Stock-Based Compensation

Stock-based compensation expense is recognized in the Company's consolidated statements of operations and includes compensation expense for the stock-based compensation awards granted or modified subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of the amended authoritative guidance. The impact of the amended authoritative guidance on the Company's consolidated financial statements for the second quarter of 2011 and 2010 was as follows (in thousands):



	Three Months Ended				Six Months Ended
	July 3, 2011		July 4, 2010		July 3, 2011		July 4, 2010
Cost of revenue	$	35	$	39	$	70	$	86
Research and development	119		180		240		355
Selling, general and administrative	282		414		569		844
Total costs and expenses	$	436	$	633	$	879	$	1,285

The amount of stock-based compensation included in inventories for the second quarter of 2011 and 2010 was not significant.

Valuation Assumptions

The amended authoritative guidance requires companies to estimate the fair value of stock-based compensation awards. The fair value of stock-based compensation awards is measured at the grant date and re-measured upon modification, as appropriate. The Company uses the Black-Scholes option pricing model to estimate the fair value of employee stock options and rights to purchase shares under the Company's ESPP, consistent with the provisions of the amended authoritative guidance. Using the Black-Scholes pricing model requires the Company to develop highly subjective assumptions including the expected term of awards, expected volatility of its stock, expected risk-free interest rate and expected dividend rate over the term of the award. The Company's expected term of awards assumption is based primarily on its historical experience with similar grants. The Company's expected stock price volatility assumption for both stock options and ESPP shares is based on the historical volatility of the Company's stock, using the daily average of the opening and closing prices and measured using historical data appropriate for the expected term. The risk-free interest rate assumption approximates the risk-free interest rate of a Treasury Constant Maturity bond with a maturity approximately equal to the expected term of the stock option or ESPP shares. This fair value is expensed over the requisite service period of the award. The fair value of RSAs and RSUs is based on the closing price of the Company's common stock on the date of grant. Equity compensation awards which vest with service are expensed using the straight-line attribution method over the requisite service period.

In addition to the assumptions used in the Black-Scholes pricing model, the amended authoritative guidance requires that the Company recognize expense for awards ultimately expected to vest; therefore we are required to develop an estimate of the number of awards expected to be forfeited prior to vesting, or forfeiture rate. The forfeiture rate is estimated based on historical pre-vest cancellation experience and is applied to all share-based awards.

The following weighted average assumptions are included in the estimated fair value calculations for stock option grants:



	Three Months Ended				Six Months Ended
	July 3, 2011		July 4, 2010		July 3, 2011		July 4, 2010
Expected term (years)	4.93		5.42		4.93		5.42
Risk-free interest rate	1.99	%	2.40	%	2.00	%	2.40	%
Expected volatility	58.69	%	58.01	%	58.50	%	58.02	%
Expected dividend	—		—		—		—

The methodologies for determining the above values were as follows:


•	Expected term: The expected term represents the period that the Company's stock-based awards are expected to be outstanding and is estimated based on historical experience.


•	Risk-free interest rate: The risk-free interest rate assumption is based upon the risk-free rate of a Treasury Constant Maturity bond with a maturity appropriate for the expected term of the Company's employee stock options.


•	Expected volatility: The Company determines expected volatility based on historical volatility of the Company's common stock according to the expected term of the options.


•	Expected dividend: The expected dividend assumption is based on the Company's intent not to issue a dividend under its dividend policy.

The weighted average estimated fair value for options granted during the second quarter of 2011 and 2010 were $1.82 and $1.48 per option, respectively. The weighted average estimated fair value for options granted during the first half of 2011 and 2010 were $2.12 and $1.48 per option, respectively. As of July 3, 2011, the fair value of unvested stock options, net of expected forfeitures, was approximately $2.1 million. This unrecognized stock-based compensation expense is expected to be recorded over a weighted average period of 2.12 years.

