NOTE 3—STOCK-BASED AWARDS AND PER SHARE INFORMATION

Stock-Based Compensation

The Company currently has one stock-based compensation plan, the 2002 Stock Incentive Plan (the “2002 Plan”). Eligible persons under the 2002 Plan include certain officers and employees of the Company and directors of the Company. Under the 2002 Plan, 6,950,000 shares of common stock have been authorized for issuance. As of September 30, 2011, 2,269,000 shares of common stock have been issued pursuant to options that were exercised, 3,803,000 shares of common stock has been reserved for options that are outstanding, and 878,000 shares of common stock remain available for future grant.

Compensation cost related to stock options recognized in operating results during the three months ended September 30, 2011 and 2010 was $324,000 and $113,000, respectively. The net impact to earnings for those periods was $(0.01) and $(0.00) per basic and diluted share, respectively. Compensation cost related to stock options recognized in operating results during the nine months ended September 30, 2011 and 2010, was $1.0 million and $499,000, respectively. The net impact to earnings for those periods was $(0.04) and $(0.02) per basic and diluted share, respectively. At September 30, 2011, the Company had $2.3 million of total unrecognized compensation cost, net of estimated forfeitures, related to unvested share-based compensation arrangements granted under our existing plans. The Company expects that cost to be recognized over a weighted-average period of 1.2 years.

The following table summarizes the income statement classification of compensation expense associated with share-based payments (in thousands):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Cost of revenue		$	45			$	7			$	111			$	26
Sales and marketing			75				40				259				146
General and administrative			177				47				536				259
Engineering and development			27				19				94				68
		$	324			$	113			$	1,000			$	499

The Black-Scholes option valuation model is used in estimating the fair value of traded options. This option pricing model requires the Company to make several assumptions regarding the key variables used to calculate the fair value of its stock options. The risk-free interest rate used is based on the U.S. Treasury yield curve in effect for the expected lives of the options at their dates of grant. Since July 1, 2005, the Company has used a dividend yield of zero as it does not intend to pay cash dividends on its common stock in the foreseeable future. The most critical assumption used in calculating the fair value of stock options is the expected volatility of the common stock. Management believes that the historic volatility of the common stock is a reliable indicator of future volatility, and accordingly, a stock volatility factor based on the historical volatility of the common stock over a period of time is used in approximating the estimated lives of new stock options. The expected term is estimated by analyzing the Company’s historical share option exercise experience over a five year period. Compensation expense is recognized using the straight-line method for all stock-based awards. Compensation expense is recognized only for those options expected to vest, with forfeitures estimated at the date of grant based on historical experience and future expectations. Forfeitures are estimated at the time of the grant and revised as necessary in subsequent periods if actual forfeitures differ from those estimates.

The stock option fair values were estimated using the Black-Scholes option-pricing model with the following assumptions:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Expected term (years)			4.30				4.60				4.08				4.75
Volatility			105	%			91	%			106	%			86	%
Annual dividend per share		$	0.00			$	0.00			$	0.00			$	0.00
Risk-free interest rate			1.23	%			1.76	%			1.70	%			2.18	%

A summary of option activity under our stock option plans for the nine months ended September 30, 2011 is as follows:

										Weighted average
						Weighted				remaining
						average				contractual term				Aggregate
		Shares				exercise price				(years)				intrinsic value(1)
Options outstanding at December 31, 2010			4,130,000			$	3.60
Plus: Options granted			893,000			$	4.50
Less: Options exercised			(642,000	)		$	2.09
Options canceled or expired			(578,000	)		$	5.52
Options outstanding at September 30, 2011			3,803,000			$	3.78				4.74			$	2,297,000
Options exercisable at September 30, 2011			1,875,000			$	4.66				4.79			$	1,059,000
Options expired during the nine months ended September 30, 2011			304,000			$	7.94

Cash proceeds along with fair value disclosures related to grants, exercises and vesting options are provided in the following table (in thousands, except per share amounts):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Proceeds from stock options exercised		$	254			$	106			$	1,218			$	148
Tax benefit related to stock options exercised (1)			N/A				N/A				N/A				N/A
Intrinsic value of stock options exercised (2)		$	167			$	45			$	1,308			$	75
Weighted-average fair value of options granted during period		$	2.84			$	0.85			$	3.25			$	1.11
Total fair value of shares vested during the period		$	311			$	135			$	874			$	494

Warrants

In May 2010, the Company granted warrants to purchase an aggregate of 101,694 shares of its common stock to MidCap Financial, LLC, and Silicon Valley Bank (the “Finance Warrants”) at a price per share of $1.77. The exercise price of the Finance Warrants was subsequently reduced to $0.84 during September 2010 in connection with Amendment No. 1 to the Loan and Security Agreement. During February 2011, MidCap Financial, LLC, and Silicon Valley Bank performed a cashless exercise of all of their warrants, which resulted in the issuance of 78,172 shares of unregistered stock.

