2. STOCK-BASED COMPENSATION

3 Months Ended

Aug. 31, 2013

Stock-Based Compensation

STOCK-BASED COMPENSATION

 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 10 and 11 in the Company’s Annual Report on Form 10-K for fiscal 2013 filed on August 28, 2013 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, 2013 and 2012 (in thousands):

	Three Months Ended
	August 31,
	2013		2012
Stock-based compensation in the form of employee stock options and ESPP shares, included in:
Cost of sales	$	8	$	13
Selling, general and administrative		104		119
Research and development		31		37
Total stock-based compensation	$	143	$	169

 During the three months ended August 31, 2013 and 2012, the Company recorded stock-based compensation related to stock options of $134,000 and $151,000, respectively.

 As of August 31, 2013, 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 $1,223,000, which is net of estimated forfeitures of $3,000.  This cost will be amortized over the remaining service period of the underlying options.  The weighted average period is approximately 5.5 years.

 During the three months ended August 31, 2013 and 2012, the Company recorded stock-based compensation related to the ESPP of $9,000 and $18,000, respectively.

 As of August 31, 2013, 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 0.7 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 four or 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 value of the Company’s stock options granted to employees for the three months ended August 31, 2013 and 2012 were estimated using the following weighted average assumptions in the Black-Scholes option valuation model:

	Three Months Ended
	August 31,
	2013			2012
Option plan shares
Expected term (in years)		4			5
Volatility		0.95			0.90
Expected dividend	$	0.00		$	0.00
Risk-free interest rates		1.46	%		0.75	%
Estimated forfeiture rate		0.25	%		0.25	%
Weighted average grant date fair value	$	0.92		$	0.88

 There were no ESPP shares granted to employees for the three months ended August 31, 2013 and 2012.

 The following table summarizes the stock option transactions during the three months ended August 31, 2013 (in thousands, except per share data):

				Outstanding Options
								Weighted
					Number			Average		Aggregate
	Available				of			Exercise		Intrinsic
	Shares				Shares			Price		Value
Balances, May 31, 2013		1,737				2,956		$	1.79	$	964
Options granted		(725	)			725		$	1.38
Options terminated		289				(289	)	$	6.99
Plan shares expired		(104	)			--
Options exercised		--				(69	)	$	0.86
Balances, August 31, 2013		1,197				3,323		$	1.27	$	1,301
Options fully vested and expected to vest at August 31, 2013						3,257		$	1.27	$	1,275
Options exercisable at August 31, 2013						1,816		$	1.28	$	769

 The options outstanding and exercisable at August 31, 2013 were in the following exercise price ranges (in thousands, except per share data):

		Options Outstanding at August 31, 2013						Options Exercisable at August 31, 2013
Range of Exercise Prices		Number Outstanding Shares		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Number Exercisable Shares		Weighted Average Remaining Contractual  Life (Years)		Weighted Average Exercise Price		Aggregate Intrinsic Value
	$0.59-$0.97		1,101		3.94	$	0.76		846		3.51	$	0.80
	$1.09-$1.42		1,484		5.59	$	1.28		453		4.53	$	1.28
	$1.55-$1.95		487		3.45	$	1.88		277		2.04	$	1.93
	$2.15-$2.52		251		0.55	$	2.24		240		0.49	$	2.25
	$0.59-$2.52		3,323		4.35	$	1.27		1,816		3.14	$	1.28	$	769

 The total intrinsic value of options exercised during the three months ended August 31, 2013 was $43,000.  The total intrinsic value of options exercised during the three months ended August 31, 2012 was $42,000.  The weighted average remaining contractual life of the options exercisable and expected to be exercisable at August 31, 2013 was 4.35 years.

 Options to purchase 1,816,000 and 1,541,000 shares were exercisable at August 31, 2013 and 2012, respectively.  These exercisable options had weighted average exercise prices of $1.28 and $2.70 as of August 31, 2013 and 2012, respectively.