NOTE 5— STOCK BASED COMPENSATION

The Company recognizes stock-based compensation in accordance with ASC 718, “Compensation—Stock Compensation.” Stock-based compensation expense, which consists of the compensation cost for employee stock options and the Company’s ESPP, and the value of options issued to non-employees for services rendered, was allocated to research and development and general and administrative in the unaudited condensed consolidated statements of operations as follows (in thousands):

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 three months ended March 31, 2014 and 2013:

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” (“SAB 107”). 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 utilized the historical volatilities of the Company. 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

As required by ASC 718, the Company recognized $1.2 million and $1.0 million of stock-based compensation expense related to stock options and purchase rights, under the Company’s stock option plans and ESPP, for the three months ended March 31, 2014 and 2013, respectively. As of March 31, 2014, the total unrecognized compensation cost related to unvested stock-based awards granted to employees under the Company’s stock option plans was approximately $9.8 million before forfeitures. This cost will be recorded as compensation expense on a straight-line basis over the remaining weighted average requisite service period of approximately 2.3 years.

Non-employee Stock-based Compensation Expense

The Company accounts for equity instruments issued to non-employees in accordance with ASC 505, “Equity.” The equity instruments consisting of stock options are valued using the Black-Scholes option pricing model. The values attributable to these options are amortized over the service period and the unvested portion of these options is remeasured at each vesting date. In connection with the grant of stock options to non-employees, the Company recorded stock-based compensation of approximately $36,000 and $35,000 for the three months ended March 31, 2014 and 2013, respectively.

Equity Incentive Plans

2004 Equity Incentive Plan On January 1, 2014, an additional 1,250,000 shares was authorized for issuance under the 2004 Equity Incentive Plan (“2004 Incentive Plan”), pursuant to the annual automatic increase to the authorized shares under the 2004 Incentive Plan. At March 31, 2014, 1,256,173 shares were authorized and available for issuance under the 2004 Equity Incentive Plan. The 2004 Incentive Plan expired pursuant to its terms on April 7, 2014.

The following table summarizes stock option activity under the Company’s 2004 Equity Incentive Plan:

The total intrinsic value of stock options exercised during the three months ended March 31, 2014 and 2013 were $0.1 million and $0.1 million, respectively, as determined at the date of the option exercise. Cash received from stock option exercises was $55,000 and $33,000 for each of the three months ended March 31, 2014 and 2013, 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 the Company’s current loss position.

2004 Employee Stock Purchase Plan On January 1, 2014, an additional 100,000 shares was authorized for issuance under the 2004 Employee Stock Purchase Plan (“2004 Purchase Plan”) pursuant to the annual automatic increase to the authorized shares under the 2004 Purchase Plan. For the three months ended March 31, 2014, plan participants had purchased 74,062 shares at an average purchase price of $3.91. At March 31, 2014, plan participants had $0.1 million withheld to purchase stock on August 14, 2014, which is included in accrued liabilities on the accompanying unaudited condensed consolidated balance sheet. At March 31, 2014, 261,834 shares were authorized and available for issuance under the ESPP.