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Stock-Based Compensation

6 Months Ended

Jun. 30, 2013

5. Stock-Based Compensation

We have several approved stock option plans for which stock options and restricted stock awards are available to grant to employees, consultants and directors. All employee and director stock options granted under our stock option plans have an exercise price equal to the market value of the underlying common stock on the grant date. There are no vesting provisions tied to performance conditions for any options, as vesting for all outstanding option grants is based only on continued service as an employee, consultant or director. All of our outstanding stock options and restricted stock awards are classified as equity instruments.

Stock Options

As of June 30, 2013, we had two equity incentive plans:

	●	The 1998 Non-Officer Stock Option Plan (the 1998 Plan), which expired in June 2008 ;
	●	The 2006 Equity Incentive Plan (the 2006 Plan).

We also had one non-employee director stock option plan as of June 30, 2013:

●

The 2001 Non-Employee Director Stock Option Plan (the Director Plan) which expired in March 2011.

A summary of the combined activity under all of the stock option plans is set forth below:

	Number of Options Outstanding			Weighted Average Exercise Price
Outstanding at January 1, 2013		1,715,200		$	5.04
Granted		15,000			5.97
Cancelled or expired		(18,256	)		6.04
Exercised		(38,456	)		4.33
Outstanding at June 30, 2013		1,673,488		$	5.05

On May 6, 2013, the Company’s shareholders approved an increase of the number of common stock authorized for issuance as incentive stock options under the 2006 Plan by 2 million shares.

The aggregate intrinsic value of the 1,673,488 stock options that are outstanding, vested and expected to vest at June 30, 2013 is $2.6 million.

On March 19, 2013, the Company received an aggregate of $166,000 from two employees in connection with the exercise of stock options into 38,456 shares of common stock. The intrinsic value related to the options exercised was $58,000 on the date of exercise.

We granted an option to purchase 15,000 shares of our common stock to an employee during the six months ended June 30, 2013 with a grant date fair value of $80,000 computed using the Black-Scholes option pricing model.

For the three and six months ended June 30, 2013, the Company recorded $577,000 and $1.2 million, respectively, of compensation expense related to the vesting of stock options. For the three and six months ended June 30, 2012, the Company recorded $2.3 million, respectively, of compensation expense related to the vesting of stock options. The fair value of the stock-based compensation was calculated using the Black-Scholes option pricing model as of the date of grant of the stock option.

See below for assumptions used in the valuation of stock options:

	For the Six
	Months Ended June 30, 2013

Annual dividend yield		--
Expected life (years)		4.3
Risk-free interest rate		0.65%
Expected volatility		154%

	For the Six
	Months Ended June 30, 2012

Annual dividend yield		--
Expected life (years)		3.8
Risk-free interest rate		0.55% - 0.57%
Expected volatility		186% - 187%

The 1998 Plan terminated effective June 15, 2008 and the Director Plan terminated effective March 2011. Although we can no longer issue stock options out of the plans, the outstanding options at the date of termination will remain outstanding and vest in accordance with their terms. Options granted under the Director Plan vested over a one to four-year period, expire five to seven years after the date of grant and have exercise prices reflecting market value of the shares of our common stock on the date of grant. Stock options granted under the 1998 and 2006 Plans are exercisable over a maximum term of ten years from the date of grant, vest in various installments over a one to four-year period and have exercise prices reflecting the market value of the shares of common stock on the date of grant.

Warrants

During the six months ended June 30, 2013, certain warrant holders exercised their warrants under the cash and net cash provisions, as defined in the agreements. See Note 3 for details of such exercises and number of common stock shares issued.

On December 3, 2010, we issued 120,000 warrants at an exercise price of $1.63 per share to an employee. The fair value of the warrants was $198,000 on the date of grant, using the Black-Scholes option pricing model, which has been amortized to expense over 24 months. During the three and six months ended June 30, 2012, we recorded $25,000 and $50,000, respectively, of stock based compensation expense related to vesting of such warrants.

On September 12, 2011, we issued 20,000 three-year stock purchase warrants to an employee at an exercise price of $3.90 per share with a vesting period over 24 months. The warrant granted to an employee had a fair value on the date of grant of $75,000. This amount is expensed over the vesting period of which $10,000 and $19,000 and $9,000 and $18,000 of expense related to this warrant is included in product research and development expense for the three and six months ended June 30, 2013 and 2012, respectively. The fair value of stock-based compensation related to the issuance of warrants is calculated using the Black-Scholes option pricing model as of the grant date of the underlying warrant.

