11. Stockholders’ Equity

Convertible Preferred Stock

The Company is authorized to issue up to 2,000,000 shares of undesignated preferred stock from time to time in one or more series. During August 2007, the Company filed a Certificate of Designation authorizing the Company to issue up to 500,000 of the 2,000,000 shares of authorized undesignated preferred stock as shares of Series A Preferred Stock, par value $0.01 per share.

In August 2007, the Company issued 500,000 shares of Series A Preferred Stock, convertible into 1 million shares of common stock, and warrants to purchase an aggregate of 600,000 shares of common stock at an exercise price of $0.01 per share. The warrants were to expire December 31, 2007 but were exercised prior to that date. The purchase price for a unit of 1 share of Series A Preferred Stock and a warrant to purchase 1.2 shares of common stock was $10.00, resulting in net proceeds to the Company of approximately $4.9 million. Of the total $4.9 million proceeds received, approximately $2.3 million was allocated to the common stock warrants based on their estimated fair value at the time of issuance. On June 11, 2013, all outstanding shares of the Company’s Series A Preferred Stock automatically converted into 1,000,000 shares of common stock.

Stock-Based Compensation

1998 Stock Plan.

The 1998 Stock Plan (“the 1998 Plan”), as amended, provides for the granting to employees (including officers and non-employee directors) of incentive stock options and for the granting to employees (including officers and non-employee directors) and consultants of nonstatutory stock options, stock purchase rights (“SPRs”), restricted stock, restricted stock units (“RSUs”), performance shares, performance units and stock appreciation rights. The exercise price of incentive stock options and stock appreciation rights granted under the 1998 Plan must be at least equal to the fair market value of the shares at the time of grant. With respect to any recipient who owns stock possessing more than 10% of the voting power of our outstanding capital stock, the exercise price of any option or SPR granted must be at least equal to 110% of the fair market value at the time of grant. Options granted under the 1998 Plan are exercisable at such times and under such conditions as determined by the administrator; generally over a four year period. The maximum term of incentive stock options granted to any recipient must not exceed ten years; provided, however, that the maximum term of an incentive stock option granted to any recipient possessing more than 10% of the voting power of the Company’s outstanding capital stock must not exceed five years. In the case of SPRs, unless the administrator determines otherwise, the Company has a repurchase option exercisable upon the voluntary or involuntary termination of the purchaser’s employment with the Company for any reason (including death or disability). Such repurchase option lapses at a rate determined by the administrator. The purchase price for shares repurchased by the Company is the original price paid by the purchaser. As of December 28, 2013 and December 29, 2012, no shares were subject to repurchase. The form of consideration for exercising an option or stock purchase right, including the method of payment, is determined by the administrator. The 1998 Plan expired in February 2008.

2008 Equity Incentive Plan.

On June 11, 2008, the shareholders approved the adoption of the 2008 Equity Incentive Plan, (“the Incentive Plan”). There are no material changes in the Incentive Plan from the 1998 Plan. The maximum aggregate number of shares that may be awarded and sold under the Incentive Plan is 300,000 shares plus any shares subject to stock options or similar awards granted under the 1998 Plan that expire or otherwise terminate without having been exercised in full and shares issued pursuant to awards granted under the 1998 Plan that are forfeited to the Company on or after the date the 1998 Plan expires.

The following table summarizes information regarding activity in our stock option plans during the fiscal years ended 2013, 2012 and 2011 (in thousands except share and per share data):

				Outstanding Options
	Shares Available for Grant			Number of Shares			Aggregate Price			Weighted Average Exercise Price
FY 2010: Balances, January 1, 2011		760,137			1,618,066		$	5,906		$	3.65
Additional shares reserved		163,378
Options granted		(319,900	)		319,900			1,148			3.59
Restricted stock granted		(100,315	)
Options exercised		—			(99,291	)		(321	)		3.24
Options cancelled		72,274			(72,274	)		(353	)		4.88
Options expired		(70,353)			—			—			—
FY 2011: Balances, December 31, 2011		505,221			1,766,401			6,380			3.61
Additional shares reserved		391,166
Options granted		(335,050	)		335,050			1,313			3.92
Restricted stock granted		(66,665	)
Options exercised		—			(174,631	)		(445	)		2.55
Options cancelled		356,277			(356,277	)		(1,550	)		4.35
Options expired		(108,971)			—			—			—
FY 2012: Balances, December 29, 2012		741,978			1,570,543			5,698			3.63
Additional shares reserved		52,128
Options granted		(149,600	)		149,600			851			5.69
Restricted stock granted		(234,012	)
Options exercised		—			(493,622	)		(1,495	)		3.03
Options cancelled		123,679			(123,679	)		(698	)		5.64
Options expired		(57,628	)		—			—			—
FY 2013: Balances, December 28, 2013		476,545			1,102,842		$	4,356		$	3.97

There were 1,579,387 shares reserved for future issuance under the stock option plans at December 28, 2013.