During September 2010, the Company issued warrants (the “IR Warrants”) to purchase an aggregate of 50,000 shares of common stock at a price per share of $0.74 to three service providers who provide investor relations services. The IR Warrants vest quarterly and will be revalued each period until the final vesting date. The holders may convert the IR Warrants into a number of shares, in whole or in part. The first tranche of IR Warrants expire on September 20, 2013. Pursuant to the agreement, the service providers were also entitled to a second tranche of IR Warrants to purchase an aggregate of 50,000 shares of common stock at a price per share of $0.74 as a performance bonus when the Company’s stock price closes at a price in excess of $6.00. The second tranche of IR Warrants were subsequently issued in April 2011 and will expire on April 11, 2014. During the three and nine month periods ended September 30, 2011, the Company recognized $16,000 and $226,000 of expense, respectively, related to the IR Warrants. The Company accounts for these non-employee stock warrants using the Black Scholes option pricing model, which measures them at the fair value of the equity instruments issued, using the stock price and other measurement assumptions as of the date which the counterparty’s performance is complete. The Company has concluded that the vesting date is the ultimate final measurement date, and will revalue any unvested warrants at the end of each reporting period until that date. During the three and nine month periods ended September 30, 2011, 21,000 and 26,000 of the IR Warrants were exercised on a cashless basis resulting in the issuance of 15,802 and 20,160 shares of the Company’s common stock, respectively. During the three months ended September 30, 2011, 12,000 of the warrants were exercised for cash.

In connection with the June 2011 Securities Purchase Agreement, on June 29, 2011, the Company issued warrants to purchase 812,974 shares of common stock at an exercise price of $6.50 per share to the June 2011 Purchasers. The June 2011 Warrants are not exercisable for six months following their issuance and have a term of five years from the date of issuance.

On August 2, 2011, the Company repurchased 90,000 of the June 2011 Warrants for $99,900, or $1.11 per underlying share, plus non-accountable expenses of $30,000.

Net Income (Loss) Per Share — Basic and Diluted

Basic net income (loss) per share is computed by dividing income (loss) available to common stockholders by the weighted-average number of common shares outstanding for the period. In computing diluted net income (loss) per share, the weighted average number of shares outstanding is adjusted to reflect the effect of potentially dilutive securities.

Outstanding stock options and warrants to purchase 4,588,000 and 3,071,000 shares were not included in the computation of diluted loss per share for the three and nine months ended September 30, 2011 and 2010, respectively, as a result of their anti-dilutive effect.

The Company declared special 1% stock dividends during each of the three completed quarters in fiscal 2011. The stock dividend declared during the quarter ended March 31, 2011 was payable March 31, 2011 to shareholders of record on March 15, 2011; the stock dividend declared during the quarter ended June 30, 2011 was payable June 30, 2011 to shareholders of record on June 10, 2011; and the stock dividend declared during the quarter ended September 30, 2011 was payable September 15, 2011 to shareholders of record on August 29, 2011. Although the Company’s Board of Directors has expressed its desire to continue to declare 1% stock dividends in future quarters, the Board of Directors deemed these three dividends to be special dividends and there is no assurance, with respect to amount or frequency, that any stock dividend will be declared again in the future. All stock information presented, other than that related to stock options and warrants, has been adjusted to reflect the effects of the stock dividends.

On August 10, 2011, the Company announced that its Board of Directors has authorized a stock repurchase program, pursuant to which the Company may repurchase up to an aggregate of 2,000,000 shares of the Company’s outstanding common stock. The stock repurchase program became effective on August 12, 2011. The Company expects to fund the stock repurchase program with existing cash and cash equivalents on hand. Any shares repurchased will be retired and shall resume the status of authorized and unissued shares. Repurchases of the Company’s common stock may be made from time to time through a variety of methods, including open market purchases, privately negotiated transactions or block transactions. The Company has no obligation to repurchase shares under the stock repurchase program, and the timing, actual number and value of the shares that are repurchased will be at the discretion of the Company’s management and will depend upon a number of considerations, including the trading price of the Company’s common stock, general market conditions, applicable legal requirements and other factors. The stock repurchase program will expire on August 12, 2013, unless the program is completed sooner, suspended, terminated or otherwise extended. During the quarter ended September 30, 2011, the Company had not repurchased any of its shares pursuant to the stock repurchase program.