On April 4, 2013, we extended a 40,000 stock purchase warrant with an exercise price of $1.00 per share that expired on January 28, 2013 that was issued to an investor in a previous convertible debt financing. The fair value of the warrant was $166,000 on the date of grant, using the Black-Scholes option pricing model, which has been expensed during the three months ended June 30, 2013. The warrant holder exercised the warrant on April 4, 2013 and the Company received cash proceeds of $40,000 (see Note 3).

The stock-based compensation expense for the three and six months ended June 30, 2013 and 2012 reflects the fair value of the vested portion of options and warrants granted to directors, employees and non-employees. Stock-based compensation expense in the accompanying consolidated statements of operations is as follows (in thousands):

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Product research and development	$	58	$	178	$	118	$	187
Sales and marketing	$	194		918		385		943
General and administrative	$	501		1,221		836		1,221
Stock compensation expense	$	753	$	2,317	$	1,339	$	2,351

		Remaining unamortized expense at June 30, 2013
Stock-based compensation		$	2,401

The remaining unamortized expense related to stock options and warrants will be recognized on a straight line basis monthly as compensation expense over the remaining vesting period which approximates 2.7 years.

The fair value of stock-based awards to employees is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from our stock options. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term and forfeiture rate of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior, as well as expected behavior on outstanding options. The risk-free rate is based on the U.S. Treasury rates in effect during the corresponding period of grant. The expected volatility is based on the historical volatility of our stock price. These factors could change in the future, which would affect fair values of stock options granted in such future periods, and could cause volatility in the total amount of the stock-based compensation expense reported in future periods.

A summary of all warrant activity is set forth below:

	June 30, 2013
Outstanding and exercisable	Warrants			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life
January 1, 2013		4,704,636		$	1.61		1.41
Issued		--			--		--
Expired/forfeited		--			--		--
Exercised		(1,046,211	)		1.35		--
Outstanding and exercisable, June 30, 2013		3,658,425		$	1.69		0.92

During the six months ended June 30, 2013, warrant holders (excluding our CFO) exercised warrants to purchase 578,066 shares of common stock using the cashless exercise provision allowed in the warrant and received 412,254 shares of our common stock. In addition, warrant holders exercised warrants to purchase 148,145 shares of common stock and paid a cash exercise price ranging between $1.00 and $3.13 per share for a total cash exercise price of $200,000.

On February 26, 2013, David Brunton, our CFO, exercised warrants to purchase 320,000 shares of common stock using the cashless exercise provision allowed in the warrant and received 266,228 shares of our common stock.

Below is a summary of Outstanding Warrants to Purchase Common Stock as of June 30, 2013:

Description	Issue Date	Exercise Price		Shares	Expiration Date

August 2009 Employee Warrants	8/25/2009	$	0.50	80,000		8/25/2016
2007 Debt Extension Warrants	9/22/2010	$	1.00	16,000		9/22/2015
September 2010 Repricing Warrant	9/28/2010	$	1.38	4,000		9/28/2013
October 2010 Repricing Warrants	10/18/2010	$	1.38	1,845,461		10/18/2013
October 2010 Employee Warrants	10/15/2010	$	1.38	800,000		10/15/2013
December 2010 Employee Warrants	12/3/2010	$	1.63	200,000		12/3/2015
January 2011 Employee Warrant	1/21/2011	$	2.00	20,000		1/21/2014
February 2011 Legal Advisor Warrant	2/22/2011	$	2.50	80,000		2/22/2016
March 2011 Investor Warrants	3/9/2011	$	3.13	538,864		3/9/2016
March 2011 Investor Warrants	4/7/2011	$	3.13	34,100		4/7/2016
May 2011 Consultant Warrant	5/17/2011	$	4.05	20,000		5/17/2014
September 2011 Employee Warrant	9/12/2011	$	3.90	20,000		9/12/2014
Total Warrants Outstanding				3,658,425

- Definition

The entire disclosure for compensation-related costs for equity-based compensation, which may include disclosure of policies, compensation plan details, allocation of equity compensation, incentive distributions, equity-based arrangements to obtain goods and services, deferred compensation arrangements, employee stock ownership plan details and employee stock purchase plan details.

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