(4) Stock-Based Compensation

We issue stock-based awards to certain of our employees and our Board of Directors and we recognize related stock-based compensation for both equity and liability-classified stock-based awards in our condensed consolidated financial statements. These awards are issued pursuant to our 2000 Stock Incentive Plan and our 2001 Employee Stock Purchase Plan (the "ESPP").

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 grant. Stock-based compensation for liability-classified awards is determined the same way, except that the fair value of liability-classified awards is remeasured 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.

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


	Three months ended October 31,
	2011	2010
Cost of sales	$ 53,000	122,000
Selling, general and administrative expenses	645,000	1,098,000
Research and development expenses	175,000	288,000
Stock-based compensation expense before income tax benefit	873,000	1,508,000
Income tax benefit	(306,000)	(542,000)
Net stock-based compensation expense	$ 567,000	966,000

Of the total stock-based compensation expense before income tax benefit recognized in the three months ended October 31, 2011 and 2010, $61,000 and $69,000, respectively, relates to stock-based awards issued pursuant to our ESPP.

Included in total stock-based compensation expense before income tax benefit in the three months ended October 31, 2011 and 2010 is an expense of $20,000 and $17,000, respectively, as a result of the required fair value remeasurement of our liability-classified stock appreciation rights ("SARs") at the end of each of the respective reporting periods.

Stock-based compensation that was capitalized and included in ending inventory at both October 31, 2011 and July 31, 2011 was $117,000.

We estimate the fair value of stock-based awards using the Black-Scholes option pricing model. The Black-Scholes option pricing model includes assumptions regarding dividend yield, expected volatility, expected option term and risk-free interest rates. The 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 the employees who receive stock-based awards.

The per share weighted average grant-date fair value of stock-based awards granted during the three months ended October 31, 2011 and 2010 approximated $5.88 and $6.67, respectively. In addition to the exercise and grant-date prices of these awards, we utilized certain weighted average assumptions to estimate the initial fair value of stock-based awards.

Weighted average assumptions related to our stock-based awards are listed in the table below:


	Three months ended October 31,
	2011	2010
Expected dividend yield	4.04%	3.66%
Expected volatility	36.00%	38.00%
Risk-free interest rate	0.88%	1.27%
Expected life (years)	5.42	5.18

Stock-based awards granted have exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of five or ten years and a vesting period of three or five years. We settle employee stock option exercises with new shares. All SARs granted through October 31, 2011 may only be settled with cash. Included in accrued expenses at October 31, 2011 and July 31, 2011 is $42,000 and $22,000, respectively, relating to the potential cash settlement of SARs.

The expected dividend yield is the expected annual dividend as a percentage of the fair market value of the stock on the date of grant. For the stock-based awards granted during the three months ended October 31, 2011 and 2010, the expected dividend yield was equal to our targeted annual dividend of $1.10 per share and $1.00 per share, respectively, divided by the quoted market price of our common stock on the date of the grant. We estimate expected volatility by considering the historical volatility of our stock, the implied volatility of publicly traded call options on our stock, the implied volatility of call options embedded in our 3.0% convertible senior notes and our expectations of volatility for the expected life of stock-based awards. 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 option term. The expected option term is the number of years we estimate that stock-based awards will be outstanding prior to exercise. The expected life of awards issued is determined by employee groups with sufficiently distinct behavior patterns.

The following table provides the components of the actual income tax benefit (shortfall) recognized for tax deductions relating to the exercise of stock-based awards:


	Three months ended October 31,
	2011	2010
Actual income tax benefit recorded for the tax deductions relating to the exercise of stock-based awards	$ 120,000	25,000
Less: Tax benefit initially recognized on exercised stock-based awards vesting subsequent to the adoption of accounting standards that require us to expense stock-based awards, excluding income tax shortfalls	(99,000)	(28,000)
Excess income tax benefit (shortfall) recorded as an increase (decrease) to additional paid-in capital	21,000	(3,000)
Less: Tax benefit initially disclosed but not previously recognized on exercised equity-classified stock-based awards vesting prior to the adoption of accounting standards that require us to expense stock-based awards	(2,000)	-
Excess income tax benefit (shortfall) from exercised equity-classified stock-based awards reported as a cash flow from financing activities in our Condensed Consolidated Statements of Cash Flows	$ 19,000	(3,000)

At October 31, 2011, total remaining unrecognized compensation cost related to unvested stock-based awards was $8,673,000, net of estimated forfeitures of $530,000. The net cost is expected to be recognized over a weighted average period of 3.7 years.

As of October 31, 2011, the amount of hypothetical tax benefits related to stock-based awards was $22,973,000. During the three months ended October 31, 2011 and 2010, we recorded $1,021,000 and $1,033,000, respectively, as a reduction to additional paid-in capital, which represented the reversal of unrealized deferred tax assets associated with certain vested equity-classified stock-based awards that expired during each respective fiscal period.