NOTE 9—EQUITY INCENTIVE PLANS AND STOCK BASED COMPENSATION

2004 Equity Incentive Plan

On April 7, 2004, the Board of Directors adopted the 2004 Equity Incentive Plan (the "2004 Plan"), and received stockholder approval on January 10, 2005. The 2004 Plan became effective upon the completion of the Company's initial public offering and 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.

In 2005, 404,801 shares of common stock were authorized for issuance pursuant to the 2004 Plan, plus any shares which had been reserved but not issued under the 2001 Equity Incentive Plan (the "2001 Plan") or issued and forfeited after the date of the initial public offering, plus any shares repurchased at or below the original purchase price and any options which expire or become unexercisable after the initial public offering, thereafter plus all shares of common stock restored by the Board of Directors pursuant to the provision of the 2004 Plan that permits options to be settled on a net appreciation basis. The Company will not grant any options under the 2001 Plan after the effectiveness of the 2004 Plan. On January 1, 2006, and annually thereafter, the authorized shares under the 2004 Plan will be automatically increased by a number of shares equal to the lesser of:

 

•

5% of the number of the Company's shares issued and outstanding prior to the preceding December 31;

 

•

202,401 shares;

 

•

an amount determined by the Board of Directors.

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:

 

•

5% of the number of the Company's shares issued and outstanding prior to the preceding December 31;

 

•

1,250,000 shares;

 

•

an amount determined by the Board of Directors.

On December 20, 2005, the Board of Directors approved an addition of 202,401 shares for issuance under the 2004 Plan effective January 1, 2006. On April 2, 2007, the Board of Directors approved an addition of 202,401 shares for issuance under the 2004 Plan effective January 1, 2007. On January 15, 2009, the Board of Directors approved an addition of 202,401 shares for issuance under the 2004 Plan effective January 1, 2009. 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.

 

Activity under the 2001 Plan and 2004 Plan is set forth below:

 

		Shares Available for Grant				Outstanding Options								Weighted Average Exercise Price
						Number of Shares				Exercise Price
Shares reserved at Plan inception			202,400				—			$	—			$	—
Balances, December 31, 2001			202,400				—				—				—
Options granted			(179,992	)			179,992				0.96				0.96
Options exercised			—				(405	)			0.96				0.96
Balances, December 31, 2002			22,408				179,587				0.96				0.96
Additional shares reserved			506,000				—				—				—
Options granted			(121,092	)			121,092				0.96–1.56				0.96
Options exercised			—				(1,285	)			0.96				0.96
Options canceled			927				(927	)			0.96				0.96
Balances, December 31, 2003			408,243				298,467				0.96–1.56				0.96
Options granted			(370,372	)			370,372				1.56–3.18				2.16
Options exercised			—				(586,365	)			0.96–3.18				1.50
Options canceled			7,926				(7,926	)			0.96–3.18				1.68
Balances, December 31, 2004			45,797				74,549				0.96–3.18				2.70
Additional shares reserved			404,800				—				—				—
Options granted			(157,849	)			157,849				3.18–89.88				49.32
Options exercised			—				(75,545	)			0.96–3.18				2.94
Options canceled			2,475				(2,475	)			34.80–74.70				39.72
Options repurchased			10,664				—				0.96–3.18				2.46
Balances, December 31, 2005			305,887				154,378				0.96–89.88				49.74
Additional shares reserved			202,401				—				—				—
Options granted (1)			(744,228	)			744,228				9.30–99.12				41.94
Options exercised			—				(22,023	)			1.56–37.56				5.52
Options canceled (1)			530,831				(530,831	)			3.18–99.12				62.88
Options repurchased			27,091				—				0.96–3.18				2.94
Balances, December 31, 2006			321,982				345,752				0.96–89.88				15.60
Additional shares reserved			202,401				—
Options granted			(283,396	)			283,396				3.84–21.66				11.04
Options exercised			—				(337	)			3.18–15.42				14.52
Options canceled			131,672				(131,672	)			3.18–84.24				16.62
Options repurchased			16,410				—				1.56–3.18				2.10
Balances, December 31, 2007			389,069				497,139				0.96–89.88				12.72
Options granted			(239,538	)			239,538				0.42–3.18				2.84
Options exercised			—				(727	)			1.56				1.56
Options canceled			118,852				(118,852	)			0.96–89.88				15.14
Options repurchased			47				—				3.13				2.10
Balances, December 31, 2008			268,430				617,098				0.42–21.66				8.41
Additional shares reserved			202,401				—
Options granted (2)			(955,265	)			955,265				0.79–3.08				1.17
Options exercised			—				(8,764	)			0.79–1.30				1.14
Options canceled (2)			627,939				(627,939	)			0.79–21.66				8.28
Balances, December 31, 2009			143,505				935,660				0.42–21.66				1.17
Additional shares reserved			2,452,401				—
Options granted			(1,849,500	)			1,849,500				0.99–1.88				1.45
Options exercised			—				(20,000	)			0.79–1.30				1.05
Options canceled			19,442				(19,442	)			0.79–1.95				1.61
Balances, December 31, 2010			765,848				2,745,718			$	0.42–3.18			$	1.36
Additional shares reserved			1,250,000				—
Options granted			(1,196,500	)			1,196,500				1.53-1.86				1.64
Options exercised			—				(11,603	)			0.79-1.44				1.24
Options canceled			258,436				(258,436	)			0.79-1.88				1.38
Balances, December 31, 2011			1,077,784				3,672,179			$	0.42-3.18			$	1.45

