5. Shareholders’ Equity.

Stock-Based Compensation. The Company’s stock-based compensation plans are administered by the Compensation Committee of the Board of Directors, which selects persons to receive awards and determines the number of shares subject to each award and the terms, conditions, performance measures and other provisions of the award.

The following table summarizes the stock-based compensation expense which was recognized in the Company’s Statements of Operations for the years ended December 31, 2012 and 2011:


Year ended December 31		2012		2011
Cost of sales	$	93,000	$	135,000
Selling		104,000		190,000
Marketing		18,000		90,000
General and administrative		127,000		306,000
	$	342,000	$	721,000

The Company uses the Black-Scholes option-pricing model to estimate fair value of stock-based awards with the following weighted average assumptions:


	2012		2011
Stock Options:
Expected life (years)	4.2		4.5
Expected volatility	71	%	70	%
Dividend yield	0	%	0	%
Risk-free interest rate	0.58	%	1.60	%

	2012		2011
Stock Purchase Plan Options:
Expected life (years)	1.0		1.0
Expected volatility	46	%	30	%
Dividend yield	0	%	0	%
Risk-free interest rate	0.12	%	0.30	%

The Company uses the straight-line attribution method to recognize expense for unvested options. The amount of stock-based compensation recognized during a period is based on the value of the awards that are ultimately expected to vest. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company will re-evaluate the forfeiture rate annually and adjust it as necessary.

As of December 31, 2012, there was approximately $649,000 of total unrecognized compensation costs related to the outstanding stock options which is expected to be recognized over a weighted average period of 2.3 years.

Stock Options. Prior to 2003, the Company had a stock option plan (the “1990 Plan”) for its employees and directors under which substantially all of the shares reserved for issuance had been issued. During May 2003, the Company’s shareholders approved the 2003 Incentive Stock Option Plan (the “2003 Plan”), which replaced the 1990 Plan. In May 2012, the Company’s shareholders voted to increase the common shares reserved for issuance from 3,175,000 to 3,675,000. Options granted under the 1990 Plan will remain in effect until they are exercised or expire according to their terms. All current option grants are made under the 2003 Plan.

Under the terms of the stock option plans, the Company grants incentive or non-qualified stock options to employees, consultants and directors generally at an exercise price at or above 100% of fair market value at the close of business on the date of grant. The stock options expire 10 years after the date of grant and generally vest over three years. The Company issues new shares of common stock when stock options are exercised.

The following table summarizes activity under the option plans:


	Plan Shares Available for Grant	Plan Options Outstanding		Weighted Average Exercise Price Per Share	Aggregate Intrinsic Value
Balance at December 31, 2010	89,805	2,597,924	$	3.55
Reserved	300,000	—
Granted	(416,450)	416,450		3.85
Exercised	—	(1,634,671)		2.31	$ 7,094,000
Cancelled - 2003 Plan	26,666	(26,666)		4.82
Cancelled - 1990 Plan	—	(118,300)		7.84

Balance at December 31, 2011	21	1,234,737		4.87

Reserved	500,000	—
Granted	(737,500)	737,500		1.67
Cancelled - 2003 Plan	337,164	(337,164)		3.77
Cancelled - 1990 Plan	—	(165,400)		9.19

Balance at December 31, 2012	99,685	1,469,673		3.03

The number of options exercisable under the option plans was:


December 31, 2011		562,488
December 31, 2012		572,552

The following table summarizes information about the stock options outstanding at December 31, 2012:


	Options Outstanding				Options Exercisable
Ranges of Exercise Prices	Number Outstanding	Weighted Average Remaining Contractual Life		Weighted Average Exercise Price Per Share	Number Exercisable	Weighted Average Exercise Price Per Share
$1.61 - $2.80	906,522	8.63	years	$ 1.85	230,055	$ 2.34
$3.13 - $5.49	512,251	7.07	years	4.56	291,597	4.66
$5.80 - $9.28	19,700	0.31	years	5.84	19,700	5.84
$9.58 - $10.90	31,200	0.15	years	10.37	31,200	10.37
	1,469,673	7.80	years	$ 3.03	572,552	$ 4.08

Options outstanding under the option plans expire at various dates during the period from January 2013 through December 2022. Options outstanding at December 31, 2012 had a weighted average remaining life of 7.8 years and an aggregate intrinsic value of $37,000. Options exercisable at December 31, 2012 had a weighted average remaining life of 5.5 years and an aggregate intrinsic value of $1,000. The weighted average grant-date fair value of options granted during the years ended December 31, 2012 and 2011 were $0.90 and $2.12.

Employee Stock Purchase Plan. The Company has an Employee Stock Purchase Plan (the “Plan”) that enables employees to contribute up to 10% of their base compensation toward the purchase of the Company’s common stock at 85% of its market value on the first or last day of the year. During the years ended December 31, 2012 and 2011, employees purchased 76,000 and 40,000 shares under the Plan. At December 31, 2012, 236,000 shares are reserved for future employee purchases of common stock under the Plan. For the years ended December 31, 2012 and 2011, the Company recognized $33,000 and $42,000, of stock-based compensation expense related to the Plan.

Dividends. On February 22, 2011, the Board declared a one-time special dividend of $2.00 per share to shareholders of record as of April 1, 2011, paid May 2, 2011. Since this special dividend exceeded 25% of the Company’s stock price, in accordance with applicable NASDAQ rules, the ex-dividend date was May 3, 2011, one day following the payment date. Outside of this special dividend, the Board of Directors presently intends to retain all earnings for use in the Company’s business and does not anticipate paying cash dividends in the foreseeable future.

Stock Repurchase Plan. On February 23, 2010, the Board of Directors authorized the repurchase of up to $2,000,000 of the Company’s common stock on or before January 31, 2011. The plan did not obligate the Company to repurchase any particular number of shares, and may have been suspended at any time at the Company’s discretion.

On February 22, 2011, the Board of Directors authorized the repurchase of up to $15,000,000 of the Company’s common stock on or before January 31, 2012, under a new plan. On May 25, 2011, the Board amended the plan to increase the maximum share purchase amount from $15,000,000 to $20,000,000. The plan did not obligate the Company to repurchase any particular number of shares, and expired on January 31, 2012. The Company repurchased a total of 3,877,000 shares totaling $17,562,000 under this plan.

During the year ended December 31, 2011, the Company repurchased shares of stock from certain executive officers and employees of the Company. These share repurchases qualify as related party transactions. The Company repurchased a total of approximately 738,000 shares from these individuals at a total amount of $1,590,000.