(3)Stock-Based Compensation and Stock Options

The MGC Diagnostics Corporation 2007 Stock Incentive Plan (the “2007 Plan”) and the MGC Diagnostics Corporation 2002 Stock Option Plan (the “2002 Plan”) both provide that incentive stock options and nonqualified stock options to purchase shares of common stock may be granted at prices determined by the Compensation Committee, except that the purchase price of incentive stock options may not be less than the fair market value of the stock at date of grant. Under the 2007 Plan, options generally expire no later than seven years from the grant date while under the 2002 Plan all options expire no later than ten years from the grant date. Options under both plans are subject to various vesting schedules. In addition, the 2007 Plan allows the granting of restricted stock awards, stock appreciation rights and performance stock.

Total stock-based compensation expense included in the Company’s statements of comprehensive income (loss) for the three months ended July 31, 2013 and 2012 was $98,000 and $86,000, respectively, and for the nine months ended July 31, 2013 and 2012 was $332,000 and $269,000, respectively.

Stock Options

A summary of the Company’s stock activity for the nine-month periods ended July 31, 2013 and 2012 is presented in the following table:



	For the Nine Months ended
	July 31, 2013			July 31, 2012
		Weighted			Weighted
		Average			Average
		Exercise			Exercise
	Shares	Price		Shares	Price
Outstanding at beginning of period	286,072	$	6.57	346,572	$	6.31
Granted	5,900		6.76	—		—
Exercised	(83,700)		5.80	(27,500)		3.52
Expired or cancelled	(18,252)		6.67	(30,500)		6.43
Outstanding at end of period	190,020	$	6.91	288,572	$	6.57

The following table summarizes information concerning stock options outstanding as of July 31, 2013:



		Weighted
		Average
		Remaining	Number
	Number	Contractual	Subject to
Exercise Prices	Outstanding	Life	Exercise
$2.00	1,150	0.18	1,150
5.08	9,000	2.82	9,000
5.16	30,250	2.07	30,250
6.23	24,500	0.79	24,500
6.60	14,160	1.06	14,160
6.76	5,900	9.29	—
7.79	41,500	0.18	41,500
7.86	63,560	1.25	63,560
Total	190,020	1.39	184,120

The total intrinsic value of options exercised during the three-month periods ended July 31, 2013 and 2012 was $14,000 and $1,000, respectively. The total intrinsic value of options exercised during the nine-month periods ended July 31, 2013 and 2012 was $131,000 and $54,000, respectively. The total intrinsic value of options outstanding and exercisable as of July 31, 2013 was $253,000 and $244,000, respectively, which was calculated using the closing stock price at the end of the third quarter less the option price of in-the-money options. The Company issues new shares when stock options are exercised. The Company received $485,000 and $97,000 of cash from the exercise of stock options for the nine-month periods ended July 31, 2013 and 2012, respectively. Unrecognized compensation expense related to outstanding stock options as of July 31, 2013 was $24,000 and is expected to be recognized over a weighted average period of 2.28 years.

Valuation Assumptions

The Company uses the Black-Scholes option-pricing model (“Black-Scholes model”) to determine the fair value of stock options as of the grant date. The fair value of stock options under the Black-Scholes model requires management to make assumptions regarding projected employee stock option exercise behaviors, risk-free interest rates, volatility of the Company’s stock price and expected dividends. The expense recognized for options granted under the 2002 Plan and 2007 Plan is equal to the fair value of stock options as of the grant date. The following table provides the weighted average fair value of options granted to employees and the related assumptions used in the Black-Scholes model for

stock option grants made during the nine months ended July 31, 2013:



	Options Granted
	November 12, 2012
Weighted average fair value of options granted	$5.33
Assumptions used:
Expected life (years)	8.30
Risk-free interest rate	0.71%
Volatility	77.72%
Dividend Yield	0.00%

a)	Expected life: For employee grants, the expected term of options granted is determined using historical data, the contractual terms of the options granted and other factors.

b)	Risk-free interest rate: The rate is based on the U.S. Treasury zero-coupon yield curve on the grant date for a maturity similar to the expected life of the options.

c)	Volatility: The expected volatility of the Company’s common stock is calculated by using the historical daily volatility of the Company’s stock price calculated over a period of time representative of the expected life of the options.

d)	Dividend yield: The dividend yield rate is not considered in the model, as the Company has not established a dividend policy for the stock and, other than the one-time special dividend the Company paid in April 2013, the Company has not historically paid any dividends.

