STOCK OPTION PLAN, STOCK-BASED COMPENSATION

In May 2007, the Board of Directors approved the 2007 Equity Incentive Plan (the “2007 Plan”). The 2007 Plan provides for the award of options to purchase up to 2,000,000 shares of common stock, appreciation rights and restricted stock awards.

In November 2010, the shareholders approved the 2010 Incentive Plan (the “2010 Plan”). The 2010 Plan provides for the award of options to purchase up to 4,000,000 shares of common stock, appreciation rights and restricted stock and performance awards.

Under the 2007 and 2010 Plans, the stock option price per share for options granted is determined by the Board of Directors and is based on the market price of the Company’s common stock on the date of grant, and each option is exercisable within the period and in the increments as determined by the Board, except that no option can be exercised later than ten years from the grant date. The stock options generally vest in one to five years.

The Company measures and recognizes compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. We also estimate the fair value of the award that is ultimately expected to vest to be recognized as expense over the requisite service periods in our Consolidated Statements of Operations.

We estimate the fair value of share-based payment awards to employees and directors on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s Consolidated Statements of Operations. Share-based compensation expense recognized in the Consolidated Statements of Operations for the years ended June 30, 2012, 2013 and 2014 included compensation expense for the share-based payment awards based on the grant date fair value. For stock-based awards issued to employees and directors, share-based compensation is attributed to expense using the straight-line single option method. As stock-based compensation expense recognized in the Consolidated Statements of Operations for the periods reported in this Form 10-K is based on awards expected to vest, forfeitures are also estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. For the periods being reported in this Form 10-K, expected forfeitures are immaterial. The Company will re-assess the impact of forfeitures if actual forfeitures increase in future quarters. Share-based compensation expense related to employee or director stock options recognized for the years ended June 30, 2012, 2013 and 2014 were $294,000, $222,000 and $272,000, respectively.

The Company’s determination of fair value of share-based payment awards to employees and directors on the date of grant uses the Black-Scholes model, which is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the expected term of the awards, and actual and projected employee stock options exercise behaviors. The Company estimates expected volatility using historical data. The expected term is estimated using the “safe harbor” provisions provided by the SEC.

During the fiscal years ended June 30, 2012, 2013 and 2014, the Company granted awards of stock options as follows:

	2012		2013		2014
Stock option awards		277,000		863,100		610,600
Weighted average Exercise price	$	0.96	$	0.81	$	0.50

As of June 30, 2014, there were options outstanding to acquire 2,657,348 shares at an average exercise price of $0.83 per share. The estimated fair value of all awards granted during the years ended June 30, 2012, 2013 and 2014 were $158,000, $500,000 and $240,000, respectively. The fair value of each option was estimated on the date of grant using the Black-Scholes option–pricing model with the following weighted average assumptions:

	2012			2013			2014
Risk-free interest rate		1.11	%		0.87	%		1.53	%
Expected term (years)		5.0			5.0			5.0
Volatility		64	%		95	%		108	%
Expected annual dividends		-			-			-

The following table summarizes the status of the 2007 and 2010 Plans as of June 30, 2014:

	2007 Plan		2010 Plan		Total
Options originally available		2,000,000		4,000,000		6,000,000
Stock options outstanding		1,699,073		958,275		2,657,348
Options available for grant		268,762		3,038,150		3,306,912

Transactions involving stock options are summarized as follows:

	Number of Shares		Weighted Average Exercise Price		Weighted Average Grant Date Fair Value

Balance at June 30, 2011		2,233,475	$	1.36	$	0.65
Granted		277,000	$	0.96	$	0.57
Exercised		-	$	-	$	-
Cancelled		(17,350)	$	1.51	$	0.70

Balance at June 30, 2012		2,493,125	$	1.32	$	0.64
Granted		863,100	$	0.81	$	0.58
Exercised		-	$	-	$	-
Cancelled		(942,700)	$	1.79	$	0.85

Balance at June 30, 2013		2,413,525	$	0.95	$	0.53
Granted		610,600	$	0.50	$	0.40
Exercised		(23,740)	$	0.85	$	0.52
Cancelled		(343,037)	$	0.95	$	0.44

Balance at June 30, 2014		2,657,348	$	0.83	$	0.52

As of June 30, 2014, the total compensation costs related to non-vested awards yet to be expensed was approximately $0.6 million, and this amount is expected to be fully amortized over the next four years.

