12. Stock-based Compensation

We account for stock-based payment awards in accordance with ASC 718, Stock Compensation, which requires the measurement and recognition of compensation expense for all equity awards granted to our employees and directors, including employee stock options, RSAs, RSUs, and ESPP purchases related to all stock-based compensation plans based on the fair value of such awards on the date of grant. We amortize stock-based compensation cost on a graded vesting basis over the vesting period, after assessing the probability of achieving the requisite performance criteria with respect to performance-based awards. Stock-based compensation cost is recognized over the requisite service period for each separately vesting tranche of the award as though the award were, in substance, multiple awards.

The following table summarizes stock-based compensation expense related to stock options, ESPP purchases, RSUs, and RSAs under ASC 718 for the three and nine months ended September 30, 2011 and 2010 (in thousands):


	Three months ended September 30,						Nine months ended September 30,
	2011			2010			2011			2010
Employee stock options	$	401		$	395		$	1,736		$	1,061
Non-vested RSUs and RSAs		4,050			4,324			13,195			9,879
ESPP		836			190			2,632			1,198

Total stock-based compensation		5,287			4,909			17,563			12,138
Tax effect on stock-based compensation		(1,870	)		(631	)		(5,600	)		(1,797	)

Net effect on net income (loss)	$	3,417		$	4,278		$	11,963		$	10,341

Valuation Assumptions

We use the Black-Scholes-Merton ("BSM") option pricing model to value stock-based compensation for all equity awards, except market -based awards. Market-based awards are valued using a Monte Carlo valuation model.

Option pricing models were developed to estimate the value of traded options that have no vesting or hedging restrictions and are fully transferable. The BSM model determines the fair value of stock-based payment awards based on the stock price on the date of grant and is affected by 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, expected term, interest rates, and actual and projected employee stock option exercise behavior. Expected volatility is based on the historical volatility of our stock over a preceding period commensurate with the expected term of the option. The expected term is based upon management's consideration of the historical life, vesting period, and contractual period of the options granted. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Expected dividend yield was not considered in the option pricing formula since we do not pay dividends and have no current plans to do so in the future.

The estimated per share weighted average fair value of stock options granted and ESPP shares issued and the assumptions used to estimate fair value for the three and nine months ended September 30, 2011 and 2010 are as follows:


	Stock Options
	Three months ended September 30,					Nine months ended September 30,
	2011⁽¹⁾		2010			2011			2010
Weighted average fair value per share		N/A	$	4.24		$	6.80		$	4.35
Expected volatility		N/A		47.2	%		47.7	%		46.5	%
Risk-free interest rate		N/A		1.1	%		1.4	%		1.5	%
Expected term (in years)		N/A		4.00			4.00			4.00

(1)	No stock options were granted during the three months ended September 30, 2011.


	Employee Stock Purchase Plan
	Three months ended September 30,						Nine months ended September 30,
	2011			2010			2011			2010
Weighted average fair value per share	$	4.98		$	3.76		$	4.79		$	3.82
Expected volatility		28%-36	%		39% 0-51	%		28%-42	%		32% -66	%
Risk-free interest rate		0.2%-0.4	%		0.2% -0.6	%		0.2%-0.6	%		0.2% -1.2	%
Expected term (in years)		0.5 -2.0			0.5 -2.0			0.5 -2.0			0.5 -2.0

Stock options outstanding and exercisable as of September 30, 2011 and activity for the nine months ended September 30, 2011 are summarized below (in thousands, except for weighted average exercise price and contractual term):


	Nine months ended September 30, 2011
	Options outstanding			Weighted average exercise price		Weighted average remaining contractual term (years)		Aggregate intrinsic value
Options outstanding at January 1, 2011		2,529		$	14.64

Options granted		40			17.97
Options forfeited and expired		(58	)		18.14

Options forfeited and expired, net of granted		(18	)
Options exercised		(143	)		13.15

Options outstanding at September 30, 2011		2,368		$	14.70		3.42	$	2,173

Options vested and expected to vest at September 30, 2011		2,267		$	14.83		3.34	$	1,962

Options exercisable at September 30, 2011		1,644		$	15.93		2.56	$	790

Aggregate intrinsic value for stock options represents the difference between the closing price per share of our common stock on the last trading day of the fiscal period and the option exercise price, multiplied by the number of in-the-money stock options outstanding, vested and expected to vest, and exercisable at September 30, 2011.

Non-vested shares of RSUs and RSAs as of September 30, 2011 and activity during the nine months ended September 30, 2011 are summarized below (shares in thousands):


	Nine months ended September 30, 2011
	Restricted Stock Units					Restricted Stock Awards
	Shares			Weighted average grant date fair value		Shares			Weighted average grant date fair value

Non-vested at January 1, 2011		2,538		$	11.67		101		$	27.21
Restricted stock granted		1,457			15.10		—			—
Restricted stock vested		(1,174	)		15.53		(101	)		27.21
Restricted stock forfeited		(210	)		11.83		—			—

Non-vested at September 30, 2011		2,611		$	12.44		—		$	—

The performance-based RSAs vested on March 15, 2011 based on achievement of a specified percentage of the 2010 operating plan. The unrecognized compensation expense of $0.1 million related to non-vested RSAs was recognized during the quarter ended March 31, 2011.

