6. Stock Based Compensation

2008 Equity Incentive Plan

For the nine months ended September 28, 2013, the only active share-based compensation plan was the 2008 Equity Incentive Plan (the “Incentive Plan”). The terms of awards granted during the nine months ended September 28, 2013 were consistent with those described in the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 29, 2012.

Summary of Stock Options

The following table summarizes information regarding activity in our stock option plan during the nine months ended September 28, 2013:

	Number of Shares		Weighted Average Exercise Price Per Share		Aggregate Intrinsic Value (thousands)
Outstanding at December 29, 2012	1,570,543		$	3.64
Granted	145,800		$	5.59
Exercised	(373,663	)	$	2.88
Canceled or forfeited	(117,879	)	$	5.54
Outstanding at September 28, 2013	1,224,801		$	3.92	$	2,706

The weighted-average grant date fair value of the options granted under the Company’s stock plans as calculated using the Black-Scholes option-pricing model was $3.19 and $2.37 per share for the three months ended September 28, 2013 and September 29, 2012, respectively. The weighted-average grant date fair value of the options granted under the Company’s stock plans as calculated using the Black-Scholes option-pricing model was $3.12 and $2.70 per share for the nine months ended September 28, 2013 and September 29, 2012, respectively.

The Company uses the Black-Scholes option-pricing model to estimate fair value of stock-based awards (options) with the following weighted average assumptions:

	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Average risk free interest rate		1.26	%		0.59	%		1.11	%		0.68	%
Expected life (in years)		4.50 years			4.55 years			4.50 years			4.55 years
Dividend yield		0.0	%		0.0	%		0.0	%		0.0	%
Average volatility		66	%		90	%		72	%		91	%

Option-pricing models require the input of various subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. The expected stock price volatility is based on analysis of the Company’s stock price history over a period commensurate with the expected term of the options, trading volume of the Company’s stock, look-back volatilities and Company specific events that affected volatility in a prior period. The expected term of employee stock options represents the weighted average period the stock options are expected to remain outstanding and is based on the history of exercises and cancellations on all past option grants made by the Company, the contractual term, the vesting period and the expected remaining term of the outstanding options. The risk-free interest rate is based on the U.S. Treasury interest rates whose term is consistent with the expected life of the stock options. No dividend yield is included as the Company has not issued any dividends and does not anticipate issuing any dividends in the future.

The following table shows stock-based compensation expense included in the condensed consolidated statements of operations for the three months and nine months ended September 28, 2013 and September 29, 2012:

	Three Months Ended							Nine Months Ended
(in thousands)	September 28, 2013			September 29, 2012				September 28, 2013			September 29, 2012
Cost of revenues	$	27	$		17		$		78	$		51
Research and development		17			19				53			58
Sales and marketing		30			29				80			84
General and administrative		103			(85	)			300			84
	$	177	$		(20	)	$		511	$		277

Approximately $17 thousand and $11 thousand of the stock-based compensation recognized was capitalized into inventory as a component of overhead for the quarters ended September 28, 2013 and September 29, 2012, respectively.

Information regarding stock options outstanding, vested and expected to vest and exercisable at September 28, 2013 is summarized below:

Number of

Weighted Average

Exercise Price

Weighted Average

Remaining Contractual

Life (Years)

Aggregate

Intrinsic Value

(thousands)

Options outstanding

1,224,801

3.92

3.73

2,706

Options vested and expected to vest

1,155,031

3.89

3.56

2,596

Options exercisable

789,589

3.67

2.42

1,967

The aggregate intrinsic value in the table above represents the pre-tax intrinsic value, based on the Company’s closing price as of September 27, 2013, that would have been received by option holders had all option holders exercised their stock options as of that date. This amount changes based on the fair market value of the Company’s stock. The total intrinsic value of options exercised for the nine months ended September 28, 2013 and September 29, 2012 were approximately $231 thousand and $225 thousand, respectively.

As of September 28, 2013, there was $1.0 million of total unrecognized compensation cost, net of expected forfeitures, related to non-vested share-based compensation arrangements under the Incentive Plan. The cost is expected to be recognized over a weighted average period of 3.09 years.

Summary of Restricted Stock Units and Awards

Information regarding the restricted stock units activity for the nine months ended September 28, 2013 is summarized below:


Outstanding at December 29, 2012	55,999
Restricted stock units granted	230,509
Restricted stock units released	(17,249	)
Restricted stock units forfeited	0
Outstanding at September 28, 2013	269,259

The grant date fair value for restricted stock units awarded during the period was $318 thousand. The weighted average stock price on the date of grant was $4.51 per share.

On March 25, 2013, the Company granted a restricted stock unit award for up to 220,000 shares of the Company’s common stock (the “Market Performance Award”) under the terms of the Company’s 2008 Equity Incentive Plan, as amended, to the Company’s President and Chief Executive Officer. The number of shares issuable pursuant to the Market Performance Award will be based upon the Company’s average stock price performance during the two months prior to and two months following the date the service condition is met, or the fair market value of the Company’s common stock in the event vesting is triggered by a change of control of the Company. The Market Performance Award is expected to vest on December 31, 2014, given that no other vesting triggers occur prior to that date. To the extent that the market condition is not met, the Market Performance Award will not vest and will be cancelled. Since the market conditions will affect the vesting of the Market Performance Award, the Company cannot use the Black-Scholes option-pricing model to value the award; instead, a binomial model must be used. The Company utilized the Monte Carlo simulation technique, which incorporated assumptions for the expected holding period, risk-free interest rate, stock price volatility and dividend yield. Compensation expense is recognized ratably until such time as the market condition is satisfied.

There were 3,503 restricted stock awards granted, vested and forfeited for the nine months ended September 28, 2013.

Stock Repurchase Program

In May 2011, the Company approved a stock repurchase program authorizing the Company to purchase in open market or privately negotiated transactions, up to $2.0 million worth of our common stock, from time to time during the next 12 months. In February 2012, the Company approved an extension of its stock repurchase program authorizing the Company to purchase up to $4.0 million worth of our common stock, from time to time prior to March 2013. In February 2013, the Board of Directors approved a new one year $3.0 million stock repurchase program that replaced the prior two year $4.0 million stock repurchase program. For the nine months ended September 28, 2013, the Company has purchased 36,537 shares at an average price of $5.31 per share. As of September 28, 2013, the Company still has the authorization to purchase up to $2.8 million in common shares under the stock repurchase program. See Item 2, Unregistered Sales of Equity Securities and Use of Proceeds in Part II, Other Information, for additional information.

Preferred Stock Conversion

On June 11, 2013, all outstanding shares of the Company’s Series A Preferred Stock automatically converted into 1,000,000 shares of common stock. The Series A Preferred shares were issued to BlueLine Capital Partners LP and affiliated entities as part of a private placement in 2007. The Certificate of Designation authorizing the Series A Preferred shares provided for their automatic conversion into common stock in the event that IRIDEX common stock traded above $5.00 per share for 30 consecutive trading days.