Note 4 - Stock-based Compensation

In accordance with ASC Topic 718, stock-based compensation cost is estimated at the grant date, based on the estimated fair value of the awards, and recognized as expense ratably over the requisite service period of the award for awards expected to vest.

Stock Incentive Plans

Under the Broadcast International, Inc. 2004 Long-Term Incentive Plan (the "2004 Plan"), the board of directors may issue incentive stock options to employees and directors and non-qualified stock options to consultants of the company. Options generally may not be exercised until twelve months after the date granted and expire ten years after being granted. Options granted vest in accordance with the vesting schedule determined by the board of directors, usually ratably over a three-year vesting schedule upon the anniversary date of the grant. Should an employee terminate before the vesting period is completed, the unvested portion of each grant is forfeited. We have used the Black-Scholes valuation model to estimate fair value of our stock-based awards, which requires various judgmental assumptions including estimated stock price volatility, forfeiture rates, and expected life. Our computation of expected volatility is based on a combination of historical and market-based implied volatility. The number of unissued stock options authorized under the 2004 Plan at September 30, 2012 was 3,585,008.

The Broadcast International, Inc. 2008 Equity Incentive Plan (the "2008 Plan") has become our primary plan for providing stock-based incentive compensation to our eligible employees and non-employee directors and consultants of the company. The provisions of the 2008 Plan are similar to the 2004 Plan except that the 2008 Plan allows for the grant of share equivalents such as restricted stock awards, stock bonus awards, performance shares and restricted stock units in addition to non-qualified and incentive stock options. We continue to maintain and grant awards under our 2004 Plan which will remain in effect until it expires by its terms. The number of unissued shares of common stock reserved for issuance under the 2008 Plan was 962,367 at September 30, 2012.

Stock Options

We estimate the fair value of stock option awards granted beginning January 1, 2006 using the Black-Scholes option-pricing model. We then amortize the fair value of awards expected to vest on a straight-line basis over the requisite service periods of the awards, which is generally the period from the grant date to the end of the vesting period. The Black-Scholes valuation model requires various judgmental assumptions including the estimated volatility, risk-free interest rate and expected option term. Our computation of expected volatility is based on a combination of historical and market-based implied volatility. The risk-free interest rate was based on the yield curve of a zero-coupon U.S. Treasury bond on the date the stock option award was granted with a maturity equal to the expected term of the stock option award. The expected option term is derived from an analysis of historical experience of similar awards combined with expected future exercise patterns based on several factors including the strike price in relation to the current and expected stock price, the minimum vest period and the remaining contractual period.

The fair values for the options granted for the nine months ended September 30, 2011 and 2012 were estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Nine Months Ended September 30, 2011			Nine Months Ended September 30, 2012
Risk free interest rate		1.96	%		1.65	%
Expected life (in years)		6.28			10.0
Expected volatility		81.03	%		78.97	%
Expected dividend yield		0.00	%		0.00	%

The weighted average fair value of options granted during the nine months ended September 30, 2011 and 2012 was $0.63 and $0.27, respectively.

Warrants

We estimate the fair value of issued warrants on the date of issuance as determined using a Black-Scholes pricing model. We amortize the fair value of issued warrants using a vesting schedule based on the terms and conditions of each associated underlying contract, as earned. The Black-Scholes valuation model requires various judgmental assumptions including the estimated volatility, risk-free interest rate and warrant expected exercise term. Our computation of expected volatility is based on a combination of historical and market-based implied volatility. The risk-free interest rate was based on the yield curve of a zero-coupon U.S. Treasury bond on the date the warrant was issued with a maturity equal to the expected term of the warrant.

The fair values for the warrants issued for the nine months ended September 30, 2011 and 2012 estimated at the date of issuance using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Nine Months Ended September 30, 2011			Nine Months Ended September 30, 2012
Risk free interest rate		2.04	%		1.17	%
Expected life (in years)		5.00			5.76
Expected volatility		85.82	%		82.78	%
Expected dividend yield		0.00	%		0.00	%

The weighted average fair value of warrants issued during the nine months ended September 30, 2011 and 2012 was $0.79 and $0.23, respectively.

