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.

On August 1, 2017, we adopted ASU 2016-09, which amended several aspects of the accounting for and reporting of our share-based payment transactions, including:

Excess tax benefits and shortfalls - ASU 2016-09 requires that all tax effects related to our share-based awards be recognized in the Condensed Consolidated Statement of Operations. ASU 2016-09 also removes the prior requirement to delay recognition of excess tax benefits until it reduces current taxes payable; instead, we are now required to recognize excess tax benefits as discrete items in the interim period in which they occur, subject to normal valuation allowance considerations. As ASU 2016-09 eliminated the concept of accumulated hypothetical tax benefits, excess tax benefits and shortfalls are no longer recognized in stockholders’ equity. As a result, ASU 2016-09 is expected to result in future volatility of our income tax expense (as the future tax effects of share-based awards will be dependent on the price of our common stock at the time of settlement). Additionally, on a prospective basis, excess income tax benefits from the settlement of share-based awards are presented as a cash inflow from operating activities in our Condensed Consolidated Statement of Cash Flows.

Diluted earnings per share - Prior to the adoption of ASU 2016-09, in addition to considering the amount an employee must pay upon assumed exercise of stock-based awards and the amount of stock-based compensation cost attributed to future services and not yet recognized, when calculating our diluted earnings per share, the assumed proceeds also included the amount of excess tax benefits, if any, that would have been credited to additional paid-in capital assuming exercise of in-the-money stock-based awards. Effective with our adoption of ASU 2016-09, excess tax benefits are to be excluded from the calculation on a prospective basis. As a result, the denominator for our diluted calculations could increase in the future as compared to prior calculations.

Forfeitures - As permitted by ASU 2016-09, we elected to continue to estimate forfeitures of share-based awards.

Statutory Tax Withholding Requirements - ASU 2016-09 now allows us, when net settling share-based awards, to withhold an amount up to the employees’ maximum individual tax rate in the relevant jurisdiction, without resulting in liability classification of the award. To qualify, we must have at least some withholding obligation. This aspect of adopting ASU 2016-09 did not have any material impact on us. However, with respect to cash payments that we make to taxing authorities on behalf of employees for such shares withheld, on a retrospective basis, we are required to present such payments as a cash outflow from financing activities in our Condensed Consolidated Statements of Cash Flows (as opposed to operating activities).

As of April 30, 2018, the aggregate number of shares of common stock which may be issued, pursuant to the Plan, may not exceed 10,362,500. 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 employee purchases under the ESPP with the issuance of new shares of our common stock.

As of April 30, 2018, we had granted stock-based awards pursuant to the Plan representing the right to purchase and/or acquire an aggregate of 8,082,846 shares (net of 3,847,804 expired and canceled awards), of which an aggregate of 5,379,719 have been exercised or settled.

As of April 30, 2018, the following stock-based awards, by award type, were outstanding:



Stock options	1,734,775
Performance shares	278,860
RSUs and restricted stock	421,886
Share units	267,606
Total	2,703,127

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, 2018, we have cumulatively issued 734,569 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,
	2018			2017		2018		2017
Cost of sales	$	55,000		56,000		146,000		162,000
Selling, general and administrative expenses	976,000			862,000		2,584,000		2,591,000
Research and development expenses	73,000			73,000		201,000		227,000
Stock-based compensation expense before income tax benefit	1,104,000			991,000		2,931,000		2,980,000
Estimated income tax benefit	(240,000		)	(349,000	)	(734,000	)	(1,051,000	)
Net stock-based compensation expense	$	864,000		642,000		2,197,000		1,929,000

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, 2018, unrecognized stock-based compensation of $8,088,000, net of estimated forfeitures of $801,000, 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, 2018 and July 31, 2017 was $12,000. There are no liability-classified stock-based awards outstanding as of April 30, 2018 or July 31, 2017.

