5. ACCOUNTING FOR STOCK-BASED COMPENSATION

The value of restricted stock grants is calculated based upon the closing stock price of the Company’s Common Stock on the date of the grant. For stock options granted to employees and directors, we recognize compensation expense based on the grant-date fair value estimated in accordance with the appropriate accounting guidance, and recognized over the expected service period. We estimate the fair value of each option award on the date of grant using the Black-Scholes option pricing model. Stock options and warrants issued to consultants are accounted for in accordance with accounting guidance. Compensation expense is calculated each quarter for consultants using the Black-Scholes option pricing model until the option is fully vested and is included in research and development or general and administrative expenses, based upon the services performed by the recipient.

In December 1996, the Company adopted the Stock Option and Long-Term Incentive Compensation Plan (the “Incentive Plan”) and the Recognition and Retention Stock Incentive Plan (the “Recognition Plan”). A total of 133,333 shares were set aside for these two plans. In May 2000, the stockholders approved an increase in the number of shares reserved for the Incentive Plan and Recognition Plan to a total of 500,000. In June 2006, the Company adopted the NexMed, Inc. 2006 Stock Incentive Plan (the “2006 Plan”). A total of 200,000 shares were initially reserved for issuance under the 2006 Plan and an additional 133,333 shares were added to the 2006 Plan in June 2008. The Company received stockholder approval at its May 24, 2010 annual meeting to add an additional 1,000,000 shares to the 2006 Plan. The Company received stockholder approval at its May 16, 2011 annual meeting to increase the number of shares reserved for the 2006 Plan by 2,500,000 to 3,833,333. Options granted under the Company’s equity compensation plans generally vest over a period of one to five years, with exercise prices of currently outstanding options ranging from $3.23 to $21.00. The maximum option term under these plans is 10 years from the date of grant.

The following table summarizes information about options outstanding at March 31, 2012:


		Options Outstanding								Options Exercisable
				Weighted Average		Weighted		Aggregate				Weighted		Aggregate
Range of		Number		Remaining		Average		Intrinsic		Number		Average		Intrinsic
Exercise Prices		Outstanding		Contractual Life		Exercise Price		Value		Exercisable		Exercise Price		Value
$	3.23 - 5.36		1,786,000		9.5 years	$	3.86	$	-		255,837	$	4.27	$	-
$	10.05 - 21.00		33,333		3.8 years		14.39		-		33,333		14.39		-

			1,819,333		9.4 years	$	4.05	$	-		289,170	$	5.44	$	-

A summary of stock option activity is as follows:

				Weighted		Weighted	Total
				Average		Average Remaining	Aggregate
	Number of			Exercise		Contractual	Intrinsic
	Shares			Price		Life	Value
Outstanding at December 31, 2011		840,833		$	4.79	9.0 years	$	642,725
Granted		983,500		$	3.42
Exercised		(5,000	)	$	2.09
Cancelled		-		$	-
Outstanding at March 31, 2012		1,819,333		$	4.05	9.4 years	$	0

Vested or expected to vest at
March 31, 2012		1,770,939		$	4.05	9.4 years	$	0

Exercisable at March 31, 2012		289,170		$	5.44	8.3 years	$	0

The fair value of each stock option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions used for the period ended March 31, 2012.

			2012
Dividend yield			0.00%
Risk-free yields			0.9% - 1.1%
Expected volatility			70%
Expected option life			5.25 - 6 years
Forfeiture rate			2.66%

Expected Volatility. For options granted before December 31, 2011, the Company used analysis of historical volatility to compute the expected volatility of its stock options. In 2012 the Company determined that the long-term historical volatility of our stock price was not indicative of the future volatility of our stock price given the significant changes in the nature of our business over these past several years. As such, the Company considered the past year historical volatility of our stock price and the expected volatility of similar entities. In evaluating similar entities the Company considered such factors as industry, stage of development, size and financial leverage. The Company believes that this estimate provides the best representation of future long-term volatility.

Expected Term. The expected term is based on several factors including historical observations of employee exercise patterns during the Company’s history and expectations of employee exercise behavior in the future giving consideration to the contractual terms of the stock-based awards. The Company began issuing incentive stock options as compared to restricted stock grants towards the end of 2011. Due to the lack of recent reliable historic data, the Company applied the simplified method in developing the estimate of the expected term. We will employ this methodology for estimating the expected term of awards until such time that more refined estimates based on historical exercise behavior of the awards can be established.

Risk-Free Interest Rate. The interest rate used in valuing awards is based on the yield at the time of grant of a U.S. Treasury security with an equivalent remaining term.

Dividend Yield. The Company has never paid cash dividends, and does not currently intend to pay cash dividends, and thus has assumed a 0% dividend yield.

Pre-Vesting Forfeitures. Estimates of pre-vesting option forfeitures are based on Company experience. The Company will adjust its estimate of forfeitures over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of compensation expense to be recognized in future periods.

Total unrecognized compensation cost related to unvested stock options as of March 31, 2012 was approximately $4.0 million. That cost is expected to be recognized over 3 years.

Compensatory Share Issuances

The value of restricted stock grants is calculated based upon the closing stock price of the Company’s Common Stock on the date of the grant. The value of the grant is expensed over the vesting period of the grant in accordance with FASB ASC 718. As of March 31, 2012 there was $0.6 million of total unrecognized compensation cost related to non-vested restricted stock. That cost is expected to be recognized over 2.75 years.

A summary of the Company’s restricted stock award activity is as follows:

	Number of Shares			Weighted Average Exercise Price
Nonvested shares at December 31, 2011		257,063		$	4.93
Shares granted		8,168		$	3.04
Shares vested and issued		(88,348	)	$	4.92
Shares forfeited		-		$	-
Nonvested shares at March 31, 2012		176,883		$	4.83

The following table indicates where the total stock-based compensation expense resulting from stock options and awards appears in the Consolidated Statements of Operations:

	Three Months Ended
	March 31,
	2012		2011

Research and development	$	79,097	$	25,638
Selling, general and administrative		455,611		593,756

Stock-based compensation expense	$	534,708	$	619,394

The stock-based compensation expense has not been tax-effected due to the recording of a full valuation allowance against U.S. net deferred tax assets.