Results of operations for the nine months ended September 30, 2011 and 2012 includes $2,072,993 and $255,001, respectively, of non-cash stock-based compensation expense. Restricted stock units and options issued to directors vest immediately. All other restricted stock units, options and warrants are subject to applicable vesting schedules. Expense is recognized proportionally as each award or grant vests.

Included in the $2,072,993 non-cash stock-based compensation expense for the nine months ended September 30, 2011 are (i) $1,544,000 for 1,400,000 restricted stock units issued to 5 members of the board of directors, (ii) $124,000 for 200,000 restricted stock units issued to one employee, (iii) $263,572 for 600,000 options issued to one individual and one corporation for consulting services, (iv) $51,207 for 874,200 options granted to 38 employees, (v) $4,263 for 8,700 options granted to 15 of our non-employee installation technicians and (vi) $85,951 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2011.

Included in the $255,001 non-cash stock-based compensation expense for the nine months ended September 30, 2012 are (i) $50,500 for 202,633 restricted stock units issued to 5 members of the board of directors, (ii) $484 for 50,000 options granted to 4 employees and (iii) $204,017 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2012.

The impact on our results of operations for recording stock-based compensation for the three and nine months ended September 30, 2011 and 2012 is as follows:

	For the three months ended September 30,				For the nine months ended September 30,
	2011		2012		2011		2012
General and administrative	$	234,185	$	38,719	$	1,915,969	$	158,947
Research and development		51,934		22,696		157,024		96,054

Total	$	286,119	$	61,415	$	2,072,993	$	255,001

Due to unexercised options and warrants outstanding at September 30, 2012, we will recognize an additional aggregate total of $286,733 of compensation expense over the next four years based upon option and warrant award vesting parameters as shown below:


2012	$	42,572
2013		164,085
2014		79,224
2015		892
Total	$	286,733

The following unaudited tables summarize option and warrant activity during the nine months ended September 30, 2012.

	Options and Warrants Outstanding			Weighted Average Exercise Price

Outstanding at December 31, 2011		20,440,551		$	1.10
Options granted		50,000			0.37
Warrants issued		24,317,900			0.33
Expired		(140,169	)		1.31
Forfeited		(1,464,419	)		1.35
Exercised		--			--

Outstanding at September 30, 2012		43,203,863		$	0.52

The following table summarizes information about stock options and warrants outstanding at September 30, 2012.

		Outstanding						Exercisable
				Weighted Average Remaining		Weighted Average				Weighted Average
Range of Exercise Prices		Number Outstanding		Contractual Life (years)		Exercise Price		Number Exercisable		Exercise Price
$	0.17-0.95		39,173,684		4.62	$	0.43		38,728,684	$	0.43
	1.00-1.65		3,411,179		3.60		1.04		3,207,646		1.04
	2.25-5.00		619,000		2.98		3.05		619,000		3.05
$	0.17-5.00		43,203,863		4.52	$	0.52		42,555,330	$	0.51

Restricted Stock Units

The value of restricted stock units is determined using the fair value of our common stock on the date of the award and compensation expense is recognized in accordance with the vesting schedule. During the nine months ended September 30, 2011 and 2012, we awarded 1,600,000 and 202,633 restricted stock units, respectively.

The following is a summary of restricted stock unit activity for the nine months ended September 30, 2012.

	Restricted Stock Units		Weighted Average Grant Date Fair Value

Outstanding at December 31, 2011		2,550,000	$	1.25
Awarded at fair value		202,633		0.25
Canceled/Forfeited		--		--
Settled by issuance of stock		--		--
Outstanding at September 30, 2012		2,752,633	$	1.18
Vested at September 30, 2012		2,752,633	$	1.18