(1)	Includes 362,000 options that had a weighted average exercise price of $74.22, which were canceled and re-granted at an exercise price of $15.42 in September 2006.

(2)	Includes 559,665 options that had a weighted average exercise price of $8.08, which were canceled and re-granted at an exercise price of $1.30 in February 2009.

At December 31, 2011, stock options outstanding and exercisable by exercise price were as follows:

 

		Options Outstanding												Options Exercisable
Range of Exercise Prices		Number Outstanding				Weighted Average Remaining Contractual Life (Years)				Weighted Average Exercise Price				Number Exercisable				Weighted Average Exercise Price
$0.42 – 1.29			306,257				6.48			$	0.80				246,775			$	0.80
$1.30 – 1.32			503,946				4.57				1.30				492,167				1.30
$1.44 – 1.44			1,466,667				8.24				1.44				596,655				1.44
$1.53 – 1.64			1,226,208				9.39				1.63				235,708				1.63
$1.69 – 1.95			164,000				8.42				1.81				114,853				1.85
$2.22 – 3.18			5,101				5.99				3.01				3,689				2.99
$0.42 – 3.18			3,672,179				7.98			$	1.45				1,689,847			$	1.36

The aggregate intrinsic value of options outstanding and options exercisable as of December 31, 2011 were $0.1 million and $0.1 million, respectively. As of December 31, 2011, the ending options vested and expected to vest was 3,635,209 and the aggregate intrinsic value of these options was $0.1 million. The weighted average remaining contractual life and weighted average exercise price of these options were 7.97 years and $1.45, 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, 2011.

The total intrinsic value of stock options exercised during the years ended December 31, 2011, 2010 and 2009 were $6,000, $15,000 and $8,000, respectively, determined at the date of the option exercise. Cash received from stock option exercises were $14,000, $21,000 and $10,000 for the years ended December 31, 2011, 2010 and 2009, 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.

On February 13, 2009, the Company cancelled 559,665 options of 41 eligible employees, consultants and directors that had a weighted average exercise price of $8.08 and re-granted 559,665 options at an exercise price of $1.30, which was the Company's closing price on February 17, 2009. As a result of the repricing of options of eligible employees and directors, the Company will incur an incremental stock-based compensation expense of $0.2 million over the weighted average vesting period of the repriced options of 2.2 years. The incremental compensation cost was measured as the fair value of the new stock option award over the fair value of the original stock option award based on the closing price on the date of re-grant. The incremental expense related to the repricing recorded for the years ended December 31, 2011, 2010 and 2009 was not significant.

2004 Employee Stock Purchase Plan

Effective with the initial public offering, the Board of Directors approved the 2004 Employee Stock Purchase Plan (the "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, 2011, employees had purchased 130,512 shares of common stock under the Purchase Plan at an average price of $1.03. For the year ended December 31, 2010, employees had purchased 118,572 shares of common stock under the Purchase Plan at an average price of $1.01. At December 31, 2011, plan participants had $0.1 million withheld to purchase stock on February 14, 2012, which is included in accrued liabilities on the accompanying consolidated balance sheet. At December 31, 2011, 353,818 shares were authorized and available for issuance under the ESPP.

Directors Compensation Program

In December 2005, the Board of Directors approved revised compensation arrangements for non-employee directors of the Company. Effective January 1, 2006, non-employee directors receive an annual retainer of $30,000, and, in addition, chairpersons of the Audit, Compensation and Nominating and Corporate Governance Committees receive annual retainers of $16,000, $14,000, and $10,000, respectively. In May 2005, each non-employee director was granted an option to purchase 2,500 shares of the Company's common stock under the Company's 2004 Equity Incentive Plan. In addition, at each annual meeting of stockholders of the Company, each non-employee director who has served as director at least six months prior to such meeting will receive an automatic grant of an option to purchase 2,500 shares of the Company's common stock. Pursuant to the provisions of the plan, in May 2008, May 2007 and June 2006, each of the five non-employee directors received an automatic grant of 2,500 shares of the Company's common stock in each respective year. In addition, in November 2008 and April 2007, pursuant to the provisions of the plan, a newly elected non- employee director on each respective date received an automatic grant of 5,000 shares.

