4. Equity-Based Compensation

At September 28, 2013, Intevac had equity-based awards outstanding under the 2012 Equity Incentive Plan, the 2004 Equity Incentive Plan (the “Plans”) and the 2003 Employee Stock Purchase Plan (the “ESPP”). Intevac’s stockholders approved all of these plans. The Plans permit the grant of incentive or non-statutory stock options, restricted stock, stock appreciation rights, restricted stock units (“RSUs” also referred to as performance units) and performance shares.

The ESPP provides that eligible employees may purchase Intevac’s common stock through payroll deductions at a price equal to 85% of the lower of the fair market value at the beginning of the applicable offering period or at the end of each applicable purchase interval. Offering periods are generally two years in length, and consist of a series of six-month purchase intervals. Eligible employees may join the ESPP at the beginning of any six-month purchase interval. Under the terms of the ESPP, employees can choose to have up to 15% of their base earnings withheld to purchase Intevac common stock.

Compensation Expense

The effect of recording equity-based compensation for the three and nine months ended September 28, 2013 and September 29, 2012 was as follows:


	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
	(In thousands)
Equity-based compensation by type of award:
Stock options	$	375		$	523		$	651		$	1,843
RSUs		130			88			314			111
Employee stock purchase plan		249			332			871			987

Total equity-based compensation		754			943			1,836			2,941
Tax effect on equity-based compensation		(8	)		(205	)		(18	)		(706	)

Net effect on net loss	$	746		$	738		$	1,818		$	2,235

Equity-based compensation expense is based on awards ultimately expected to vest and such amount has been reduced for estimated forfeitures. Forfeitures were estimated based on Intevac’s historical experience, which Intevac believes to be indicative of Intevac’s future experience.

Stock Options and ESPP

The fair value of stock options and ESPP awards is estimated at the grant date using the Black-Scholes option valuation model. The determination of fair value of stock options and ESPP awards on the date of grant using an option-pricing model is affected by Intevac’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards and actual employee stock option exercise behavior.

Option activity as of September 28, 2013 and changes during the nine months ended September 28, 2013 were as follows:


	Shares			Weighted Average Exercise Price
Options outstanding at December 31, 2012		3,128,408		$	11.52
Options granted		902,770		$	5.59
Options cancelled and forfeited		(1,339,934	)	$	13.73
Options exercised		(69,838	)	$	3.91
Options outstanding at September 28, 2013		2,621,406		$	8.55
Vested and expected to vest at September 28, 2013		2,386,932		$	8.77
Options exercisable at September 28, 2013		1,412,001		$	10.34

Intevac issued 457,000 shares under the ESPP during the nine months ended September 28, 2013.

Intevac estimated the weighted-average fair value of stock options and employee stock purchase rights using the following weighted-average assumptions:


	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Stock Options:
Weighed-average fair value of grants per share	$	2.81		$	2.87		$	2.48		$	3.90
Expected volatility		55.06	%		63.19	%		56.40	%		63.80	%
Risk free interest rate		1.04	%		0.41	%		1.09	%		0.74	%
Expected term of options (in years)		4.02			3.94			4.22			4.63
Dividend yield		None			None			None			None


	Three Months Ended						Nine Months Ended
	September 28, 2013			September 29, 2012			September 28, 2013			September 29, 2012
Stock Purchase Rights:
Weighed-average fair value of grants per share	$	1.97		$	2.31		$	1.63		$	3.01
Expected volatility		43.09	%		63.23	%		51.54	%		62.36	%
Risk free interest rate		0.21	%		0.21	%		0.26	%		0.28	%
Expected term of purchase rights (in years)		1.00			1.85			1.77			1.68
Dividend yield		None			None			None			None

The computation of the expected volatility assumptions used in the Black-Scholes calculations for new grants and purchase rights is based on the historical volatility of Intevac’s stock price, measured over a period equal to the expected term of the grant or purchase right. The risk-free interest rate is based on the yield available on U.S. Treasury Strips with an equivalent remaining term. The expected term of employee stock options represents the weighted-average period that the stock options are expected to remain outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the equity-based awards and vesting schedules. The expected term of purchase rights represents the period of time remaining in the current offering period.

The dividend yield assumption is based on Intevac’s history of not paying dividends and the assumption of not paying dividends in the future.

Stock Option Exchange Program

During our Annual Stockholder’s Meeting held on May 9, 2013, our stockholders approved a one-time Employee Stock Option Exchange Program (the “Exchange Program”) pursuant to which eligible employees were provided an opportunity to exchange, on a grant-by-grant basis, eligible outstanding stock options for a lesser number of new options, to be granted under our 2012 Equity Incentive Plan. Options eligible for the Exchange Program are those that were granted prior to the 12-month period preceding the start of the Exchange Program offering period, and have exercise prices per share that are greater than $8.49, 50% above our closing per share stock price measured as of July 5, 2013 which is shortly before the start of the Exchange Program. The Exchange Program offering period commenced on July 6, 2013 and closed on August 6, 2013, at which time a total of 87 eligible option holders exchanged 766,000 outstanding stock options for 336,000 stock options.

The Exchange Program was launched to increase the intended retention and incentive value of employee equity awards, reduce the potential dilutive effect of our equity incentive program, and reduce pressure to grant additional equity awards to employees in the short term. Participation in the Exchange Program was made available to all employees in the United States and Singapore except for the Named Executive Officers. Non-employee members of our board of directors were also not eligible to participate. The exchange of options under the Exchange Program resulted in a total incremental charge to compensation expense of $126,000. This incremental charge is being recognized over the vesting periods of the new options. These vesting periods range from one to three years beginning on the first anniversary of the grant.

RSUs

A summary of the RSU activity is as follows:


	Shares			Weighted Average Grant Date Fair Value
Non-vested RSUs at December 31, 2012		100,461		$	7.33
Granted		169,637		$	4.51
Vested		(21,327	)	$	7.54
Cancelled and forfeited		(11,922	)	$	6.72
Non-vested RSUs at September 28, 2013		236,849		$	5.32

RSUs are converted into shares of Intevac common stock upon vesting on a one-for-one basis. RSUs typically are scheduled to vest over four years. Vesting of RSUs is subject to the grantee’s continued service with Intevac. The compensation expense related to these awards is determined using the fair market value of Intevac common stock on the date of the grant, and the compensation expense is recognized over the vesting period.

Performance-based RSUs (“performance-based awards”) granted to certain executive officers are also subject to the achievement of specified performance goals. These performance-based awards become eligible to vest only if performance goals are achieved and then actually will vest only if the grantee remains employed by Intevac through each applicable vesting date. The fair value of these performance-based awards is estimated on the date of grant and assumes that the specified performance goals will be achieved. If the goals are achieved, these awards vest over a specified remaining service period, provided that the grantee remains employed by Intevac through each scheduled vesting date. If the performance goals are not met, no compensation expense is recognized and any previously recognized compensation expense is reversed. The expected cost of each award is reflected over the service period and is reduced for estimated forfeitures. For performance-based awards granted during fiscal 2013, the performance goals require the achievement of targeted revenues and adjusted annual operating profit levels measured at the end of two and three-year periods.