Note 2.Stock-Based Compensation

The following table shows the income statement components of stock-based compensation expense recognized in the Condensed Consolidated Statements of Income:

	Three Months Ended
	October 31,
	2015			2014

Cost of sales	$	79,000		$	99,000
Operating expenses:
Selling	190,000			186,000
General and administrative	1,425,000			1,279,000
Research and development	26,000			17,000

Total operating expenses	1,641,000			1,482,000

Stock-based compensation before income taxes	1,720,000			1,581,000
Income tax benefits	(613,000		)	(539,000		)

Total stock-based compensation expense, net of tax	$	1,107,000		$	1,042,000

The above stock-based compensation expense before income taxes was recorded in the Condensed Consolidated Financial Statements as stock-based compensation expense and an increase to additional paid-in capital. The related income tax benefits were recorded as either an increase to current deferred income tax assets or long-term deferred income tax assets (which are netted with long-term deferred income tax liabilities) and a reduction to income tax expense. All of our stock options and stock awards (which consist only of restricted shares) are expected to be deductible for tax purposes, except for certain restricted shares granted to employees residing outside of the United States, and were tax-effected using the Company’s estimated U.S. effective tax rate at the time of grant.

All of our stock options and stock awards are subject to graded vesting in which portions of the award vest at different times during the vesting period, as opposed to awards that vest at the end of the vesting period. We recognize compensation expense for awards subject to graded vesting using the straight-line basis over the vesting period, reduced by estimated forfeitures. At October 31, 2015, total unrecognized stock-based compensation expense, before income taxes, related to total nonvested stock options and stock awards was $22,064,000 with a remaining weighted average period of 26 months over which such expense is expected to be recognized. Most of our nonvested awards relate to stock awards.

We determine the fair value of each stock award using the closing market price of our common stock on the date of grant.

A summary of nonvested stock award activity follows:

			Weighted
	Number of		Average
	Shares		Fair Value

Nonvested stock awards at July 31, 2015	343,519		$	32.77
Granted	161,923		54.23
Canceled	(522	)	31.81
Vested	(152,601	)	28.60

Nonvested stock awards at October 31, 2015	352,319		$	44.44

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions for options granted during the three months ended October 31, 2015 and 2014:

Weighted-Average
Black-Scholes Option	Three Months Ended		Three Months Ended
Valuation Assumptions	October 31, 2015		October 31, 2014

Dividend yield	0.22	%	0.25	%
Expected volatility (1)	55.90	%	33.90	%
Risk-free interest rate (2)	1.41	%	1.55	%
Expected lives (in years) (3)	5.00		5.00

(1)

Volatility was based on historical closing prices of our common stock.

(2)

The U.S. Treasury rate based on the expected life at the date of grant.

(3)

Based on historical exercise behavior.

Additionally, all options were considered to be deductible for tax purposes in the valuation model. Such non-qualified options were tax-effected using the Company’s estimated U.S. effective tax rate at the time of grant. For the three months ended October 31, 2015 and 2014, these non-qualified options had a weighted average fair value of $26.49 and $11.54, respectively.

There were no option exercises during the three months ended October 31, 2015. For the three months ended October 31, 2014, the aggregate intrinsic value (i.e. the excess market price over the exercise price) of all options exercised was approximately $2,420,000.

A summary of stock option activity follows:

		Weighted
	Number of	Average
	Shares	Exercise Price

Outstanding at July 31, 2015	107,500	$	25.73
Granted	15,000	55.36

Outstanding at October 31, 2015	122,500	$	29.36


Exercisable at July 31, 2015	45,000	$	20.32


Exercisable at October 31, 2015	80,834	$	22.72

If certain criteria are met when options are exercised or restricted stock becomes vested, we are allowed a deduction on our United States income tax return. Accordingly, we account for the income tax effect on such income tax deductions as a reduction of previously recorded deferred income tax assets and as a reduction of income taxes payable. Excess tax benefits arise when the ultimate tax effect of the deduction for tax purposes is greater than the tax benefit on stock compensation expense which was determined based upon the award’s fair value at the time the award was granted. The differences noted above between actual tax deductions and the previously recorded deferred income tax assets are recorded as additional paid-in capital. For the three months ended October 31, 2015 and 2014, income tax deductions of $3,041,000 and $4,198,000, respectively, were generated and increased additional paid-in capital by $1,489,000 and $2,473,000, respectively. We classify the cash flows resulting from excess tax benefits as financing cash flows in our Condensed Consolidated Statements of Cash Flows.