NOTE 4— STOCK BASED COMPENSATION

The Company recognizes stock-based compensation in accordance with ASC 718, "Compensation—Stock Compensation." Stock-based compensation cost recognized for the three and six months ended June 30, 2011 and 2010 includes compensation cost for all stock-based awards granted or modified after January 1, 2006, that were earned during the three and six months ended June 30, 2011 and 2010, based on the recognition of the grant date fair value estimated in accordance with ASC 718 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.

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 three and six months ended June 30, 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" ("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 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

As required by ASC 718, the Company recognized $0.2 million and $0.5 million of stock-based compensation expense related to stock options and purchase rights granted subsequent to the Company's initial public offering in February 2005, under the Company's stock option plans and ESPP, for the three and six months ended June 30, 2011, respectively, and $0.2 million and $0.3 million of stock based compensation for the three and six months ended June 30, 2010, respectively. As of June 30, 2011, the total unrecognized compensation cost related to unvested stock-based awards granted to employees under the Company's stock option plans was approximately $2.5 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 3.1 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 $11,000 and $31,000 for the three and six months ended June 30, 2011, respectively, and $4,000 and $9,000 for the three and six months ended June 30, 2010, respectively.

Stock-based compensation expense, which consists of the compensation cost for employee stock options, and the value of options issued to non-employees for services rendered, was allocated to research and development and general and administrative as follows (in thousands):

Equity Incentive Plans

2004 Equity Incentive Plan On January 27, 2011 the Board of Directors approved an addition of 1,250,000 shares for issuance under the 2004 Equity Incentive Plan effective January 1, 2011. At June 30, 2011, 1,172,658 shares were authorized and available for issuance under the 2004 Equity Incentive Plan.

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 six months ended June 30, 2011 and 2010 were $4,000 and $15,000, respectively, as determined at the date of the option exercise. Cash received from stock option exercises was $10,000 and $21,000 for each of the six months ended June 30, 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 the Company's current loss position.

2004 Employee Stock Purchase Plan On January 27, 2011 the Board of Directors approved an addition of 100,000 shares for issuance under the 2004 Employee Stock Purchase Plan effective January 1, 2011. For the six months ended June 30, 2011, plan participants had purchased 63,658 shares at an average purchase price of $1.03. At June 30, 2011, plan participants had $69,000 withheld to purchase stock on August 14, 2011, which is included in accrued liabilities on the accompanying unaudited condensed consolidated balance sheet. At June 30, 2011, 420,672 shares were authorized and available for issuance under the ESPP.