Note 6-Stock Based Compensation

On March 26, 2009, the Board of Directors adopted the 2009 Stock Option Plan providing for the issuance of up to 6,000,000 shares to Optex Systems Holdings officers, directors, employees and to independent contractors who provide services to Optex Systems Holdings.

Options granted under the 2009 Stock Option Plan vest as determined by the Board of Directors of Optex Systems Holdings or a committee set up to act as a compensation committee of the Board of Directors and terminate after the earliest of the following events: (i) expiration of the option as provided in the option agreement, (ii) 90 days following the date of termination of the employee, or (iii) ten years from the date of grant (five years from the date of grant for incentive options granted to an employee who owns more than 10% of the total combined voting power of all classes of Optex Systems Holdings stock at the date of grant). In some instances, granted stock options are immediately exercisable into restricted shares of common stock, which vest in accordance with the original terms of the related options. Optex Systems Holdings recognizes compensation expense ratably over the requisite service period.

The option price of each share of common stock is determined by the Board of Directors or a committee set up to act as a compensation committee, provided that with respect to incentive stock options, the option price per share will in all cases be equal to or greater than 100% of the fair value of a share of common stock on the date of the grant, except an incentive option granted under the 2009 Stock Option Plan to a shareholder that owns more than 10% of the total combined voting power of all classes of Optex Systems Holdings’ stock, will have an exercise price of not less than 110% of the fair value of a share of common stock on the date of grant. No participant may be granted incentive stock options, which would result in shares with an aggregate fair value of more than $100,000 first becoming exercisable in one calendar year.

As of June 30, 2013, 17,705,149 of awarded stock options had vested and 484,000 shares had been forfeited due to employee turnover. As of July 1, 2012, 2,242,649 of awarded stock options had vested and 263,000 shares had been forfeited due to employee turnover. The vested options as of June 30, 2013 include 3,750,000 shares that were vested early as a result a board resolution on January 3, 2013 regarding the resignation of Ron Richards, which was effective December 31, 2012. The total vested options for Ron Richards of 5,000,000 shares were extended to expire on December 31, 2014.

Optex Systems Holdings recorded compensation costs for options and shares granted under the plan amounting to for $33 thousand and $119 thousand, for the three and nine months ended June 30, 2013, respectively. The recorded compensation costs for the nine months ending June 30, 2013 included an additional expense of $26 thousand in relation to the early vesting of Ron Richard’s options on January 3, 2013. For the three and nine months ended July 1, 2012, recorded compensation costs for options and shares granted under the plan were $42 and $111 thousand, respectively. The impact of the option compensation cost expense was immaterial to the basic and diluted net loss per share for the quarters ended June 30, 2013 and July 1, 2012, respectively. A deduction is not allowed for income tax purposes until nonqualified options are exercised. The amount of this deduction will be the difference between the fair value of Optex Systems Holdings’ common stock and the exercise price at the date of exercise. For the three and nine months ended June 30, 2013, the estimated deferred tax assets related to option compensation costs were $11 thousand and $40 thousand, respectively. For the three and nine months ended July 1, 2012, the estimated deferred tax assets related to option compensation costs were $14 thousand and $38 thousand, respectively. These tax effects have been recorded in the financial statement expenses. No tax deduction is allowed for incentive stock options. Accordingly no deferred tax asset is recorded for GAAP expense related to these options.

Optex Systems Holdings records its stock based compensation expense in accordance with ASC 718-10, “Compensation – Stock Compensation”. In estimating the value of stock options issued, management has valued the options at their date of grant utilizing the Black-Scholes-Merton option pricing model. For options issued on December 9, 2011, the fair value of the underlying shares was determined based on the closing price of Optex Systems Holdings’ publicly-traded shares as of December 9, 2011. Further, Optex Systems Holdings used an expected volatility of 364.2% which was calculated using the historical Optex Systems Holdings stock prices over the prior 12 month trading period. Estimation of these equity instruments’ fair value is affected by our stock price, as well as assumptions regarding subjective and complex variables such as employee exercise behavior and our expected stock price volatility over the term of the award. As our assumptions are based on historical information, judgment is required to determine if historical trends are fair indicators of future outcomes.

The risk-free interest rates used of 1.5% to 2.2% were determined based on the implied yield available on U.S. Treasury issues with an equivalent term approximating the expected life of the options of 4.5 to 7 years depending on the date of the grant and expected life of the options. The expected life of options used was based on the contractual life of the option grant. Optex Systems Holdings determined the expected dividend rate based on the assumption and expectation that earnings generated from operations are not expected to be adequate to allow for the payment of dividends in the near future and the assumption that Optex Systems Holdings does not presently have any intention of paying cash dividends on its common stock.

Optex Systems Holdings has granted stock options to officers and employees as follows:

The following table summarizes the status of Optex Systems Holdings’ aggregate stock options granted under the incentive stock option plan:

There were zero new options granted in the three and nine months ended June 30, 2013, and zero options exercised during the three and nine months ended June 30, 2013.

The following table summarizes the status of Optex Systems Holdings’ aggregate non-vested shares granted under the 2009 Stock Option Plan:

As of June 30, 2013, the unrecognized compensation cost related to non-vested share based compensation arrangements granted under the plan was approximately $161 thousand. These costs are expected to be recognized on a straight line basis through December 8, 2018. The total fair value of options and shares vested during the nine months ended June 30, 2013 was $180 thousand and the total intrinsic value was zero.

Warrant Agreements: Optex Systems Holdings calculates the fair value of warrants issued with debt or preferred stock using the Black-Scholes-Merton valuation method. The total proceeds received in the sale of debt or preferred stock and related warrants are allocated among these financial instruments based on their relative fair values. The discount arising from assigning a portion of the total proceeds to the warrants issued is recognized as interest expense for debt from the date of issuance to the earlier of the maturity date of the debt or the conversion dates using the effective yield method.

As of June 30, 2013, Optex Systems Holdings had the following warrants outstanding:

There were 100,000 warrants with an exercise price of $0.15 per warrant, granted to Longview Fund on January 5, 2010 in exchange for an allonge agreement, which expired on January 4, 2013, unexcercised. During the three and nine months ended June 30, 2013 and the three and nine months ended July 1, 2012, Optex Systems Holdings recorded zero interest expense related to the outstanding warrants. Interest expense related to outstanding warrants was fully amortized as of September 30, 2012.