Note 11 – Stock Options and Stock-based Employee Compensation

Long-Term Incentive Plans

In October 2011, our stockholders approved the 2011 Plan, which replaced the 2007 Plan. (See, Note 10 – Common shares reserved for potential future issuance upon exercise of stock options or granting of additional equity incentive awards.) The 2011 Plan continues many of the features of the 2007 Plan, but is updated to reflect changes to The Nasdaq Capital Market rules regarding equity compensation, other regulatory changes and market and corporate governance developments. Awards outstanding under the 2007 Plan and 1998 Plan continue to be governed by the terms of those plans and the applicable award agreements.

Under the 2011 Plan, we may grant awards for up to 6.2 million shares of our common stock. Additionally, any shares returnable to the 2007 Plan as a result of cancellations, expirations and forfeitures will become available for issuance under the 2011 Plan. Awards under the Plan may include stock options, stock appreciation rights (SARs), restricted stock (RSAs), restricted stock units, other performance and stock-based awards, and dividend equivalents.

An administrative committee (the Committee – currently the Compensation Committee of the Board of Directors) or Committee delegates may determine the types, the number of shares covered by, and the terms and conditions of, such awards. Eligible participants may include any of our employees, directors, advisors or consultants.

As of December 31, 2012, under the 2011 Plan, there were 3,365,166 stock options outstanding and 2,965,887 shares available for grant. No SARs, RSAs, restricted stock units, other performance and stock-based awards, and dividend equivalents have been granted under the 2011 Plan. Although individual grants may vary, option awards generally are exercisable upon vesting, vest based upon three years of continuous service and have a 10-year term.

During 2010, there were 154,333 RSAs granted under the 2007 Plan. The RSA's granted to non-officer employees vested on the first anniversary of the grant date. The RSA's granted to officers provided for vesting on the earliest of (i) the second anniversary of the grant date; (ii) FDA marketing approval for SURFAXIN; or (iii) the effective date of a strategic alliance or collaboration agreement as determined by the Board of Directors. These RSAs vested on March 6, 2012 with the FDA marketing approval for SURFAXIN. There were no unvested RSAs outstanding as of December 31, 2012. As of December 31, 2011, there were 128,334 unvested RSAs outstanding.

A summary of activity under our long-term incentive plans is presented below:

(in thousands, except for weighted-average data)				Weighted- Average	Weighted- Average Remaining
Stock Options	Shares			Exercise Price	Contractual Term (In Yrs)

Outstanding at December 31, 2009	1,065		$	56.46

Granted	20			3.19
Exercised	–			–
Forfeited or expired	(142	)		51.93
Outstanding at December 31, 2010	943		$	56.06

Granted	1,771			1.84
Exercised	–			–
Forfeited or expired	(276	)		44.95
Outstanding at December 31, 2011	2,438		$	17.97

Granted	1,724			2.63
Exercised	(3	)		1.83
Forfeited or expired	(162	)		24.39
Outstanding at December 31, 2012	3,997		$	11.11	7.9

Exercisable at December 31, 2012	1,654		$	23.53	6.9

Based upon application of the Black-Scholes option-pricing formula described below, the weighted-average grant-date fair value of options and awards granted during the years ended December 31, 2012, 2011 and 2010 was $2.02, $1.45 and $2.48, respectively. For the year ended December 31, 2012, there were 3,334 options exercised, resulting in approximately $6,000 in proceeds. There were no options exercised during the years ended December 31, 2011 and 2010. The total intrinsic value of options outstanding, vested and exercisable as of December 31, 2012 is $0.5 million, $0.2 million and $0.2 million, respectively.

A summary of nonvested shares issuable upon exercise of outstanding options and changes during 2012 is presented below:

(shares in thousands)	Option Shares			Weighted- Average Grant- Date Fair Value

Non-vested at December 31, 2011		1,771		$	1.85
Granted		1,724			2.63
Vested		(1,087	)		2.04
Forfeited		(65	)		2.37
Non-vested at December 31, 2012		2,343		$	2.33

The following table provides detail with regard to options outstanding, vested and exercisable at December 31, 2012:

(shares in thousands)

Outstanding

Vested and Exercisable

Price per share

Weighted-

Average Price

per Share

Weighted- Average Remaining Contractual Life

Weighted-

Average Price

per Share

Weighted- Average Remaining Contractual Life

$1.58 - $156.45

3,997

11.11

7.9 Years

1,654

23.53

6.9 Years

Stock-Based Compensation

We recognized stock-based compensation expense in accordance ASC Topic 718 for the years ended December 31, 2012, 2011 and 2010, of $2.4 million, $0.9 million and $1.4 million, respectively.

Stock-based compensation expense was classified as follows:

	December 31,
(in thousands)	2012		2011		2010

Research and development	$	487	$	289	$	479
Selling, General and administrative		1,924		578		931
Total	$	2,411	$	867	$	1,410

On December 31, 2012, W. Thomas Amick, our former Chief Executive Officer, resigned from his position and as a member of our Board. Under the terms of a separation agreement between Mr. Amick and the company, all of Mr. Amick's outstanding options vested immediately and all such options shall remain exercisable to the end of their stated terms. The company recognized $0.8 million in stock option modification costs related to these items.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing formula that uses assumptions noted in the following table. Expected volatilities are based upon the historical volatility of our common stock and other factors. We also use historical data and other factors to estimate option exercises, employee terminations and forfeiture rates within the valuation model. The risk-free interest rates are based upon the U.S. Treasury yield curve in effect at the time of the grant.

	December 31,
	2012	2011	2010

Weighted average expected volatility	111%	113%	112%
Weighted average expected term	4.6 years	4.8 years	4.9 years
Weighted average risk-free interest rate	0.74%	1.08%	1.47%
Expected dividends	–	–	–

The total fair value of the underlying shares of the options vested during 2012, 2011 and 2010, equals $2.2 million, $0.6 million and $1.5 million, respectively. As of December 31, 2012, there was $3.4 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average vesting period of 2.1 years.