Note 2 - STOCK-BASED COMPENSATION

3 Months Ended

Aug. 31, 2011

Notes to Financial Statements

STOCK-BASED COMPENSATION

Note 2 - Stock-based compensation

Stock-based compensation expense consists of expenses for stock options and employee stock purchase plan, or ESPP, shares. Stock-based compensation cost is measured at each grant date, based on the fair value of the award using the Black-Scholes option valuation model, and is recognized as expense over the employee’s requisite service period. This model was developed for use in estimating the value of publicly traded options that have no vesting restrictions and are fully transferable. The Company’s employee stock options have characteristics significantly different from those of publicly traded options. All of the Company’s stock based compensation is accounted for as an equity instrument. See Notes 8 and 9 in the Company’s Annual Report on Form 10-K for fiscal 2011 filed on August 26, 2011 for further information regarding the stock option plan and the ESPP.

The following table summarizes compensation costs related to the Company’s stock-based compensation for the three months ended August 31, 2011 and 2010, respectively (in thousands):

	Three Months Ended
	August 31,
	2011		2010
Stock-based compensation in the form of employee
stock options and ESPP shares, included in:
Cost of sales	$	19	$	32
Selling, general and administrative		93		143
Research and development		53		99
Total stock-based compensation	$	165	$	274

During the three months ended August 31, 2011 and 2010, the Company recorded stock-based compensation related to stock options of $155,000 and $223,000, respectively.

As of August 31, 2011, the total unrecognized stock-based compensation cost related to unvested stock-based awards under the Company’s 1996 Stock Option Plan and 2006 Equity Incentive Plan was approximately $963,000, which is net of estimated forfeitures of $2,000. This cost will be amortized over the remaining service period of the underlying options. The weighted average period is approximately 3.2 years.

During the three months ended August 31, 2011 and 2010, the Company recorded stock-based compensation related to the ESPP of $10,000 and $51,000, respectively.

As of August 31, 2011, the total compensation cost related to options to purchase the Company’s common stock under the ESPP but not yet recognized was approximately $8,000. This cost will be amortized on a straight-line basis over a weighted average period of approximately 0.5 years.

Valuation Assumptions

Valuation and Amortization Method. The Company estimates the fair value of stock options granted using the Black-Scholes option valuation model and a single option award approach. The fair value under the single option approach is amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.

Expected Term. The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on historical experience, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as evidenced by changes to the terms of its stock-based awards.

Expected Volatility. Volatility is a measure of the amounts by which a financial variable such as stock price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company uses the historical volatility for the past five years, which matches the expected term of most of the option grants, to estimate expected volatility. Volatility for each of the ESPP’s four time periods of six months, twelve months, eighteen months, and twenty-four months is calculated separately and included in the overall stock-based compensation cost recorded.

Dividends. The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model.

Risk-Free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes option valuation model on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with a remaining term equivalent to the expected term of the stock awards including the ESPP.

Estimated Forfeitures. When estimating forfeitures, the Company considers voluntary termination behavior as well as analysis of actual option forfeitures.

Fair Value. The fair values of the Company’s stock options granted to employees for the three months ended August 31, 2011 and 2010 were estimated using the following weighted average assumptions in the Black-Scholes option valuation model.

	Three Months Ended
	August 31,
	2011			2010
Option Plan Shares
Expected Term (in years)		5			5
Volatility		0.80			0.80
Expected Dividend	$	0.00		$	0.00
Risk-free Interest Rates		1.57	%		1.78	%
Estimated Forfeiture Rate		0.25	%		0.25	%
Weighted Average Grant Date Fair Value	$	0.80		$	1.25

There were no ESPP shares granted to employees for the three months ended August 31, 2011 and 2010.

The following table summarizes the stock option transactions during the three months ended August 31, 2011 (in thousands, except per share data):

	Outstanding Options
			Weighted
		Number	Average	Aggregate
	Available	of	Exercise	Intrinsic
	Shares	Shares	Price	Value
Balances, May 31, 2011	687	2,083	$3.40	$298
Options granted	(432)	432	$1.27
Options terminated	140	(140)	$3.70
Plan shares expired	(136)
Balances, August 31, 2011	259	2,375	$2.99	$123
Options fully vested and expected to
vest at August 31, 2011		2,328	$2.99	$120
Options exercisable at August 31, 2011		1,547	$3.59	$123

The options outstanding and exercisable at August 31, 2011 were in the following exercise price ranges (in thousands, except per share data):

	Options Outstanding						Options Exercisable
	at August 31, 2011						at August 31, 2011
			Weighted								Weighted
			Average		Weighted				Weighted		Average
Range of	Number		Remaining		Average		Number		Average		Remaining		Aggregate
Exercise	Outstanding		Contractual		Exercise		Exercisable		Exercise		Contractual		Intrinsic
Prices	Shares		Life(Years)		Price		Shares		Price		Life(Years)		Value
$0.85-$0.85		454		2.83	$	0.85		454	$	0.85		2.83
$1.25-$2.81		1,296		4.15	$	1.83		496	$	2.20		2.49
$2.84-$5.96		272		0.81	$	5.02		272	$	5.02		0.81
$6.00-$9.30		231		1.38	$	7.66		228	$	7.67		1.38
$9.94-$9.94		122		1.81	$	9.94		97	$	9.94		1.81
$0.85-$9.94		2,375		3.12	$	2.99		1,547	$	3.59		2.09	$	123

There were no stock options exercised for the three months ended August 31, 2011. The total intrinsic value of options exercised was $1,000 during the three months ended August 31, 2010. The weighted average contractual life of the options exercisable and expected to be exercisable at August 31, 2011 was 3.12 years.

Options to purchase 1,547,000 and 1,393,000 shares were exercisable at August 31, 2011 and 2010, respectively. These exercisable options had weighted average exercise prices of $3.59 and $4.16 as of August 31, 2011 and 2010, respectively.