5. ACCOUNTING FOR STOCK-BASED COMPENSATION:

All equity-based payments to employees, including grants of employee stock options and restricted stock units, are recognized as an expense in our consolidated statement of operations based on the grant date fair value of the award. We utilize the straight-line method of expense recognition over the award’s service period for our graded vesting options. The fair value of stock options granted has been determined using the Black-Scholes model. The compensation expense recognized for all equity based awards is net of estimated forfeitures, which are based on historical data. We have classified equity based compensation within our statement of operations in the same manner as our cash based employee compensation costs.

Equity based compensation expense in the three months ended September 30, 2012 totaled $95,000 and includes $60,000 for stock option awards, $13,000 for our employee stock purchase plan, and $22,000 for unvested restricted stock units. Equity based compensation expense in the nine months ended September 30, 2012 totaled $349,000 and includes $190,000 for stock option awards, $43,000 for our employee stock purchase plan, $75,000 for unvested restricted stock units and $41,000 for shares issued to our non-employee directors upon their re-election to our board in May 2012.

Equity based compensation expense in the three months ended September 30, 2011 totaled $95,000 and includes $56,000 for stock option awards, $20,000 for our employee stock purchase plan, and $19,000 for unvested restricted stock units. Equity based compensation expense in the nine months ended September 30, 2011 totaled $343,000 and includes $169,000 for stock option awards, $62,000 for our employee stock purchase plan, $72,000 for unvested restricted stock units and $40,000 for shares issued to our non-employee directors upon their re-election to our board in May 2011.

At September 30, 2012, the total unrecognized compensation cost related to non-vested equity based compensation arrangements was $725,000 and the related weighted average period over which it is expected to be recognized is 1.65 years.

Stock Options

We have two stock incentive plans that are administered under the supervision of the Compensation Committee of the Board of Directors. In May 2012, our shareholders approved an amendment to our active stock incentive plan to increase the number of shares that may be issued under the plan by 350,000 shares. Including the newly approved shares, there are 1,056,689 shares of common stock reserved in the aggregate for issuance of options and other stock based benefits under these plans, including restricted stock units and share grants to employees, officers and others. Reserved shares underlying canceled options are available for future grant under our active plan. Options are granted at an option price per share equal to or greater than the market value on the date of grant. Generally, options granted to employees vest over a four-year period and expire seven or ten years after the date of grant. As of September 30, 2012, there were 530,905 shares of common stock available under these plans for future issuance to employees, officers and others.

The following is a summary of stock option activity during the nine months ended September 30, 2012:



	Options Outstanding		Weighted Average Exercise Price Per Share
Outstanding, December 31, 2011	515,987	$	10.07
Granted	105,833		7.30
Exercised	—		—
Expired	(130,500)		12.19
Forfeited	(4,687)		7.22
Outstanding, September 30, 2012	486,633	$	8.92

Exercisable, September 30, 2012	281,693	$	9.88

The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price. At September 30, 2012, the weighted average remaining contractual term of all outstanding options was 3.93 years and their aggregate intrinsic value was $311,189. At September 30, 2012, the weighted average remaining contractual term of options that were exercisable was 2.89 years and their aggregate intrinsic value was $235,205. We received no proceeds from the exercise of stock options in the nine months ended September 30, 2012. We received proceeds of $12,000 from the exercise of stock options in the nine months ended September 30, 2011. The excess tax benefit associated with the exercise of stock options in the nine months ended September 30, 2011 was inconsequential.

The fair values of the options granted to our employees were estimated on the date of grant using the Black-Scholes model. The Black-Scholes valuation model incorporates ranges of assumptions that are disclosed in the table below. The risk-free interest rate is based on the United States Treasury yield curve at the time of grant with a remaining term equal to the expected life of the awards. For options granted in the nine months ending September 30, 2012, we estimated the expected term for our graded vesting options, representing the length of time in years that the options are expected to be outstanding, using historical experience. Previously, we used the simplified method for expected term because our historical exercise experience was not expected to be representative of future exercise patterns. Expected volatility was computed based on historical fluctuations in the daily price of our common stock.

For stock options granted during the nine months ended September 30, 2012, we utilized the fair value of our common stock on the date of grant and employed the following key assumptions in computing fair value using the Black-Scholes option-pricing model:



			2012
Risk-free interest rates			0.86%
Expected life in years			4.95
Expected volatility			45.81%
Dividend yield			0.00%
Weighted average fair value on grant date			$2.94

Restricted Stock Units

Our 1998 Stock Incentive Plan also permits our Compensation Committee to grant other stock-based benefits, including restricted stock units. Restricted stock units are valued at a price equal to the fair market value of our common stock on the date of grant, vest over a four year period provided the employee is still working for the company and entitle the holders to one share of our common stock for each restricted stock unit. The aggregate fair value of outstanding restricted stock units as of September 30, 2012 was $284,000.

A summary of activity in non-vested restricted stock units for the nine months ended September 30, 2012 is as follows:



Non-vested restricted stock units	Shares		Weighted Average Grant Date Fair Value
Non-vested at December 31, 2011	19,404	$	7.58
Granted	21,389		7.30
Vested	(87)		7.71
Forfeited	(1,555)		7.23
Non-vested at September 30, 2012	39,151	$	7.44

Employee Stock Purchase Plan

We have an Employee Stock Purchase Plan available to eligible U.S. employees. Under terms of the plan, eligible employees may designate from 1% to 10% of their compensation to be withheld through payroll deductions, up to a maximum of $6,500 in each plan year, for the purchase of common stock at 85% of the lower of the market price on the first or last day of the offering period. There were 19,759 shares issued under this plan in the nine months ended September 30, 2012 and 25,003 shares issued in the nine months ended September 30, 2011. As of September 30, 2012, 166,582 shares remain available for future issuance under this plan.

Stock Grant Plan for Non-Employee Directors

Our stock grant plan for non-employee directors provides for automatic grants of 1,000 shares of our common stock to each of our non-employee directors upon their re-election to the board of directors. The plan provides for a total of 30,000 shares of our common stock for issuance to directors and will expire on May 19, 2018. We issued a total of 5,000 shares of common stock under this plan in connection with our annual meeting in May 2012, resulting in $41,000 of stock compensation expense in the nine months ended September 30, 2012. There are presently 11,000 shares of common stock reserved in the aggregate for future issuance under this plan.