The following table summarizes information with respect to stock options outstanding and exercisable at December 28, 2013:

	Options Outstanding						Options Vested and Exercisable
Range of Exercise Prices	Number of Shares Outstanding at December 28, 2013		Weighted Average Remaining Contractual Life (years)		Weighted Average Exercise Price		Number of Shares Exercisable at December 28, 2013		Weighted Average Exercise Price
$0.90 - $2.34		124,474		2.00	$	1.44		124,474	$	1.44
$2.35 - $2.78		117,142		0.90	$	2.49		117,142	$	2.49
$2.93 - $3.60		127,694		3.63	$	3.42		88,432	$	3.36
$3.72 - $3.75		65,833		4.78	$	3.72		39,000	$	3.72
$3.86 - $3.86		171,875		5.96	$	3.86		26,573	$	3.86
$3.89 - $4.11		111,325		4.60	$	3.98		62,498	$	3.97
$4.12 - $4.74		126,775		4.05	$	4.46		78,546	$	4.32
$4.86 - $5.92		173,091		3.52	$	5.63		104,367	$	5.45
$6.00 - $9.06		81,633		2.22	$	6.74		60,492	$	6.90
$10.19 - $10.19		3,000		6.93	$	10.19		—	$	0.00
$0.90 - $10.19		1,102,842		3.62	$	3.97		701,524	$	3.69

The determination of the fair value of options granted by the Company is computed using the Black-Scholes option pricing model with the following weighted average assumptions:

	Employee Stock Option Plan
	FY 2013	FY 2012	FY 2011
Average risk free interest rate	1.12%	0.68%	0.98%
Expected life (in years)	4.50 years	4.55 years	4.70 years
Dividend yield	—	—	—
Average volatility	71.5%	89.2%	92.2%

The weighted average grant date fair value of options granted as calculated using Black-Scholes option pricing was $3.16, $2.60, and $2.47 per share for the fiscal years 2013, 2012 and 2011, respectively.

Option pricing models require the input of various subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. The expected stock price volatility is based on analysis of the Company’s stock price history over a period commensurate with the expected term of the options, trading volume of the Company’s stock, look-back volatilities and Company specific events that affected volatility in a prior period. The Company had elected to use the simplified method for estimating the expected term prior to July 3, 2011. Effective July 3, 2011, the expected term of employee stock options represents the weighted average period the stock options are expected to remain outstanding and is based on the history of exercises and cancellations on all past option grants made by the Company, the contractual term, the vesting period and the expected remaining term of the outstanding options. The risk-free interest rate is based on the U.S. Treasury interest rates whose term is consistent with the expected life of the stock options. No dividend yield is included as the Company has not issued any dividends and does not anticipate issuing any dividends in the future.

The following table shows stock-based compensation expense by functional line item in the consolidated statements of operations for 2013, 2012 and 2011 (in thousands):

	FY 2013 Year Ended		FY 2012 Year Ended		FY 2011 Year Ended
	December 28, 2013		December 29, 2012		December 31, 2011
Cost of revenues	$	108	$	63	$	60
Research and development		71		77		76
Sales and marketing		113		105		112
General and administrative		397		143		230
Total stock-based compensation expense – continuing operations		689		388		478
Total stock-based compensation expense – discontinued operations		—		8		66
Total stock-based compensation expense	$	689	$	396	$	544

Stock-based compensation expense capitalized to inventory was immaterial for 2013, 2012, and 2011.

