NOTE 6—STOCKHOLDERS' EQUITY, STOCK PLANS AND STOCK-BASED COMPENSATION EXPENSE

Stock Option Plans

As of December 31, 2012, the Company had the following stock-based employee compensation plans:

2004 Equity Incentive Plan and 1998 Stock Plan

In 1998, the Company adopted the 1998 Stock Plan, or 1998 Plan, under which 4,650,000 shares of the Company's common stock were reserved for issuance to employees, directors and consultants.

On January 12, 2004, the Board of Directors adopted the 2004 Equity Incentive Plan. A total of 1,750,000 shares of common stock were originally reserved for issuance pursuant to the 2004 Equity Incentive Plan. In addition, the shares reserved for issuance under the 2004 Equity Incentive Plan included shares reserved but un-issued under the 1998 Plan and shares returned to the 1998 Plan as the result of termination of options or the repurchase of shares.

Options granted under the 1998 Plan and 2004 Equity Incentive Plan may be incentive stock options or non-statutory stock options. Stock purchase rights may also be granted under the 2004 Equity Incentive Plan. Incentive stock options may only be granted to employees. The Board of Directors determines the period over which options become exercisable. Options granted under the Plan to employees generally vest over a four year term from the vesting commencement date and become exercisable 25% on the first anniversary of the vesting commencement date and an additional 1/48th on the last day of each calendar month until all of the shares have become exercisable. During 2012, 2011 and 2010 the officers of the Company were granted options that vest over a three year term at the rate of 1/3rd on the one year anniversary of the vesting commencement date and 1/36th thereafter. The contractual term of the options granted in 2012, 2011 and 2010 was seven years.

In accordance with the 2004 Equity Incentive Plan, prior to 2012, the Company's non-employee directors were granted $60,000 of grant date fair value, fully vested, stock awards annually on the date of the Company's Annual Meeting of stockholders. Commencing with 2012, the Company's non-employee directors get $60,000 of restricted stock units (RSUs) annually that cliff-vest on the one year anniversary of the grant date. In the year ended December 31, 2012 and 2011, the Company issued 52,938 and 37,925 shares of stock respectively.

In addition, in the year ended December 31, 2012 and 2011, the Company's Board of Directors granted 95,250 and 39,300, respectively, of RSUs to certain members of the Company's management. These RSUs vest at the rate of one-third on June 1of the year of grant, and one-third in each of the subsequent two years. The Company measured the fair market values of the underlying stock on the dates of grant and recognizes the stock-based compensation expense using the straight-line method over the vesting period.

2004 Employee Stock Purchase Plan

On January 12, 2004, the Board of Directors adopted the 2004 Employee Stock Purchase Plan. Under the 2004 Employee Stock Purchase Plan, or 2004 ESPP, eligible employees are permitted to purchase common stock at a discount through payroll deductions. The 2004 ESPP offering and purchase periods are for approximately six months. The 2004 ESPP has an evergreen provision based on which shares of common stock eligible for purchase are increased on the first day of each fiscal year by an amount equal to the lesser of:

600,000 shares;

ii.

2.0% of the outstanding shares of common stock on such date; or

iii.

an amount as determined by the Board of Directors.

The Company's Board of Directors voted not to increase the shares available for future grant on January 1, 2012 and 2011. The price of the common stock purchased is the lower of 85% of the fair market value of the common stock at the beginning or end of a six month offering period. Under the 2004 ESPP the Company issued 46,982 shares in 2012 and 45,161 shares in 2011. At December 31, 2012, 1,009,954 shares remained available for future issuance.

Option Activity

Activity under the 1998 Plan and 2004 Equity Incentive Plan is summarized as follows:

