12. Share-based Compensation

The following table presents share-based compensation expense included in our condensed consolidated statements of operations:


	For the Three Months Ended October 31
(in millions)	2013			2012
Cost of product sales	$	0.2		$	0.2
Cost of engineering sales		0.1			0.4
Research and product development		0.6			0.3
Selling and marketing		0.3			0.3
General and administrative		1.5			1.4
Total share-based compensation expense before tax		2.7			2.6
Income tax effect		(0.9	)		(0.8	)
Share-based compensation expense included in net (loss) income	$	1.8		$	1.8

We recognize compensation expense on performance-based restricted stock grants with earnings per share (“EPS”)-related and total shareholder return (“TSR”)-related conditions along with time-based stock options and restricted stock award conditions. The following table summarizes share-based compensation expense associated with each of our share-based compensation programs:


	For the Three Months Ended October 31
(in millions)	2013			2012
Peformance-based EPS related condition compensation expense	$	0.5		$	1.1
Performance-based TSR related condition compensation expense		0.6			0.7
Total performance-based stock compensation expense		1.1			1.8
Time-based stock options and restricted stock		1.6			0.8
Total share-based compensation expense before tax		2.7			2.6
Income tax effect		(0.9	)		(0.8	)
Total share-based compensation included in net (loss) income	$	1.8		$	1.8

Stock options

We estimate the fair value of stock options using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of stock options include the exercise price of the award, the expected option term, the expected volatility of our stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and our expected annual dividend yield. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

During the three months ended October 31, 2013 and 2012, we granted 107,767 and 97,300 non-qualified stock options, respectively. The fair value of each option grant was estimated on the grant date using the Black-Scholes valuation model with the following assumptions:


	For the Three Months Ended
	October 31
	2013			2012
Expected option term (1)		5.37 years			5.42 years
Expected volatility (2)		38.6	%		41.0	%
Risk-free interest rate (3)		1.77	%		0.78	%
Expected annual dividend yield (4)		0.52	%		0.57	%
Weighted average grant date fair value	$	27.54		$	24.77

(1)	The expected option term factor was estimated using historical data.

(2)	The expected volatility factor for each grant is determined based on the review of the average of historical daily price changes of our common stock over the most recent expected option term.

(3)	The risk free interest rate for periods equal to the expected term of the stock option is based on the U.S. Treasury yield curve in effect at the time of grant.

(4)	The expected annual dividend yield is calculated by dividing the expected annual dividends by the stock price on the date of grant.

Restricted stock

We estimate the fair value of restricted stock and restricted stock units that vest based on time by the quoted market price of our common stock on the date of grant. We estimate the fair value of performance-based restricted stock and restricted stock units with market conditions based on the use of a Monte-Carlo simulation model. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

Stock compensation expense is amortized over each award’s vesting period on a straight-line basis for all awards with service conditions, while the graded vesting method applies to all awards with both service and performance conditions.

For awards with an EPS-related condition, we recognize compensation expense over the performance period, net of estimated forfeitures, based on the number of shares that are deemed probable of vesting at the end of the three-year performance cycle. This probability assessment is performed each quarter and changes in estimates can result in significant expense fluctuations due to the cumulative catch-up adjustment.

For awards with a TSR-related condition, we recognize compensation expense on a straight-line basis, net of estimated forfeitures, over an average derived service period of 2.8 years for the awards granted in fiscal years 2014, 2013, and 2012. The total compensation expense for awards with a TSR-related condition is not contingent on the performance outcome. The weighted average grant date fair values of restricted stock units granted with a TSR-related condition was $115.45 and $106.36 per share for the three months ended October 31, 2013 and 2012, respectively.

At October 31, 2013 and 2012, we had 189,039 and 326,585 target performance contingent restricted stock units outstanding, respectively. These awards vest if specific pre-established levels of performance have been achieved at the end of a three-year performance cycle. The three-year performance cycles for restricted stock units outstanding at October 31, 2013 end on July 31, 2014, 2015, and 2016. The three-year performance cycles for restricted stock units outstanding at October 31, 2012 ended or will end on July 31, 2013, 2014, and 2015. The actual number of shares/units to be issued will be determined at the end of the three-year performance cycle and can range from zero to 200% of the target award. We grant performance restricted stock units with either an EPS-related performance condition or a TSR-related performance condition as determined against a specified peer group condition. During the three months ended October 31, 2013, we granted 35,562 performance restricted stock units with an EPS-related performance condition and 27,355 performance restricted stock units with a TSR-related performance condition. As of October 31, 2013, of the 189,039 restricted stock units outstanding, 102,182 had an EPS-related performance condition and 86,857 had a TSR-related performance condition.

The fair value of the restricted stock units with a TSR-related condition at date of grant was estimated using the Monte-Carlo simulation model with the following assumptions:


	For the Three Months Ended October 31
	2013			2012
Stock Price (1)	$	77.08		$	70.04
Expected volatility (2)		27.6	%		28.0	%
Risk-free interest rate (3)		0.82	%		0.32	%
Expected annual dividend yield (4)		0.00	%		0.00	%

(1)	The stock price is the closing price of our common stock on the date of grant.

(2)	The expected volatility factor for each grant is determined based on the historical volatility for the peer group companies and our common stock over a period equal to the remaining term of the performance period from the date of grant for all awards.

(3)	The risk free interest rate for periods equal to the performance period is based on the U.S. Treasury yield curve in effect at the time of grant.

(4)	Dividends are considered reinvested when calculating TSR. For the purpose of the fair value model, the dividend yield is therefore considered to be 0%.

Employee Stock Purchase Plan (“ESPP”)

We estimate the fair value of ESPP shares using the Black-Scholes valuation model. For the three months ended October 31, 2013 and 2012, the financial impact from ESPP shares was minimal.