2. STOCK-BASED COMPENSATION

9 Months Ended

Feb. 28, 2014

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 and nine months ended February 28, 2014 and 2013 (in thousands):

	Three Months Ended				Nine Months Ended
	February 28,				February 28,
	2014		2013		2014		2013
Stock-based compensation in the form of employee stock options and ESPP shares, included in:
Cost of sales	$	10	$	9	$	33	$	26
Selling, general and administrative		184		159		471		315
Research and development		41		33		121		86
Total stock-based compensation	$	235	$	201	$	625	$	427

There was no stock-based compensation costs capitalized as part of inventory at February 28, 2014.  As of February 28, 2013, stock-based compensation costs of $25,000 were capitalized as part of inventory.

During the three months ended February 28, 2014 and 2013, the Company recorded stock-based compensation related to stock options of $205,000 and $189,000, respectively.  During the nine months ended February 28, 2014 and 2013, the Company recorded stock-based compensation related to stock options of $533,000 and $381,000, respectively.

As of February 28, 2014, 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 $1,013,000, 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 service period is approximately 2.6 years.

During the three months ended February 28, 2014 and 2013, the Company recorded stock-based compensation related to the ESPP of $30,000 and $12,000, respectively.  During the nine months ended February 28, 2014 and 2013, the Company recorded stock-based compensation related to the ESPP of $92,000 and $46,000, respectively.

As of February 28, 2014, the total compensation cost related to options to purchase the Company’s common stock under the ESPP but not yet recognized was approximately $137,000.  This cost will be amortized on a straight-line basis over a weighted average service period of approximately 1.1 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 February 28, 2013, and the nine months ended February 28, 2014 and 2013 were estimated using the following weighted average assumptions in the Black-Scholes option valuation model:

	Three Months Ended			Nine Months Ended
	February 28,			February 28,
	2013			2014			2013
Option plan shares
Expected term (in years)		5			4			5
Volatility		0.94			0.95			0.91
Expected dividend		$0.00			$0.00			$0.00
Risk-free interest rates		0.76	%		1.40	%		0.72	%
Estimated forfeiture rate		0.25	%		0.25	%		0.25	%
Weighted average grant date fair value		$0.62			$1.03			$0.78

There were no options granted during the three months ended February 28, 2014.

The fair values of the ESPP purchase rights granted for the nine months ended February 28, 2014 were estimated using the following weighted-average assumptions:

	Nine Months Ended
	February 28,2014
Employee stock purchase plan purchase rights
Expected term (in years)		0.5-2.0
Volatility		0.86-1.00
Expected dividend	$	0.00
Risk-free interest rates		0.04%-0.33	%
Estimated forfeiture rate		0	%
Weighted average grant date fair value	$	1.34

There were no ESPP purchase rights granted during the three months ended February 28, 2014 and 2013, and the nine months ended February 28, 2013.  There were no ESPP shares issued during the three months ended February 28, 2014 and 2013.  Total ESPP shares issued during the nine months ended February 28, 2014 and 2013 were 75,000 shares and 79,000 shares, respectively.  As of February 28, 2014 there were 400,000 ESPP shares available for issuance.

The following table summarizes the stock option transactions during the three and nine months ended February 28, 2014 (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 granted		(107	)			107		$	2.68
Options terminated		131				(131	)	$	2.26
Options exercised		--				(149	)	$	1.71
Balances, November 30, 2013		1,221				3,150		$	1.25	$	4,968
Options granted		--				--
Options terminated		--				--
Options exercised		--				(85	)	$	0.93
Balances, February 28, 2014		1,221				3,065		$	1.26	$	3,370
Options fully vested and expected to vest at February 28, 2014						3,004		$	1.26	$	3,303
Options exercisable at February 28, 2014						1,852		$	1.21	$	2,051

The options outstanding and exercisable at February 28, 2014 were in the following exercise price ranges (in thousands, except per share data): 

		Options Outstanding						Options Exercisable
		at February 28, 2014						at February 28, 2014
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		1,000		3.76	$	0.75		804		3.50	$	0.79
$	1.09-$1.42		1,442		5.11	$	1.28		585		4.37	$	1.29
$	1.73-$1.95		461		3.05	$	1.88		361		2.47	$	1.91
$	2.15-$2.68		162		4.83	$	2.50		102		4.00	$	1.57
$	0.59-$2.68		3,065		4.35	$	1.26		1,852		3.60	$	1.21	$ 2,051

The total intrinsic value of options exercised during the three and nine months ended February 28, 2014 was $162,000 and $315,000, respectively.  The total intrinsic value of options exercised during the three and nine months ended February 28, 2013 was $0 and $42,000, respectively.  The weighted average remaining contractual life of the options exercisable and expected to be exercisable at February 28, 2014 was 4.35 years.