NOTE 9—EQUITY INCENTIVE PLANS AND STOCK BASED COMPENSATION

2004 Equity Incentive Plan

The 2004 Equity Incentive Plan (“2004 Plan”), provides for the granting of incentive stock options, nonstatutory stock options, stock appreciation rights, stock awards and cash awards to employees and consultants. Options granted under the 2004 Plan may be either incentive stock options (“ISOs”) or nonqualified stock options (“NSOs”). ISOs may be granted only to Company employees (including officers and directors who are also employees). NSOs may be granted to Company employees and consultants. Stock options may be granted with an exercise price not less than 100% of the fair market value of the common stock on the date of grant. Stock options are generally granted with terms of up to ten years and vest over a period of four years.

On March 1, 2010, the Board of Directors approved an addition of 202,401 shares for issuance under the 2004 Plan effective January 1, 2010. On March 1, 2010 the Board of Directors approved an addition of 2,250,000 shares for issuance under the 2004 Plan and on May 19, 2010 the stockholders of the Company approved the same addition of 2,250,000 shares for issuance under the 2004 Plan. The annual automatic increase to the authorized shares under the 2004 Plan was amended, effective January 1, 2011 to the lesser of:

Activity under the 2004 Plan is set forth below:

At December 31, 2012, stock options outstanding and exercisable by exercise price were as follows:

The aggregate intrinsic value of options outstanding and options exercisable as of December 31, 2012 were $9.4 million and $5.8 million, respectively. As of December 31, 2012, the ending options vested and expected to vest was 5,050,008 and the aggregate intrinsic value of these options was $9.3 million. The weighted average remaining contractual life and weighted average exercise price of these options were 8 years and $3.16, respectively. The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock for options that were in-the-money at December 31, 2012.

The total intrinsic value of stock options exercised during the years ended December 31, 2012, 2011 and 2010 were $1.7 million, $6,000 and $15,000, respectively, determined at the date of the option exercise. Cash received from stock option exercises were $0.6 million, $14,000 and $21,000 for the years ended December 31, 2012, 2011 and 2010, respectively. The Company issues new shares of common stock upon exercise of options. In connection with these exercises, there was no tax benefit realized by the Company due to its current loss position.

2004 Employee Stock Purchase Plan

The 2004 Employee Stock Purchase Plan (the “Purchase Plan”) contains consecutive, overlapping 24 month offering periods. Each offering period includes four six-month purchase periods. The price of the common stock purchased will be the lower of 85% of the fair market value of the common stock at the beginning of an offering period or at the end of the purchase period. For the year ended December 31, 2012, employees had purchased 150,677 shares of common stock under the Purchase Plan at an average price of $1.18. For the year ended December 31, 2011, employees had purchased 130,512 shares of common stock under the Purchase Plan at an average price of $1.03. At December 31, 2012, plan participants had $0.1 million withheld to purchase stock on February 14, 2013, which is included in accrued liabilities on the accompanying consolidated balance sheet. At December 31, 2012, 303,141 shares were authorized and available for issuance under the ESPP.

Stock-based Compensation

The Company recognizes stock-based compensation in accordance with ASC 718, “Compensation—Stock Compensation.” Under this guidance, stock-based compensation cost is based on the recognition of the grant date fair value estimated in accordance with the provisions of ASC 815 over the service period, which is generally the vesting period. In addition, ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation expense recognized under ASC 718 in the Company’s consolidated statements of operations for the years ended December 31, 2012, 2011 and 2010 related to stock options and ESPP were $3.0 million, $1.0 million and $0.8 million, respectively.

Valuation Assumptions

The Company estimated the fair value of stock options granted using the Black-Scholes option-pricing formula and a single option award approach. This fair value is being amortized ratably over the requisite service periods of the awards, which is generally the vesting period. The fair value of employee stock options and employee purchase rights under the Company’s ESPP was estimated using the following weighted-average assumptions for the years ended December 31, 2012, 2011 and 2010:

To determine the expected term of the Company’s employee stock options granted, the Company utilized the simplified approach as defined by SEC Staff Accounting Bulletin No. 107, “Share-Based Payment”. To determine the risk-free interest rate, the Company utilized an average interest rate based on U.S. Treasury instruments with a term consistent with the expected term of the Company’s stock based awards. To determine the expected stock price volatility for the Company’s stock based awards, the Company examined historical volatilities for industry peers as well as the Company and utilized a blend of the historical volatilities of the Company and its industry peers. The fair value of all the Company’s stock based awards assumes no dividends as the Company does not anticipate paying cash dividends on its common stock.

Employee Stock-based Compensation Expense

Stock-based Compensation Expense As required by ASC 718 the Company recognized $2.8 million, $1.0 million and $0.8 million of stock-based compensation expense related to stock options granted and purchase rights granted under the Company’s stock option plans, for the years ended December 31, 2012, 2011 and 2010, respectively. As of December 31, 2012, the total unrecognized compensation cost related to unvested stock-based awards granted to employees under the Company’s stock option plans was approximately $8.6 million before estimated forfeitures. This cost will be recorded as compensation expense ratably over the remaining weighted average requisite service period of approximately 2.6 years.

Non-employee Stock-based Compensation Expense

Stock-based compensation expense related to stock options granted to non-employees is recognized ratably, as the stock options are earned. The Company issued options to non-employees, which generally vest ratably over the time period the Company expects to receive services from the non-employee. The values attributable to these options are amortized over the service period and the unvested portion of these options was remeasured at each vesting date. The Company believes that the fair value of the stock options is more reliably measurable than the fair value of the services received. The fair value of the stock options granted were revalued at each reporting date using the Black-Scholes valuation model as prescribed by ASC 505-50 Equity-Based Payments to Non-Employees using the following assumptions:

The stock-based compensation expense will fluctuate as the fair market value of the common stock fluctuates. In connection with the grant of stock options to non-employees, the Company recorded stock-based compensation of approximately $0.2 million, $0.1 million and $37,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

Total stock-based compensation expense was allocated to research and development and general and administrative as follows (in thousands):