The grant date fair value of restricted stock vested during the nine months ended September 30, 2011 was $18.2 million. The aggregate intrinsic value at September 30, 2011 for RSUs expected to vest was $30.8 million and the remaining weighted average vesting period was 1.4 years. Aggregate intrinsic value for RSUs expected to vest represents the closing price per share of our common stock on the last trading day of the fiscal period, multiplied by the number of RSUs expected to vest as of September 30, 2011.

Amended and Restated 2009 Equity Incentive Award Plan

On May 18, 2011, our stockholders approved amendments to the 2009 Equity Incentive Award Plan to increase the number of shares of common stock reserved under the plan for future issuance from 5 to 7 million shares, provide flexibility with respect to the granting of performance-based awards, and authorize the granting of performance-based awards under the plan through the 2016 annual meeting of stockholders.

Performance-based and Market-based Stock Options and RSUs

RSUs granted during the nine months ended September 30, 2011 included 90,000 market-based RSUs, which vest when our average closing stock price exceeds defined multiples of the average closing stock price for 20 consecutive trading days preceding January 5, 2011. If these multiples are not achieved by January 5, 2018, the awards are forfeited. The grant date fair value is estimated to be $1.1 million and is being amortized over the average derived service period of 3.93 years. The average derived service period and total fair value were determined using the Monte Carlo valuation model based on our assumptions, which included a risk-free interest rate of 2.9% and an implied volatility of 40%. On May 10, 2011, 28,000 market-based RSUs vested due to achievement of the threshold multiple of the average closing stock price for 20 consecutive trading days preceding January 5, 2011. As of September 30, 2011, 62,000 market-based RSUs remain outstanding.

RSUs granted during the nine months ended September 30, 2011 included 323,600 performance-based RSUs, which vest when specified performance criteria are met based on 2011 revenue and non-GAAP operating income targets; otherwise, they are forfeited. Non-GAAP operating income is defined as operating income determined in accordance with GAAP, adjusted to remove the impact of certain expenses, and the tax effects of these adjustments. The grant date fair value was estimated to be $5.0 million, which is being amortized over their service periods of 1.0 year. The probability of achieving these awards was determined based on a review of the actual results achieved by each business unit during the nine months ended September 30, 2011 compared with the 2011 operating plan as well as the overall strength of the business unit within the EFI organization. Stock-based compensation expense was adjusted based on this probability assessment. As actual results are achieved during the year, the probability assessment will be updated and stock-based compensation expense adjusted accordingly. As of September 30, 2011, 314,886 performance-based RSUs remain outstanding.

RSUs granted during the nine months ended September 30, 2011 included 195,156 performance-based RSUs, which vest when specified performance criteria are met based on revenue and non-GAAP operating income targets during any four consecutive quarters between the first quarter of 2011 and the second quarter of 2014; otherwise, they are forfeited. Non-GAAP operating income is defined as operating income determined in accordance with GAAP, adjusted to remove the impact of certain expenses, and the tax effects of these adjustments. The grant date fair value was estimated to be $3.0 million, which is being amortized over their average derived service periods of 3.0 years.

RSUs granted during the year ended December 31, 2010 included 384,875 performance-based RSUs, which vested when specified performance criteria were met based on 2010 revenue targets and non-GAAP operating income targets; otherwise, they were forfeited. Non-GAAP operating income was defined as operating income determined in accordance with GAAP, adjusted to remove the impact of certain expenses, and the tax effects of these adjustments. The grant date fair value was estimated to be $4.7 million, which was amortized over their service periods of 1.0 year. The performance criteria was achieved with respect to approximately 88% of these RSUs as of December 31, 2010. Accordingly, these RSUs vested on March 2, 2011 when the associated service requirement was met.

RSUs and stock options granted during the year ended December 31, 2009 included 98,000 market-based RSUs and 294,076 market-based stock options. These awards vest when our average closing stock price exceeds defined multiples of the June 18, 2009 or August 28, 2009 closing stock prices for 20 consecutive trading days. If these multiples are not achieved by June 18, 2016 or August 28, 2016, the awards are forfeited. The grant date fair value is estimated to be $0.9 million for the RSUs and $1.7 million for the stock options, which are being amortized over their average derived service periods of 4.35 and 4.88 years, respectively. The average derived service period and total fair value were determined using the Monte Carlo valuation model based on our assumptions, which included a risk-free interest rate of 3.5% and 3.1%, respectively, and an implied volatility of 50%. On January 3 and 10, 2011, an aggregate of 29,335 market-based RSUs vested due to achievement of the threshold multiple of the June 18, 2009 and August 28, 2009 closing stock prices for 20 consecutive trading days. On April 27, 2011, 59,598 of these market-based stock options were vested due to achievement of the threshold multiple. As of September 30, 2011, 48,665 market-based RSUs and 178,790 market-based stock options remain outstanding.

Stock options granted during the year ended December 31, 2009 included 32,674 performance-based stock options. These performance-based stock options vest when our annual non-GAAP return on equity exceeds defined thresholds of the 2008 non-GAAP return on equity. Non-GAAP return on equity is defined as non-GAAP net income divided by stockholders' equity. Non-GAAP net income is defined as net income determined in accordance with GAAP adjusted to remove the impact of certain recurring and non-recurring expenses, and the tax effects of these adjustments. If these defined thresholds are not achieved by August 28, 2016, the stock options are forfeited. The grant date fair value is estimated to be $0.1 million, which is being amortized over the average derived service period of 3.71 years. The performance-based stock options were valued using the BSM valuation model. As of September 30, 2011, 26,487 performance-based stock options remain outstanding.