 30, 2016, at the election of certain holders of vested stock options, 19,200 stock options were net settled upon exercise, which resulted in the issuance of 706 net shares of our common stock after reduction of shares retained to satisfy the exercise price and minimum statutory tax withholding requirements. As there were no exercises during the nine months ended April 30, 2017, there were no net settlements of stock options or the related issuance of common stock during the respective period.

The estimated per-share weighted average grant-date fair value of stock options granted during the three and nine months ended April 30, 2016 was $3.95 and $5.55, respectively, which was determined using the Black-Scholes option pricing model, and included the following weighted average assumptions:



	Three months ended		Nine months ended
	April 30, 2016		April 30, 2016
Expected dividend yield	5.58	%	4.42	%
Expected volatility	35.80	%	34.39	%
Risk-free interest rate	1.39	%	1.53	%
Expected life (years)	5.04		5.15

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. 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, 2016	217,213		$	28.32
Granted	418,684		13.10
Converted to common stock	(38,706	)	14.75
Forfeited	(5,155	)	25.10
Outstanding at October 31, 2016	592,036		17.80
Granted	2,632		11.40
Converted to common stock	(19,866	)	29.41
Forfeited	(6,826	)	19.65
Outstanding at January 31, 2017	567,976		17.34
Granted	5,836		11.04
Forfeited	(9,848	)	13.64
Outstanding at April 30, 2017	563,964		$	17.34	$	7,901,000

Vested at April 30, 2017	35,400		$	26.94	$	496,000

Vested and expected to vest at April 30, 2017	540,161		$	17.34	$	7,568,000

There were no fully-vested awards converted into our common stock during the three months ended April 30, 2017 and 2016. The total intrinsic value relating to fully-vested awards converted into our common stock during the nine months ended April 30, 2017 and 2016 was $633,000 and $275,000, respectively. Performance shares granted to employees prior to fiscal 2014 generally vest over a 5.3 year period, beginning on the date of grant once pre-established performance goals were attained, and are convertible into shares of our common stock 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, 2017, 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. Cumulatively through April 30, 2017, 744 share units granted 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 fiscal 2017 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, 2017, we accrued $228,000 of dividend equivalents and paid out $164,000. Such amounts were recorded as a reduction to retained earnings. As of April 30, 2017 and July 31, 2016, accrued dividend equivalents were $521,000 and $457,000, respectively.

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, 2017 and 2016 were $244,000 and $74,000, respectively, which is reported as a cash outflow from operating activities in the accrued expenses and other current liabilities line item in our Condensed Consolidated Statements of Cash Flows for each respective period.