Stock-Based Compensation Award Activity

The following table summarizes the shares available for grant under the 2009 Plan as of July 3, 2011:



	Shares Available for Grant
	(in thousands)
Balance at January 2, 2011	1,542
Authorized	1,500
Options granted	(20	)
Options forfeited or expired	751
RSUs granted	—
RSUs forfeited or expired	—
Balance at July 3, 2011	3,773

Stock Options

The following table summarizes stock options outstanding and stock option activity under the 1999 Plan and the 2009 Plan, and the related weighted average exercise price, for the first six months of 2011:



	Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Term	Aggregate Intrinsic Value
	(in thousands)				(in years)	(in thousands)
Balance outstanding at January 2, 2011	8,069		$	2.74
Granted	20		4.17
Forfeited or expired	(751	)	4.49
Exercised	(528	)	2.68
Balance outstanding at July 3, 2011	6,810		$	2.56	6.32	$	7,981
Exercisable at July 3, 2011	4,420		$	2.74	5.28	$	4,593
Vested and expected to vest at July 3, 2011	6,810		$	2.56	6.32	$	7,981

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on the Company's closing stock price of $3.62 as of the end of the Company's current reporting period, which would have been received by the option holders had all option holders exercised their options as of that date.

The total intrinsic value of options exercised during the first six months of 2011 and 2010 was $1.6 million and $409,000, respectively. Total cash received from employees as a result of employee stock option exercises during the first six months of 2011 and 2010 was approximately $1.4 million and $458,000, respectively. The Company settles employee stock option exercises with newly issued common shares. In connection with these exercises, there was no tax benefit realized by the Company due to the Company's current loss position. Total stock-based compensation related to stock options was $436,000 and $879,000 for the second quarter and first half of 2011, respectively.

Restricted Stock Awards and Restricted Stock Units

The Company began issuing restricted stock awards, or RSAs, in the second quarter of 2007 and restricted stock units, or RSUs, in the third quarter of 2007. RSAs entitle the holder to purchase shares of common stock at par value during a short period of time, and purchased shares are held in escrow until they vest. RSUs entitle the holder to receive, at no cost, one common share for each restricted stock unit as it vests. The Company withheld shares in settlement of employee tax withholding obligations upon the vesting of restricted stock units. There was no stock-based compensation related to RSUs for the second quarter of 2011.

Employee Stock Purchase Plan

The weighted average estimated fair value, as defined by the amended authoritative guidance, of rights issued pursuant to the Company's 2009 ESPP plan during the second quarter of 2011 and 2010 was $0.80 and $1.03 per right, respectively.

As of July 3, 2011, $2.3 million shares under the 2009 ESPP remained available for issuance. For the second quarter and first half of 2011, the Company recorded compensation expense related to the ESPP of $42,000 and $86,000, respectively.

The fair value of rights issued pursuant to the Company's ESPP was estimated on the commencement date of each offering period using the following weighted average assumptions:



	Three Months Ended				Six Months Ended
	July 3, 2011		July 4, 2010		July 3, 2011		July 4, 2010
Expected term (months)	6.00		6.00		6.00		6.00
Risk-free interest rate	0.10	%	0.22	%	0.10	%	0.22	%
Volatility	47.00	%	65.00	%	47.00	%	65.00	%
Dividend yield	—		—		—		—

The methodologies for determining the above values were as follows:


•	Expected term: The expected term represents the length of the purchase period contained in the ESPP.


•	Risk-free interest rate: The risk-free interest rate assumption is based upon the risk-free rate of a Treasury Constant Maturity bond with a maturity appropriate for the term of the purchase period.


•	Expected volatility: The Company determines expected volatility based on historical volatility of the Company's common stock for the term of the purchase period.


•	Expected dividend: The expected dividend assumption is based on the Company's intent not to issue a

dividend under its dividend policy.

As of July 3, 2011, the unrecognized stock-based compensation expense relating to the Company's ESPP was $59,000 and is expected to be recognized over a weighted average period of approximately 4.5 months.