Stock-Based Compensation and Equity

Stock-Based Compensation

During 2004, the Company adopted the 2004 Stock Option and Incentive Plan, as amended and restated in 2006, 2008, and 2009 (the “2004 Stock Plan”). The 2004 Stock Plan, among other things, provides for granting of incentive and nonqualified stock option and stock bonus awards to officers, employees and outside consultants. Outstanding options under the 2004 Stock Plan generally vest over three or four years and terminate 10 years after the grant date, or earlier if the option holder is no longer an executive officer, employee, consultant, advisor or director, as applicable, of the Company. As of December 31, 2011, 657,672 shares of common stock were authorized for issuance under the 2004 Stock Plan, of which 55,629 shares had been issued, 316,089 shares were subject to outstanding options at a weighted average exercise price of $13.36 per share and 255,330 shares were available for future grant. In March 2006, the Company’s Board of Directors voted to discontinue the provision of the 2004 Stock Plan which automatically increased the number of options available for grant under the 2004 Stock Plan based on the net increase in the total number of outstanding shares of common stock during the year.

During May 2009, the Company adopted the 2009 Non-Qualified Inducement Stock Plan (the "2009 Inducement Plan"). The 2009 Inducement Plan is intended to encourage and enable employees, including prospective employees, of the Company upon whose judgment, initiative, and efforts the Company largely depends for the successful conduct of its business to acquire a proprietary interest in the Company. The 2009 Inducement Plan, among other things, provides for the granting of awards, including non-qualified stock options, restricted stock, and unrestricted stock. As of December 31, 2011, 83,333 shares of common stock were authorized for issuance under the 2009 Inducement Plan, of which no shares had been issued, 12,500 shares were subject to outstanding options at a weighted average exercise price of $1.60 per share, and 70,833 shares were available for future grant.

The exercise price of each stock option issued under the 1996 and 1998 Stock Plans was specified by the Board of Directors at the time of grant. The exercise price of stock options awarded under the 2004 Stock Plan and the 2009 Inducement Plan may not be less than the fair market value of the common stock on the date of the option grant. For holders of more than 10% of the Company’s total combined voting power of all classes of stock, incentive stock options may not be granted at less than 110% of the fair market value of the Company’s common stock at the date of grant and for a term not to exceed five years.

In June 2004, the Company adopted the 2004 Employee Stock Purchase Plan (the “2004 ESPP”). All of the Company’s employees who had been employed by the Company for at least 60 days and whose customary employment is for more than 20 hours per week and for more than five months in any calendar year were eligible to participate and any employee who owned 5% or more of the voting power or value of the Company’s stock was not eligible to participate. The 2004 ESPP authorized the issuance of up to a total of 62,500 shares of the Company’s common stock to participating employees.

Under the 2004 ESPP, participating employees could authorize the Company to withhold up to 10% of their earnings during consecutive six-month payment periods for the purchase of the shares. At the conclusion of each period, participating employees could purchase shares at 85% of the lower of their fair market value at the beginning or end of the period. The 2004 ESPP was regarded as a compensatory plan in accordance with the provisions of the Compensation – Stock Compensation topic of the Codification. As of December 31, 2009, there were no remaining shares to be issued under the 2004 ESPP.

In May 2010, the Company adopted the 2010 Employee Stock Purchase Plan (the “2010 ESPP”). The 2010 ESPP authorizes the issuance of up to a total of 41,667 shares of the Company’s common stock to participating employees plus an annual increase on the first day of each of the Company's fiscal years beginning in 2011, equal to the lesser of (i) 41,667 shares, (ii) 1 percent of the shares of common stock outstanding on the last day of the immediately preceding fiscal year, or (iii) such lesser number of shares as is determined by the Board. All of the Company’s full-time employees and certain part-time employees are eligible to participate in the 2010 ESPP. For part-time employees to be eligible, they must have customary employment of more than five months in any calendar year and more than 20 hours per week. Employees who, after exercising their rights to purchase shares under the 2010 ESPP, would own shares representing 5% or more of the voting power of the Company’s common stock, are ineligible to participate.

Under the 2010 ESPP, participating employees can authorize the Company to withhold up to 10% of their earnings during consecutive six-month payment periods for the purchase of the shares. At the conclusion of each period, participating employees can purchase shares at 85% of the lower of their fair market value at the beginning or end of the period. The 2010 ESPP is regarded as a compensatory plan in accordance with the provisions of the Compensation – Stock Compensation topic of the Codification. For the years ended December 31, 2011 and 2010 the Company issued 24,539 and 10,874 shares of its common stock, respectively, under the 2010 ESPP. As of December 31, 2011, there were 6,254 remaining shares to be issued under the 2010 ESPP.