In January 2009, each of the five non-employee directors received a one-time grant to purchase 10,000 shares of the Company's common stock. In May 2009, at the Company's annual meeting, an amendment to the Company's 2004 Equity Incentive Plan to increase the size of the automatic annual option grant to continuing non-employee directors from 2,500 shares to 10,000 shares, was approved by the shareholder of the Company. In accordance with the amendment, each of the five non-employee directors received an automatic grant of an option to purchase 10,000 shares of the Company's common stock. In May 2010, at the Company's annual meeting, an amendment to the Company's 2004 Equity Incentive Plan to increase the size of the automatic annual option grant to continuing non-employee directors from 10,000 shares to 12,500 shares, was approved by the shareholder of the Company. In accordance with the amendment, each of the five non-employee directors received an automatic grant of an option to purchase 12,500 shares of the Company's common stock. In addition, in May 2010, pursuant to the provisions of the plan, a newly elected non- employee director received an automatic grant of 25,000 shares. In May 2011, each of the six non-employee directors received an automatic grant of an option to purchase 12,500 shares of the Company's common stock.

Stock-based Compensation

The Company recognizes stock-based compensation in accordance with ASC 718, "Compensation—Stock Compensation," using the modified prospective transition method, except for options granted prior to the Company's initial public offering in February 2005, for which the fair value was determined for disclosure purposes using the minimum value method. Under this transition method, stock-based compensation cost recognized for the years ended December 31, 2011, 2010 and 2009 includes:

 

•

compensation cost for all unvested stock-based awards as of January 1, 2006 that were granted subsequent to the Company's initial public offering in February 2005, and prior to January 1, 2006, that were earned during the year ended December 31, 2009 based on the recognition of the grant date fair value estimated in accordance with ASC 815 over the service period, which is generally the vesting period;

 

•

compensation cost for all stock-based awards granted or modified subsequent to January 1, 2006, that were earned during the years ended December 31, 2011, 2010 and 2009 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 statement of operations for the years ended December 31, 2011, 2010 and 2009 related to stock options and ESPP were $1.0 million, $0.8 million and $2.2 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 on a straight-line basis 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, 2011, 2010 and 2009:

 

		Years ended December 31,
		2011				2010				2009
Employee Stock Options
Risk-free interest rate			1.88	%			2.35	%			1.71	%
Expected life (in years)			5.98				5.99				5.71
Dividend yield			—				—				—
Volatility			92	%			85	%			84	%
Weighted-average fair value of stock options granted		$	1.23			$	1.05			$	0.51
Employee Stock Purchase Plan
Risk-free interest rate			0.15	%			0.40	%			0.71	%
Expected life (in years)			1.25				1.25				1.25
Dividend yield			—				—				—
Volatility			80	%			88	%			67	%
Weighted-average fair value of ESPP purchase rights		$	0.66			$	0.80			$	0.52

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. 110, "Share-Based Payment" ("SAB 110"). 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 award 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 $1.0 million, $0.8 million and $2.2 million of stock-based compensation expense related to stock options granted and purchase rights granted subsequent to the Company's initial public offering in February 2005, under the Company's stock option plans, for the years ended December 31, 2011, 2010 and 2009, respectively, in addition to the amortization of deferred compensation above. As of December 31, 2011, the total unrecognized compensation cost related to unvested stock-based awards granted to employees under the Company's stock option plans was approximately $2.2 million before estimated forfeitures. This cost will be recorded as compensation expense on a straight-line basis over the remaining weighted average requisite service period of approximately 2.7 years.

Non-employee Stock-based Compensation Expense

Stock-based compensation expense related to stock options granted to non-employees is recognized on a straight-line basis, 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:

 

		Years Ended December 31,
		2011				2010				2009
Risk-free interest rate			1.37	%			1.94	%			2.54	%
Expected life (in years)			5.15				5.00				5.26
Dividend yield			—				—				—
Expected volatility			92	%			85	%			84	%

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 $0.1 million, $37,000 and $27,000 for the years ended December 31, 2011, 2010 and 2009, respectively.

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

 

		Year Ended December 31,
		2011				2010				2009
Stock-based compensation expense:
Research and development		$	471			$	381			$	1,003
General and administrative			568				422				1,208
		$	1,039			$	803			$	2,211