6. Stock-based Compensation

(a) Valuation of Options, SARs, and Performance Shares Granted

The Company has elected to use the BSM option-pricing model to estimate the fair value of stock options and SARs that it grants. The BSM model incorporates various assumptions including volatility, expected term of the option from the date of grant to the time of exercise, risk-free interest rates, and dividend yields. The weighted average fair value of options and SARs granted during the years ended December 31, 2012, 2011, and 2010, was $1.85, $4.05, and $3.94, respectively, and was determined using the following weighted average assumptions:



	Year ended 31 December
	2012	2011	2010
Expected dividend yield	—%	—%	—%
Risk-free interest rate	0.9%	1.2%	1.2%
Expected volatility	63.9%	64.2%	67.5%
Expected term (in years)	6.10	4.10	4.20

The expected dividend yield reflects the fact that the Company has not paid any dividends in the past and does not currently intend to pay dividends in the foreseeable future. The risk-free interest rate assumption is based on U.S. Treasury yields in effect at the time of grant for the expected term of the option. The expected volatility is based on both the historical volatility of the Company's common stock over the most recent period commensurate with the expected life of the option as well as on implied volatility calculated from the market traded options on the Company's stock. The expected term has been calculated by applying a Monte Carlo simulation model that incorporates the Company's historical data on post-vest exercise activity and employee termination behavior.

The grant date fair value of RSUs and RSAs granted to employees is determined by multiplying the fair market value of the Company's stock on the grant date times the number of RSUs and RSAs awarded. During 2011, the Company issued a limited number of performance shares to non-employee consultants. The final measurement date for these awards is determined at the earlier of the date at which a commitment for performance by the consultant to earn the performance shares is reached, or the date at which the consultant's performance necessary for the performance shares to vest has been completed. Between the date of issuance and the final measurement date, which is expected to be the date the consultants' performance is complete and the awards vest, the awards are remeasured based on the fair market value of the Company's stock at each reporting date. During the year ended December 31, 2012, awards granted to non-employee consultants and the related share-based payment expense was not significant.

(b) Equity Compensation Expense for RSUs and RSAs with Financial or other Performance-Based Vesting Requirements

As of December 31, 2012, there were 230,000 non-vested RSUs and RSAs that were subject to service-based vesting conditions as well as certain financial or other performance-based vesting requirements that must be achieved before vesting can occur. The following table contains pertinent information regarding these outstanding awards as of December 31, 2012 (in thousands except for number of awards granted):



Grant Date	# of Awards Granted	Fair Value on Grant Date		Cumulative Expense Recognized		Unearned Compensation Expense		Latest Date Performance Condition Could be Met
August 2010	142,500	$	1,058	$	451	$	607	April 2015
April 2011	17,500	156		51		105		April 2015
May 2011	20,000	212		67		145		April 2015
November 2011	50,000	277		53		224		April 2015
Total	230,000	$	1,703	$	622	$	1,081

Through December 31, 2012, cumulative compensation expense of $622,000 associated with these 230,000 unvested RSUs and RSAs has been recognized. From the date of grant through June 30, 2012, the Company had believed it was probable that the associated performance requirements would be achieved and therefore recognized expense on these awards. During the third quarter of 2012 and as of December 31, 2012, the Company believes that the performance condition is no longer probable of achievement. However, the Company has not yet determined that the performance condition is improbable of achievement. Therefore, beginning in the third quarter of 2012, the Company has discontinued the recognition of compensation costs related to these awards. If, prior to the expiration of the RSUs and RSAs, the Company determines that the performance condition is again probable, compensation expense will once again be recognized. Alternatively, if the Company determines that the performance condition is improbable of achievement, the cumulative compensation expense of $622,000 associated with these awards will be reversed.

c) Expense Allocation

Compensation expense for all share-based payment awards has been recognized using the accelerated multiple-option approach. As stock-based compensation expense recognized in the Consolidated Statements of Operations for the years ended December 31, 2012, 2011, and 2010 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures have been estimated based on historical experience.

As of December 31, 2012, total compensation cost related to non-vested stock options and other equity based awards not yet recognized was $8.9 million, which is expected to be recognized over the next 20 months on a weighted-average basis.

The following table summarizes stock-based compensation expense for the years ended December 31, 2012, 2011, and 2010 and its allocation within the consolidated statements of operations (in thousands):



	Year ended 31 December,
	2012		2011		2012
Cost of product	$	567	$	864	$	1,172
Cost of service	111		112		125
Stock based compensation expense included in cost of revenues	678		976		1,297
Product development	2,304		3,891		4,185
Sales and marketing	1,896		2,251		2,939
General and administrative	2,098		2,531		3,907
Stock based compensation expense included in operating expenses	$	6,298	$	8,673	$	11,031
Total stock based compensation expense related to stock options and share awards	$	6,976	$	9,649	$	12,328
Tax benefit	$	—	$	—	$	—
Stock-based compensation expense related to stock options and share awards, net of tax	$	6,976	$	9,649	$	12,328

As of December 31, 2012, approximately $38,000 and $3,000 of stock-based compensation expense was capitalized as part of the cost of inventory and deferred cost of goods sold, respectively. As of December 31, 2011, approximately $38,000 and $23,000 of stock-based compensation expense was capitalized as part of the cost of inventory and deferred cost of goods sold, respectively.