The Company uses the Black-Scholes option pricing model for determining the fair value of shares of common stock issued or to be issued under the 2004 ESPP and 2010 ESPP. The following assumptions are used in determining fair value: The risk-free interest rate assumption is based on the United States Treasury’s constant maturity rate for a six month term (corresponding to the expected option term) on the date the option was granted. The expected dividend yield is zero because the Company does not currently pay dividends nor expects to do so during the expected option term. An expected term of six months is used based on the duration of each plan offering period. The volatility assumption is based on a consideration of stock price volatility over the most recent period of time corresponding to the expected term and is also based on expected future stock price volatility.

The weighted average grant-date fair value used in the calculation of stock-based compensation expense in the accompanying statement of operations for the years ended December 31, 2011, 2010, and 2009 is calculated using the following assumptions:

	Years Ended December 31,
	2011			2010			2009
Risk-free interest rate		0.9%-2.3	%		1.0%-2.8	%		1.6%-2.6	%
Expected dividend yield		—			—			—
Expected option term		5-6 years			5 years			5 years
Volatility		70.0	%		70.0	%		70.0%-120.0	%

The risk-free interest rate assumption is based on the United States Treasury’s constant maturity rate for a five year term (corresponding to the expected option term) on the date the option was granted. The expected dividend yield is zero as the Company does not currently pay dividends nor expects to do so during the expected option term. The expected option term of five years is estimated based on an analysis of actual option exercises and a review of comparable medical device companies. The volatility assumption is based on weekly historical volatility during the time period that corresponds to the expected option term, a review of comparable medical device companies and expected future stock price volatility. The pre-vesting forfeiture rate is based on the historical and projected average turnover rate of employees.

A summary of option activity for the year ended December 31, 2011 is presented below:

	Number of Options			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value
Outstanding at December 31, 2010		532,872		$	28.95
Granted		157,273			3.11
Exercised		—			—
Forfeited		(111,236	)		8.36
Expired		(240,312	)		43.37
Outstanding at December 31, 2011		338,597			13.47		7.72	$	—
Vested or expected to vest at December 31, 2011
		324,785			13.87		7.66		—
Exercisable at December 31, 2011		208,492			18.41		7.16		—

Expected to vest options are determined by applying the pre-vesting forfeiture rate to the total outstanding options. Aggregate intrinsic value represents the total pre-tax intrinsic value (the aggregate difference between the closing stock price of the Company’s common stock as of December 31, 2011, as applicable, and the exercise price for the in-the-money options) that would have been received by the option holders if all the in-the-money options had been exercised on December 31, 2011.

The weighted average per share grant-date fair values of options granted during the years ended December 31, 2011, 2010, and 2009 was $1.89, $4.74, and $8.70, respectively.

The aggregate intrinsic value of options issued or exercised during the years ended December 31, 2011, 2010, and 2009 was $0, $3,000, and $11,000, respectively.

Total unrecognized stock-based compensation costs related to non-vested stock options was $435,602, which related to 130,147 shares with a per share weighted fair value of $3.35 as of December 31, 2011. This unrecognized cost is expected to be recognized over a weighted average period of approximately 0.8 years.

Stock options granted to non-employees are recorded at fair value and adjusted to market over the vesting period in accordance with the provisions of Equity topic of the Codification. The Company determines fair value using the Black-Scholes option pricing model, an expected term equal to the option term, a risk-free interest rate corresponding to the expected term, a stock price volatility over the most recent period of time corresponding to the expected term and also based on expected future stock price volatility, and a dividend yield of zero. There were no options granted to non-employees during the year ended December 31, 2011.

Beginning in 2010, certain employees have been granted restricted stock. During 2011 and 2010, the Company granted 21,777 shares of restricted stock and 15,698 shares of restricted stock, respectively. There was no issuance of restricted stock in 2009. The fair value of restricted stock is calculated based on the closing sale price of the Company’s common stock on the date of issuance. No restricted stock shares vested during the year ended December 31, 2010.

A summary of restricted stock activity for the year ended December 31, 2011 is presented below:

	Restricted Shares			Weighted Average Grant Date Fair Value
Restricted shares at December 31, 2010		15,701		$	8.12
Granted		21,777			3.30
Vested		(3,695	)		(9.48	)
Canceled		(6,854	)		(5.43	)
Restricted shares at December 31, 2011		26,929		$	4.72

During the year ended December 31, 2011, certain employees, in lieu of paying withholding taxes on the vesting of restricted stock, authorized the withholding of an aggregate of 883 shares of common stock to satisfy the minimum tax withholding requirements related to such vesting. Shares withheld were calculated using the market price of the common stock on the vesting dates.

During 2010, certain employees received bonus payments in the form of common stock. A total of 1,839 such shares were issued with a total intrinsic value of $23,000.

