. SHARE-BASED COMPENSATION

Stock Option Plans

December 31, 2017,

the Company had

two

equity incentive plans. The

2005

Equity Incentive Plan (

“2005

Equity Plan”) was terminated with respect to new grants in

March 2015,

but remains in effect for grants issued prior to that time. The

2015

Equity Incentive Plan (

“2015

Equity Plan”) was approved by the Company’s Board of Directors on

December 6, 2016

and by the Company’s stockholders on

March 14, 2017.

The

2015

Equity Plan authorizes for issuance as stock options, restricted stock, stock appreciation rights, restricted stock units and performance awards, an aggregate of

5,000,000

new shares of common stock to employees, directors, advisors or consultants. At

December 31, 2017,

there were options outstanding covering

2,216,002

and

2,279,315

shares of common stock under the

2005

Equity Plan and

2015

Equity Plan, respectively.

Stock Option Activity

The following table summarizes information about stock option activity during the

three

months ended

December 31, 2017:

	Number			Weighted Average
	of Shares			Exercise Price
Outstanding October 1, 2017		4,663,502		$	2.16
Granted		3,500		$	2.21
Forfeited/expired		(80,833	)	$	2.84
Exercised		(90,852	)	$	1.76
Outstanding December 31, 2017		4,495,317		$	2.15
Exercisable December 31, 2017		3,251,811		$	2.24

Options outstanding are exercisable at prices ranging from

$0.

$3.17

and expire over the period from

2018

2024

with an average life of

4.6

years. The aggregate intrinsic value of options outstanding and exercisable at

December 31, 2017

was

$1,780,084

and

$1,368,424,

respectively.

During the quarter ended

December 31, 2016,

the Company incurred non-cash share-based compensation expense of

07,324

resulting from the modification of stock options in accordance with a Separation Agreement and General Release related to the

June 30, 2016

departure of the Company’s prior chief executive officer (“CEO”). As per the agreement, all unvested options became fully vested on

December 31, 2016

and shall remain exercisable for a period of

months following the

December 31, 2016

separation date as defined in the agreement. The expense is measured as the excess of the fair value of the modified awards over the fair value of the original awards immediately before its terms are modified as per ASC

718

35.

Performance-Based Stock Options

August 1, 2016,

the Company awarded a performance-based stock option (PVO) to purchase

750,000

shares of the Company

’s common stock to a key executive, with a contractual term of

seven

years. Vesting is based upon the achievement of certain performance criteria for each of fiscal

2019

and

2020

(

375,000

shares for each year) including minimum free cash flow margin and net revenue targets at

four

different target levels for each of the years.

Additionally, vesting is subject to the executive being employed by the Company at the time the Company achieves such financial targets.

The Company has made the assumption that the lowest performance target level for each of the years will be met, and therefore

187,500

shares of the PVO

are assumed to vest. The weighted average grant date fair value for the PVO was

$0.81

per share, which was estimated on the date of grant using the Black-Scholes option pricing model. Non-cash share-based compensation expense related to this award is recognized on a straight-line basis over the requisite service periods. The Company will continue to review these targets each quarter and will adjust the expected outcome as needed, recognizing compensation expense cumulatively in such period for the difference in expense.

Restricted Stock Units

During the quarter ended

December 31, 2016,

the Board of Directors approved the

grant of

25,000

RSUs to each of our non-employee directors, subject to stockholder approval of the

Amended and Restated

2015

Equity Incentive Plan at the

2017

Annual Meeting of Stockholders. These RSUs were granted as replacements for

20,000

stock options that would have been granted on the date of the

2016

Annual Meeting of Stockholders and vested on the

first

anniversary of the

2016

Annual Meeting of Stockholders, which was

May 17, 2017.

As a result of the stockholders approval of the Amended and Restated

2015

Equity Incentive Plan at the

2017

Annual Meeting of Stockholders on

March 14, 2017,

the RSUs previously granted were made effective at a market value of

$197,500

and were expensed on a straight line basis through the

May 17, 2017

vest date.

March 14, 2017,

the Board of Directors approved an additional grant of

25,000

RSUs to each of our non-employee directors that will vest on the

first

anniversary of the grant date. These were also issued at a market value of

$197,500,

which will be expensed on a straight line basis through the

March 14, 2018

vest date.

Share-Based Compensation

The Company recorded share-based compensation expense and classified it in the condensed consolidated statements of

operations as follows:

	Three months ended
	December 31,
	2017		2016
Cost of revenues	$	6,209	$	5,877
Selling, general and administrative		109,322		435,497
Research and development		22,930		23,375
Total	$	138,461	$	464,749

The employee stock option

s granted in the

three

months ended

December 31, 2017

and

2016

had a weighted-average estimated fair value of

$0.89

per share and

$0.71

per share, respectively, using the Black-Scholes option pricing model with the following weighted-average assumptions (annualized percentages):

	Three months ended
	December 31,
	2017		2016
Volatility		45.4%	52.4%	-	53.7%
Risk-free interest rate		2.2%	1.7%	-	2.0%
Forfeiture rate		10.0%		10. 0%
Dividend yield		0.0%		0. 0%
Expected life in years		4.6	3.8	-	4.6

The Company

did

not

declare a dividend for the quarters ended

December 31, 2017

and

2016.

Expected volatility is based on the historical volatility of the Company’s common stock over the period commensurate with the expected life of the options. The risk-free interest rate is based on rates published by the Federal Reserve Board. The expected life is based on observed and expected time to post-vesting exercise. The expected forfeiture rate is based on past experience and employee retention data. Forfeitures are estimated at the time of the grant and revised in subsequent periods if actual forfeitures differ from those estimates or if the Company updates its estimated forfeiture rate. Such amounts will be recorded as a cumulative adjustment in the period in which the estimate is changed.

Since the Company has a

net operating loss carryforward as of

December 31, 2017,

excess tax benefit for the tax deductions related to share-based awards was recognized for the

three

months ended

December 31, 2017

and

2016.

As of

December 31, 2017,

there was approximately

$600,000

of total unrecognized compensation cost related to non-vested share-based employee compensation arrangements. The cost is expected to be recognized over a weighted-average period of

2.1

years.