Information regarding stock options outstanding, exercisable and expected to vest as of December 28, 2013 is summarized below:

					Weighted Average		Aggregate
	Number of		Weighted Average		Remaining Contractual		Intrinsic Value
	Shares		Exercise Price		Life (years)		(thousands)
Options outstanding		1,102,842	$	3.97		3.62	$	6,287
Options vested and expected to vest		1,042,611	$	3.93		3.48	$	5,981
Options exercisable		701,524	$	3.69		2.33	$	4,196

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the Company’s closing stock price on the last trading day of fiscal 2013 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on December 28, 2013. This amount changes based on the fair market value of the Company’s common stock. The total intrinsic value of options exercised for fiscal years 2013, 2012 and 2011 were approximately $1.5 million, $261 thousand, and $84 thousand, respectively.

As of December 28, 2013, there was $1.4 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements under both of the plans. The cost is expected to be recognized over a weighted average period of 2.89 years.

Restricted Stock Awards/Restricted Stock Units

Effective for the 2011 fiscal year, each non-employee member of the Board received an annual equity award of either restricted stock or RSU, at the election of such Board member, in each case equal to $20 thousand worth of our common stock (determined at the fair market value of the shares at the time such award is granted) under the Company’s 2008 Equity Incentive Plan. Each equity award or RSU vests in full on the one-year anniversary of the date of grant provided that the non-employee member continues to serve on the Board through such date.

Summary of Restricted Stock Units and Awards

The Company recognizes the estimated compensation expense of restricted stock units and awards, net of estimated forfeitures, over the vesting term. The estimated compensation expense is based on the fair value of the Company’s common stock on the date of grant.

Information regarding the restricted stock units outstanding, vested and expected to vest as of December 28, 2013 is summarized below:

	Number of Shares		Weighted Average Remaining Contractual Life (years)		Aggregate Intrinsic Value (thousands)
Restricted stock units outstanding		269,259		0.86	$	2,604
Restricted stock units vested and expected to vest		243,471		0.85	$	2,354

The intrinsic value of the restricted stock units is calculated based on the closing price of IRIDEX shares as quoted on the NASDAQ Global Market on the last trading day of the year, December 27, 2013 of $9.67.

On March 25, 2013, the Company granted a restricted stock unit award for up to 220,000 shares of the Company’s common stock (the “Market Performance Award”) under the terms of the Company’s 2008 Equity Incentive Plan, as amended, to the Company’s President and Chief Executive Officer. The number of shares issuable pursuant to the Market Performance Award will be based upon the Company’s average stock price performance during the two months prior to and two months following the date the service condition is met, or the fair market value of the Company’s common stock in the event vesting is triggered by a change of control of the Company. The Market Performance Award is expected to vest on December 31, 2014, given that no other vesting triggers occur prior to that date. To the extent that the market condition is not met, the Market Performance Award will not vest and will be cancelled. Since the market conditions will affect the vesting of the Market Performance Award, the Company cannot use the Black-Scholes option pricing model to value the award; instead, a binomial model must be used. The Company utilized the Monte Carlo simulation technique, which incorporated assumptions for the expected holding period, risk-free interest rate, stock price volatility and dividend yield. The total value of the Market Performance Award was $258 thousand. Compensation expense is recognized ratably until such time as the market condition is satisfied.

Information regarding the restricted stock units and awards activity during the year ended December 28, 2013, December 29, 2012 and December 31, 2011 is summarized below:

	Number of Shares			Weighted Average Grant Date Fair Value

Outstanding at January 1, 2011		—		$	—
Restricted stock units granted		90,189		$	3.49
Outstanding at December 31, 2011		90,189		$	3.49
Restricted stock units granted		55,999		$	3.85
Restricted stock units released		(15,189	)	$	3.95
Restricted stock units forfeited		(75,000	)	$	3.40
Outstanding at December 29, 2012		55,999		$	3.85
Restricted stock units granted		230,509		$	4.51
Restricted stock units released		(17,249	)	$	3.77
Outstanding at December 28, 2013		269,259		$	4.42

Information regarding the restricted stock units and awards activity during the year ended December 28, 2013, December 29, 2012 and December 31, 2011 is summarized below:

	Number of Shares			Weighted Average Grant Date Fair Value
Outstanding at January 1, 2011		—		$	—
Restricted stock awards granted		10,126		$	3.95
Outstanding at December 31, 2011		10,126		$	3.95
Restricted stock awards granted		10,666		$	3.75
Restricted stock awards released		(10,126	)	$	3.95
Outstanding at December 29, 2012		10,666		$	3.75
Restricted stock awards granted		3,503		$	5.71
Restricted stock awards released		(10,666	)	$	3.75
Outstanding at December 28, 2013		3,503		$	5.71