Cash received from option exercises and purchases under the 2004 ESPP and the 2010 ESPP for the years ended December 31, 2011, 2010, and 2009 was $34,000, $163,000, and $104,000, respectively. The Company issues new shares upon option exercises, purchases under the Company’s ESPPs, and vesting of restricted stock.

The Company recorded stock-based compensation expense of $837,000, $1.2 million, and $2.1 million for the years ended December 31, 2011, 2010, and 2009, respectively.

Equity

On September 8, 2009, the Company entered into securities purchase agreements in connection with a private placement of its securities to certain institutional and other accredited investors pursuant to which the Company agreed to sell and issue (i) an aggregate of 1,469,420 newly issued shares of its common stock, par value $0.0001 per share and (ii) warrants to purchase an aggregate of 1,430,480 shares of common stock. The sale of securities resulted in aggregate gross proceeds of approximately $18.7 million. The net proceeds, after deducting offering expenses (including fees to the placement agent and co-agent), were approximately $17.2 million.

The common stock and warrants were sold as a unit for a price of $12.72. The warrants are exercisable at any time from six months after the closing date through the fifth anniversary of the closing date. The warrants have an exercise price of $13.20 per share, reflecting a 10% premium over the consolidated closing bid price for the Company’s common stock as reported on the NASDAQ Global Market, the market the Company traded on prior to transferring its listing to the NASDAQ Capital Market, on September 4, 2009. The warrants contain certain limitations that prevent the holder of any warrants from acquiring shares upon exercise of a warrant that would result in the number of shares beneficially owned by it and its affiliates to exceed 19.99% of the total number of shares of the Company’s common stock then issued and outstanding (with a separate threshold of 9.99% of the total number of shares outstanding for any shareholder who has not exceeded that threshold as of the date of closing). The number of shares for which the warrants are exercisable and the associated exercise prices are subject to certain adjustments as set forth in the warrants. The holder has the right to net exercise any outstanding warrants for shares of the Company’s common stock. In addition, upon certain changes in control of the Company, to the extent the warrants are not assumed by the acquiring entity, the holder could elect to receive, subject to certain limitations and assumptions, cash equal to the Black-Scholes value of the outstanding warrants.

The warrants issued in connection with the private offering were within the scope of the Distinguishing Liabilities from Equity Topic of the Codification. This Codification topic requires issuers to classify as liabilities (or assets under certain circumstances) free-standing financial instruments which, at inception, require or may require an issuer to settle an obligation by transferring assets. Accordingly, the Company reflected these warrants as a liability in the Balance Sheet. The fair value of the warrants at the issuance date was estimated using the Black-Scholes model. The estimated fair value of the warrants, including the warrants issued to the placement agents, was $14.5 million on the date of issuance and was recorded as a reduction of additional paid-in capital. In addition, the warrants were revalued at September 30, 2009 using the Black-Scholes model and the change in the fair value of the warrants was recognized in the warrants fair value adjustment line item in the Company’s consolidated statement of operations.

At September 30, 2009, the estimated fair value of the warrants increased to $21.9 million and was presented as a long term liability in the balance sheet as of that date. The increase in the fair value of the warrants from the date of issuance to September 30, 2009 required the Company to record an increase in the value of the liability of $7.4 million.

In October 2009, the Company executed addenda to the warrants issued in connection with the securities purchase agreements of September 8, 2009. The addenda revised the rights of warrant holders such that upon a change in control, as defined, the warrant holders will receive the Black-Scholes value of the warrants in the same currency and same proportions as will be received by the common stockholders of the Company, thereby removing the criteria in the agreements that required liability classification of the warrants. Following the addenda, the warrant liability was revalued at fair value resulting in a $2.2 million credit to warrants fair value adjustment that was recorded in the Statement of Operations in October 2009. The remaining liability for common stock warrants of $19.7 million was then reclassified to additional paid-in capital.

As of December 31, 2011, the Company had 50,000,000 shares of common stock authorized and 3,904,320 shares issued and outstanding. Each share of common stock entitles the holder to one vote on all matters submitted to a vote of the Company’s stockholders. Common stockholders are not entitled to receive dividends unless declared by the Board of Directors.

At December 31, 2011, the Company has reserved authorized shares of common stock for future issuance as follows:

Warrants			1,430,480
Outstanding stock options			338,597
Possible future issuance under stock option plans			326,163
Possible future issuance under employee stock purchase plan			6,254
Total			2,101,494

On March 7, 2007, the Company’s Board of Directors adopted a Shareholder Rights Plan and declared a dividend distribution of one preferred stock purchase right for each outstanding share of the Company’s common stock to shareholders of record as of the close of business on March 8, 2007. As of December 31, 2011 and 2010, there was no preferred stock outstanding.