				Options Outstanding
	Shares Available For Grant			Number of Shares			Weighted- Average Exercise Price		Weighted-Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value (in $ millions)(1)
Balances as of December 31, 2009		1,840,381			2,692,555		$	10.87		5.1		1.6
Options granted (2)		(961,500	)		961,500		$	10.14
Options exercised		—			(90,362	)	$	3.74
Options cancelled (expired or forfeited) (2)		267,274			(267,274	)	$	9.91
Stock awards granted		(146,291	)		—			—
Restricted stock units cancelled (expired or forfeited)		5,583			—			—
Balances as of December 31, 2010		1,005,447			3,296,419		$	10.93		4.4	$	1.1
Options granted (2)		(1,206,500	)		1,206,500		$	8.61
Options exercised		—			(207,624	)	$	5.92
Options cancelled (expired or forfeited) (2)		746,273			(746,273	)	$	13.40
Stock awards granted		(77,225	)		—			—
Restricted stock units cancelled (expired or forfeited)		6,542			—			—
Balances as of December 31, 2011		474,537			3,549,022		$	9.92		4.6	$	0.4
Additional shares reserved (3)		1,910,000			—			—
Options granted (2)		(921,500	)		921,500		$	7.04
Options exercised		—			(211,551	)	$	7.00
Options cancelled (expired or forfeited) (2)		470,732			(470,732	)		9.45
Stock awards granted		(314,159	)		—			—
Restricted stock units cancelled (expired or forfeited)		24,746			—			—
Balances as of December 31, 2012		1,644,356			3,788,239		$	9.44		4.3	$	2.6
Exercisable as of December 31, 2012					2,224,660		$	10.50		3.3	$	0.8

(1)	Based on the closing stock price of the Company's stock of $9.00 on December 31, 2012, $7.45 on December 30, 2011 and $8.29 on December 31, 2010.

(2)	Included in options granted and options cancelled are shares granted and cancelled in connection with the Company's Option Exchange Program in 2009.

(3)	Approved by stock holders in 2012.

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the aggregate difference between the Company's closing stock price on the last trading day of the fiscal year and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 31, 2012. The aggregate intrinsic amount changes based on the fair market value of the Company's common stock. Total intrinsic value of options exercised was $397,000 in 2012, $521,000 in 2011, and $128,000 in 2010. The options outstanding and exercisable at December 31 of the respective year were in the following exercise price ranges:

		Options Outstanding			Options Exercisable
Range of Exercise Prices		Number Outstanding	Weighted-Average Remaining Contractual Life (in years)		Number Outstanding	Weighted-Average Exercise Price
$	4.25–$ 6.54	81,180		1,51	79,283	$	5.14
$	6.88–$ 6.88	765,500		6.56	—		—
$	7.11–$ 8.49	427,626		3.56	317,441		8.37
$	8.52–$ 8.52	18,000		6.05	2,708		8.52
$	8.66–$ 8.66	518,596		3.41	475,115		8.66
$	8.72–$8.72	694,758		5.38	286,635		8.72
$	8.75–$9.74	102,000		5.19	54,563		9.28
$	10.24–$10.24	557,917		4.35	386,253		10.24
$	10.43–$14.14	411,033		1.97	411,033		11.81
$	14.78–$25.73	211,629		1.85	211,629		20.47
$	4.25–$25.73	3,788,239		4.34	2,224,660	$	10.50

As of December 31, 2011 there were 1,806,558 options that were exercisable at a weighted average exercise price of $10.86.

RSU and Stock Awards Activity Table

Information with respect to restricted stock units' activity is as follows (in thousands):

	Number of Shares			Weighted-Average Grant- Date Fair Value		Aggregate Fair Value (1) (in thousands)
Outstanding at December 31, 2010		67,096		$	10.24
Granted		77,225		$	8.32
Vested(2)		(85,526	)	$	8.93	$	691	(3)
Forfeited		(6,542	)	$	9.99
Outstanding at December 31, 2011		55,253		$	9.55
Granted		148,188		$	6.85
Vested(2)		(41,522	)	$	9.79	$	279	(4)
Forfeited		(13,210	)	$	7.39
Outstanding at December 31, 2012		148,709		$	6.99

(1)	Represents the value of the Company's stock on the date that the restricted stock units vest.
(2)	The number of restricted stock units vested includes shares that the Company withheld on behalf of the employees to satisfy the statutory tax withholding requirements.
(3)	On the grant date, the fair value for these vested awards was $737,000.
(4)	On the grant date, the fair value for these vested awards was $407,000.

Performance Stock Units

In the third quarter of 2012, the Company granted its executive officers 42,250 PSUs that shall vest on June 1, 2013 subject to the recipient's continued service through that date. At the vest date, the Company shall issue fully-paid up common stock based on the actual revenue achievement as a percentage of three revenue based performance goals. If the revenue achievement is below 50% for a performance goal, then zero (0) shares of common stock shall be issued for that goal; and for achievement of greater than 50% the number of common stock shares to be issued shall be prorated but capped at 200% of the target.