Restricted Stock Awards

Restricted stock awards are awards of common stock that are subject to restrictions on transfer and to a risk of forfeiture if the holder leaves the Company before the restrictions lapse. The holder of a restricted stock award is generally entitled at all times on and after the date of issuance of the restricted shares to exercise the rights of a shareholder of the Company, including the right to vote the shares. The value of stock awards that vest over time was established by the market price on the date of its grant. A summary of the Company’s restricted stock activity for the nine-month periods ended July 31, 2013 and 2012 is presented in the following table:



	For the Nine Months ended
	July 31, 2013			July 31, 2012
		Weighted			Weighted
		Average			Average
		Grant Date			Grant Date
	Shares	Fair Value		Shares	Fair Value
Unvested at beginning of period	101,071	$	5.23	126,852	$	4.12
Granted	40,595		6.28	67,914		5.51
Vested	(49,505)		5.44	(78,229)		3.98
Forfeited	(17,667)		4.66	(6,666)		2.62
Unvested at end of period	74,494	$	5.79	109,871	$	5.17

Unrecognized compensation expense related to outstanding restricted stock awards to employees and directors as of July 31, 2013 was $340,000 and is expected to be recognized over a weighted average period of 1.42 years.

Performance Share Awards

Within his employment offer, the Company’s Chief Executive Officer has the ability to earn share awards equal to one-third of his base compensation subject to agreed operating performance criteria. On December 18, 2012, the Company’s chief executive officer was awarded 20,833 shares of Company common shares to be delivered if the Company meets specific fiscal 2013 financial targets and the officer meets certain performance objectives. The officer is not entitled to rights of ownership and shares are not regarded as outstanding until delivered. These shares are valued at $117,000, with $(9,000) and $43,000 recognized as a (benefit) expense in the three- and nine-month periods ended July 31, 2013, leaving up to $74,000 that may be amortized in the remaining quarter of fiscal 2013. For the three- and nine-month periods ended July 31, 2012, the Company made no provision for expense related to performance share grants, as it was not probable that the shares would be awarded based on expected prior year results.

The Company has also issued performance share awards to non-employee consultants. These awards are an obligation within a consulting arrangement that does not grant any ownership rights until the shares are issued. The value of stock awards to non-employees remains variable until performance criteria have been achieved, when individual share groups to be granted vest, establishing the value of each group over the dates that its related performance criteria was completed. Under variable accounting, amounts are expensed in relation to the shares expected to be granted over the performance period, with value of those whose performance criteria has been met at the market value on the date earned and value of all others marked to market as of the reporting date. As of July 31, 2013, of the 19,064 shares available to be issued, 10,644 shares were estimated as earned with an aggregate market value fixed at $79,000. Expense (benefit) under this agreement for the three-month periods ended July 31, 2013 and 2012 was $25,000 and $(1,000), respectively and for the nine-month periods ending July 31, 2013 and 2012 was $40,000 and $14,000, respectively.

Employee Stock Purchase Plan

The MGC Diagnostics Corporation 2003 Employee Stock Purchase Plan, as amended July 1, 2012 to increase shares available for sale by 100,000 shares, (“Purchase Plan”) allows participating employees to purchase up to 200,000 shares of the Company’s common stock at a discount through payroll deductions. The Purchase Plan is available to all employees subject to certain eligibility requirements. Under the Purchase Plan participating employees may purchase the Company’s common stock on a voluntary after tax basis. Employees may currently purchase the Company’s common stock at a price that is the lower of 85% of the fair market value of one share of common stock at the beginning or end of each stock purchase period or phase. The Stock Plan is carried out in six-month phases, with phases beginning on January 1 and July 1 of each calendar year. For the phases that ended on December 31, 2012 and June 30, 2013, employees purchased 13,884 shares at a price of $4.85 per share and 12,195 shares at a price of $5.01 per share, respectively. As of July 31, 2013, the Company has withheld approximately $11,000 from employees participating in the phase that began on July 1, 2013. As of July 31, 2013, 112,310 shares of common stock were available for future purchase under the Purchase Plan.

The following table presents the statements of comprehensive income (loss) classification of pre-tax stock-based compensation expense recognized for the three- and nine-month periods ended July 31, 2013 and 2012:



	Three Months ended July 31,				Nine Months ended July 31,
(In thousands)	2013		2012		2013		2012
Cost of revenues	$	2	$	1	$	5	$	3
Selling and marketing		17		14		49		29
General and administrative		78		63		274		211
Research and development		1		8		4		26
Stock-based compensation expense	$	98	$	86	$	332	$	269

The table above includes benefits reclassified to discontinued operations from selling and marketing totaling $0 and $(4,000) for the three- and nine-month periods ended July 31, 2012, respectively.

Tax Impact of Stock-Based Compensation

The Company reports the benefits of tax deductions in excess of recognized stock-based compensation expense on the consolidated statement of cash flows as financing cash flows. For the nine-month periods ended July 31, 2013 and 2012, there were no excess tax benefits.