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



	Three months ended April 30,					Nine months ended April 30,
	2018			2017		2018		2017
Stock options	$	309,000		368,000		845,000		1,000,000
Performance shares	363,000			361,000		846,000		1,227,000
RSUs and restricted stock	376,000			221,000		1,150,000		633,000
ESPP	56,000			41,000		152,000		120,000
Share units	—			—		(62,000	)	—
Stock-based compensation expense before income tax benefit	1,104,000			991,000		2,931,000		2,980,000
Estimated income tax benefit	(240,000		)	(349,000	)	(734,000	)	(1,051,000	)
Net stock-based compensation expense	$	864,000		642,000		2,197,000		1,929,000

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

During the nine months ended April 30, 2018, we recorded a $62,000 net benefit which primarily represents the recoupment of certain share units.

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, 2018 and July 31, 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.

Stock Options

The following table summarizes the Plan's activity during the nine months ended April 30, 2018:



	Awards (in Shares)		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Outstanding at July 31, 2017	1,855,875		$	28.60
Expired/canceled	(41,040	)	28.97
Outstanding at October 31, 2017	1,814,835		28.59
Expired/canceled	(9,350	)	29.02
Outstanding at January 31, 2018	1,805,485		28.59
Expired/canceled	(2,400	)	28.11
Exercised	(68,310	)	27.40
Outstanding at April 30, 2018	1,734,775		$	28.64	4.80	$	4,095,000

Exercisable at April 30, 2018	1,303,808		$	28.64	4.29	$	2,973,000

Vested and expected to vest at April 30, 2018	1,693,769		$	28.61	4.76	$	4,014,000

Stock options outstanding as of April 30, 2018 have exercise prices ranging from $20.90 to $33.94, representing 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 three and nine months ended April 30, 2018 was $225,000. There were no stock options exercised during the nine months ended April 30, 2017. There were no stock options granted during the nine months ended April 30, 2018 and 2017.

During the three and nine months ended April 30, 2018, at the election of certain holders of vested stock options, 63,410 stock options were net settled upon exercise. As a result, 4,937 net shares of our common stock were issued after reduction of shares retained to satisfy the exercise price and minimum statutory tax withholding requirements.

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, 2017	830,197		$	16.95
Granted	307,194		18.25
Settled	(100,321	)	20.67
Forfeited	(61,520	)	18.88
Outstanding at October 31, 2017	975,550		16.86
Settled	(526	)	11.40
Forfeited	(4,311	)	15.26
Outstanding at January 31, 2018	970,713		16.86
Granted	3,212		28.37
Settled	(687	)	11.04
Forfeited	(4,886	)	15.36
Outstanding at April 30, 2018	968,352		$	16.91	$	29,622,000

Vested at April 30, 2018	309,853		$	17.55	$	9,478,000

Vested and expected to vest at April 30, 2018	933,270		$	16.94	$	28,549,000

The total intrinsic value relating to fully-vested awards settled during the three months ended April 30, 2018 was $17,000. There were no fully-vested awards converted into our common stock during the three months ended April 30, 2017. The total intrinsic value relating to fully-vested awards settled during the nine months ended April 30, 2018 and 2017 was $1,964,000 and $633,000, 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, 2018, 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 granted prior to July 31, 2017 were 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. Share units granted on or after July 31, 2017 were granted to certain employees in lieu of fiscal 2017 non-equity incentive compensation and are convertible into shares of our common stock on the one-year anniversary of the grant date. Cumulatively through April 30, 2018, 14,777 share units granted have been settled.

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 and an applicable estimated discount for post vesting restrictions. RSUs, performance shares and restricted stock granted since fiscal 2013 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 since fiscal 2014 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 settlement of the underlying shares into our common stock. During the nine months ended April 30, 2018, we accrued $247,000 of dividend equivalents and paid out $129,000. Accrued dividend equivalents were recorded as a reduction to retained earnings. As of April 30, 2018 and July 31, 2017, accrued dividend equivalents were $672,000 and $554,000, respectively.

We recorded $96,000 of income tax expense in our Condensed Consolidated Statements of Operations for the nine months ended April 30, 2018, which represents net income tax shortfalls from the settlement of stock-based awards and the reversal of deferred tax assets associated with expired and unexercised stock-based awards. During the nine months ended April 30, 2017, net income tax shortfalls from similar items totaled $590,000 and, pursuant to prior GAAP, were recorded as a reduction to additional paid-in capital.