Stock-Based Compensation

Stock-based compensation expense for stock options, restricted stock units, stock awards and ESPP shares for the year ended December 31, 2012, 2011 and 2010 was as follows (in thousands):

	Year EndedDecember 31,
	2012		2011		2010
Stock options	$	2,421	$	3,047	$	3,628
RSUs		501		775		927
PSUs		138		—		—
ESPP		100		85		95
Total stock-based compensation expense	$	3,160	$	3,907	$	4,650

As of December 31, 2012, the unrecognized compensation cost, net of expected forfeitures, was $4.0 million for stock options and stock awards, which will be recognized using the straight- line attribution method over an estimated weighted-average remaining amortization period of 2.46 years. For the ESPP, the unrecognized compensation cost, net of expected forfeitures, was $43,000, which will be recognized using the straight- line attribution method over an estimated weighted-average amortization period 0.33 years.

The amount of cash received from the exercise of stock options and employee stock purchases, net of taxes withheld and paid was $1.7 million in 2012, $1.4 million in 2011, and $518,000 in 2010, and the total direct tax benefit (deficit) realized, including the excess tax benefit (deficit), from stock-based award activity was $6,000 in 2012, $29,000 in 2011, and $8,000 in 2010. The Company elected to account for the indirect effects of stock-based awards—primarily the research and development tax credit—through the Statement of Operations.

Total stock-based compensation expense recorded by department during the year ended December 31, 2012, 2011 and 2010 was as follows (in thousands):

	Year EndedDecember 31,
	2012		2011		2010
Cost of revenue	$	658	$	659	$	724
Sales and marketing		657		788		1,189
Research and development		514		698		629
General and administrative		1,331		1,762		2,108
Total stock-based compensation expense	$	3,160	$	3,907	$	4,650

Valuation Assumptions and Fair Value of Stock Options and ESPP Grants

The Company uses the Black-Scholes option pricing model to estimate the fair value of options granted under its equity incentive plans and rights to acquire stock granted under its employee stock purchase plan. The Company based the weighted average estimated values of employee stock option grants and rights granted under the employee stock purchase plan, as well as the weighted average assumptions used in calculating these values, on estimates at the date of grant, as follows:

	Stock Options									Stock Purchase Plan
	2012			2011			2010			2012			2011			2010
Estimated fair value of grants during the year	$	2.47		$	3.10		$	3.76		$	2.16		$	2.06		$	2.41
Expected term (in years)(1)		4.17			4.15			3.84			0.50			0.50			0.50
Risk-free interest rate(2)		0.45	%		1.41	%		1.73	%		0.15	%		0.08	%		0.2	%
Volatility(3)		44	%		43	%		46	%		43	%		39	%		40	%
Dividend yield(4)		—	%		—	%		—	%		—	%		—	%		—	%

(1)

The expected term represents the period during which the Company's stock-based awards are expected to be outstanding. The estimated term is based on historical experience of similar awards, giving consideration to the contractual terms of the awards, vesting requirements, and expectation of future employee behavior, including post-vesting terminations.

(2)	The risk-free interest rate is based on U.S. Treasury debt securities with maturities close to the expected term of the option as of the date of grant.

(3)	Estimated volatility is based on historical volatility. The Company also considers implied volatility when there is sufficient volume of freely traded options with comparable terms and exercise prices in the open market.

(4)	The Company has not historically issued any dividends and does not expect to do so in the foreseeable future.

The Company periodically estimates forfeiture rates based on its historical experience within separate groups of employees and adjusts the stock-based payment expense accordingly.

RSU Withholdings

For RSU's granted to employees, the number of shares issued on the date the RSUs vest is net of the statutory withholding requirements paid on behalf of the employees. The Company withheld 14,974 in 2012, 16,629 in 2011, and 14,283 in 2010, shares of common stock to satisfy its employees' tax obligations of $101,000 in 2012, $146,000 in 2011, and $126,000 in 2010. The Company paid this amount in cash to the appropriate taxing authorities. Although shares withheld are not issued, they are treated as common stock repurchases for accounting and disclosure purposes, as they reduce the number of shares that would have been issued upon vesting.