The weighted average exercise prices for options granted and exercisable and the weighted average remaining contractual life for options outstanding as of June 30, 2012, 2013 and 2014 were as follows:

	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)		Intrinsic Value

As of June 30, 2012
Employees – Outstanding		2,258,125	$	1.32		2.28	$	-
Employees – Expected to Vest		833,518	$	1.32		2.28	$	-
Employees – Exercisable		1,331,994	$	1.54		1.34	$	-
Non-Employees – Outstanding		235,000	$	1.30		1.95	$	-
Non-Employees – Vested		223,750	$	1.44		1.88	$	-
Non-Employees – Exercisable		223,750	$	1.44		1.88	$	-

As of June 30, 2013
Employees – Outstanding		2,248,525	$	0.94		3.13	$	475,236
Employees – Expected to Vest		2,023,673	$	0.94		3.13	$	427,712
Employees – Exercisable		845,275	$	1.08		1.85	$	101,882

Non-Employees – Outstanding		165,000	$	1.10		2.37	$	6,600
Non-Employees – Vested		157,500	$	1.10		2.38	$	6,600
Non-Employees – Exercisable		157,500	$	1.10		2.38	$	6,600

As of June 30, 2014
Employees – Outstanding		2,514,848	$	0.82		2.93	$	-
Employees – Expected to Vest		2,263,363	$	0.82		2.93	$	-
Employees – Exercisable		1,068,411	$	0.97		1.86	$	-

Non-Employees-Outstanding		142,500	$	0.96		2.47	$	-
Non-Employees-Vested		123,750	$	0.99		2.28	$	-
Non-Employees-Exercisable		123,750	$	0.99		2.28	$	-

The aggregate intrinsic value in the table above is the sum of the amounts by which the quoted market price of our common stock exceeded the exercise price of the options at June 30, 2014, for those options for which the quoted market price was in excess of the exercise price.

Additional information with respect to outstanding options as of June 30, 2014 is as follows:

Options Outstanding					Options Exercisable
Options Exercise Price Range		Number of Shares		Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number of Shares		Weighted Average Remaining Contractual Life
$	1.29		298,600	0.62 years	$	1.29		298,600	0.62 years
$	1.27		15,000	1.20 years	$	1.27		11,250	1.20 years
$	1.15		22,500	1.39 years	$	1.15		22,500	1.39 years
$	1.07		22,500	2.42 years	$	1.07		22,500	2.42 years
$	1.05		22,500	0.39 years	$	1.05		22,500	0.39 years
$	0.95		237,375	2.71 years	$	0.95		119,713	2.71 years
$	0.86		520,735	1.61 years	$	0.86		387,198	1.61 years
$	0.81		823,638	3.61 years	$	0.81		206,650	3.61 years
$	0.80		22,500	3.36 years	$	0.80		22,500	3.36 years
$	0.75		75,000	1.87 years	$	0.75		56,250	1.87 years
$	0.74		22,500	4.36 years	$	0.74		22,500	4.36 years
$	0.64		15,000	4.37 years	$	0.64		-	4.37 years
$	0.50		559,500	4.61 years	$	0.50		-	4.61 years

In addition, the Company issued 10,000 shares of restricted stock from the 2007 Plan during fiscal year ended June 30, 2010 with a weighted average fair value of $0.58 per share.

We use the detailed method provided in ASC 718 for calculating the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of ASC 718.