(10)Shareholders’ Equity

Stock Options, Restricted Stock Awards and Other Stock-based Compensation

Under the MGC Diagnostics Corporation 2002 Stock Option Plan (the “2002 Plan”), the Company had reserved 800,000 shares of its common stock for issuance upon exercise of stock options. As of October 31, 2015, options for 800,000 shares had been granted, 636,045 shares had been issued upon exercise of options, 163,955 had been cancelled or forfeited and no options to purchase shares were outstanding. No future shares will be issued under the 2002 Plan.

At a Special Meeting of Shareholders held on August 22, 2007, the shareholders approved the MGC Diagnostics Corporation 2007 Stock Incentive Plan (the “2007 Plan”) and reserved 250,000 shares of its common stock for issuance under the 2007 Plan. The 2007 Plan has been amended several times and currently authorizes the issuance of up to 850,000 shares under various incentive forms. As of October 31, 2015, stock options for 177,900 shares were outstanding, 81,157 shares had been issued upon exercise of stock options, 364,363 shares had been issued pursuant to fully vested restricted stock awards, 10,221 shares had been issued as performance share awards, 12,807 shares were issued in lieu of Director regular cash retainer fees, 49,993 shares were subject to unvested restricted stock awards and 153,559 shares were available for future grant in some form. Under the terms of the 2007 Plan, as amended, up to 850,000 shares may be issued pursuant to incentive stock awards, up to 550,000 may be issued as incentives for non-employee directors and up to 500,000 may be issued pursuant to restricted stock grants. As of October 31, 2015, these sub-limits permit a maximum of 85,644 additional restricted stock awards to be issued.

The 2007 Plan provides 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 the date of grant. Options under both plans are subject to vesting schedules established on the date of grant. 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) was $496,000 and $441,000 for the years ended October 31, 2015 and 2014, respectively.

Stock Options

A summary of the Company’s stock option activity for the years ended October 31, 2015 and 2014 is presented in the following table:



	For the Year ended
	October 31, 2015			October 31, 2014
		Weighted			Weighted
		Average			Average
		Exercise			Exercise
	Shares	Price		Shares	Price
Outstanding at beginning of period	52,650	$	7.01	110,370	$	6.83
Granted	150,000		6.07	22,500		9.12
Exercised	(11,137)		5.13	(865)		6.60
Expired or cancelled	(13,613)		5.16	(79,355)		7.37
Outstanding at end of period	177,900	$	6.48	52,650	$	7.01

The following table summarizes information concerning stock options outstanding as of October 31, 2015:



		Weighted
		Average
		Remaining	Number
	Number	Contractual	Subject to
Exercise Prices	Outstanding	Life	Exercise
$6.07	150,000	6.58	—
6.76	5,400	7.03	3,598
9.12	22,500	5.59	7,499
Total	177,900	6.47	11,097

The total intrinsic value of options exercised during the years ended October 31, 2015 and 2014 was $8,000 and $1,000, respectively. The total intrinsic value of options outstanding and exercisable as of October 31, 2015 was $80,000 and $0, respectively, which was calculated using the closing stock price at the end of the year less the option price of in-the-money options. The Company issues new shares when stock options are exercised. Unrecognized compensation expense related to outstanding stock options as of October 31, 2015 was $483,000 and is expected to be recognized over a weighted average period of 2.50 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 years ended October 31, 2015:



	Options Granted	Options Granted
	May 28, 2015	June 1, 2014
Weighted average fair value of options granted	$3.27	$5.17
Assumptions used:
Expected life (years)	7.00	7.00
Risk-free interest rate	1.25%	1.70%
Volatility	53.11%	55.78%
Dividend Yield	0.00%	0.00%

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.

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.

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.

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 years ended October 31, 2015 and 2014 is presented in the following table:


				Year ended October 31,
	For the Year ended
	October 31, 2015			October 31, 2014
		Weighted			Weighted
		Average			Average
		Grant Date			Grant Date
	Shares	Fair Value		Shares	Fair Value
Unvested at beginning of period	57,035	$	8.40	66,094	$	5.88
Granted	31,261		7.03	37,725		9.68
Vested	(38,303)		8.32	(46,784)		5.87
Unvested at end of period	49,993	$	7.61	57,035	$	8.40

Unrecognized compensation expense related to outstanding restricted stock awards to employees and directors as of October 31, 2015 was $210,000 and is expected to be recognized over a weighted average period of 1.20 years.

In connection with the separation of the Company’s former Chief Executive Officer, his remaining restricted stock awards were accelerated from the normal vesting on July 14, 2014 to May 31, 2014, resulting in an addition to stock-based compensation expense of $39,000 in the year ended October 31, 2014.

Director Stock Awards in Lieu of Cash Retainer Fees

During fiscal 2013, the Company initiated a program that allows non-employee Board members to elect and receive shares from the 2007 Plan in lieu of some or all of their quarterly cash retainer fees. During the year ended October 31, 2015 and 2014, the Company issued 7,057 and 4,387 shares, respectively, under this program. The expense was recognized at the time of share issuance and totaled $45,000 in both of the years ended October 31, 2015 and 2014.

Performance Share Awards

The Company’s former chief executive officer serving at the beginning of fiscal 2014 had the ability to earn share awards equal to one-third of his base compensation subject to achieving specific operating performance criteria. On December 18, 2013, this officer was awarded 8,832 shares of Company common stock with a value of $117,000 to be delivered if the Company met specific fiscal 2014 financial targets. The officer was not entitled to rights of ownership and the shares were not regarded as outstanding until delivered. These awards expired when the former chief executive officer’s employment ended on May 31, 2014.

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 remained 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 were expensed in relation to the shares expected to be granted over the performance period. The value of the shares whose performance criteria had been met became fixed at the market value on the date earned and the value of all other shares were marked to market as of the reporting date. Expense under this agreement for the year ended October 31, 2014 was $9,000. No non-employee consultant performance awards were granted during fiscal 2015 and none are outstanding as of October 31, 2015.

Employee Stock Purchase Plan

The MGC Diagnostics Corporation 2003 Employee Stock Purchase Plan, as amended (“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 eligibility requirements. Under the Purchase Plan, participating employees may purchase the Company’s common stock on a voluntary after-tax basis 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 phase. The Purchase 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, 2014 and June 30, 2015 employees purchased 12,040 and 11,711 shares at prices of $5.44 and $4.45 per share, respectively. For the phases that ended on December 31, 2013 and June 30, 2014 employees purchased 9,398 and 10,079 shares at prices of $7.11 and $7.06 per share, respectively. As of October 31, 2015, the Company has withheld approximately $35,000 from employees participating in the phase that began on July 1, 2015. As of October 31, 2015, 69,082 shares of common stock were available for future purchase under the Purchase Plan.

The following table presents the classification of pre-tax stock-based compensation expense recognized in the consolidated statements of comprehensive income (loss) for the years ended October 31, 2015 and 2014:



	Year ended October 31,
(In thousands)	2015		2014
Cost of revenues	$	4	$	5
Selling and marketing		97		81
General and administrative		389		348
Research and development		6		7
Stock-based compensation expense	$	496	$	441

Tax Impact of Stock-Based Compensation

The Company reports the benefit of tax deductions in excess of recognized stock-based compensation expense on the consolidated statements of cash flows as financing cash flows. For the years ended October 31, 2015 and 2014, there were no excess tax benefits.