Note 11 – Stock Options and Stock-based Employee Compensation

Long-Term Incentive Plans

In October 2011, our stockholders approved the 2011 Plan, which replaced the 2007 Plan. See, Note 10 – Common shares reserved for potential future issuance upon exercise of stock options or granting of additional equity incentive awards. The purpose of the 2011 Plan is to (i) encourage eligible participants to acquire a proprietary interest in our company, (ii) provide employees incentives to contribute to our future success, thereby enhancing stockholder value, and (iii) attract and retain exceptionally qualified individuals upon whom, in large measure, our sustained progress, growth and profitability depend. The 2011 Plan continues many of the features of the 2007 Plan, but is updated to reflect changes to Nasdaq rules regarding equity compensation, other regulatory changes and market and corporate governance developments. Awards outstanding under the 2007 Plan and 1998 Plan continue to be governed by the terms of that plan and the applicable award agreements.

Under the 2011 Plan, we may grant awards for up to 3.7 million shares of our common stock. Additionally, any shares returnable to the 2007 Plan as a result of cancellations, expirations and forfeitures will become available for issuance under the 2011 Plan. As of December 31, 2011, under the 2011 Plan, awards with respect to 1,709,000 shares are outstanding, 114,721 shares have been made available for issuance from the 2007 Plan and 2,105,721 shares are available for grant. An administrative committee (the Committee – currently the Compensation Committee of the Board of Directors) or Committee delegates may determine the types, the number of shares covered by, and the terms and conditions of, such awards. Eligible participants may include any of our employees, directors, advisors or consultants.

Awards under the plans may include:

Stock Options and Stock Appreciation Rights (SARs)

The Committee may award nonqualified stock options, incentive stock options, or SARs with a term of not more than ten years and a purchase price not less than 100% of the fair market value on the date of grant. The Committee will establish the vesting schedule for stock options and the method of payment for the exercise price, which may include cash, shares, or other awards. Although individual grants may vary, option awards generally are exercisable upon vesting, vest based upon three years of continuous service and have a 10-year term. In addition, awards under the 2011 Plan must comply with the provisions of Section 162(m) of the Internal Revenue Code.

Restricted Stock and Restricted Stock Units

The Committee may grant restricted stock awards (RSAs) and restricted stock units and, among other things, establish the applicable restrictions, including any limitation on voting rights or the receipt of dividends, and will establish the manner and timing under which restrictions may lapse. If employment is terminated during the applicable restriction period (other than as a result of death or disability), shares of restricted stock and restricted stock units still subject to restriction will be forfeited, except as determined otherwise by the Committee.

Performance Awards and Other Stock-Based Awards

The Committee may grant performance awards, which may be denominated in cash, shares, other securities or other awards and payable to, or exercisable by, the participant upon the achievement of performance goals during performance periods, as established by the Committee. The Committee may grant other stock-based awards that are denominated or payable in shares, under the terms and conditions as the Committee determines.

Dividend Equivalents

The Committee may grant dividend equivalent awards that entitle the participant receiving such award the right to receive payments equivalent to dividends or interest with respect to the number of shares and on the terms as determined by the Committee. The Committee may provide that the amounts (if any) of such awards will be deemed to have been reinvested in additional shares or otherwise reinvested.

No SARs, Performance Awards or Dividend Equivalents have been granted under any 2011 Plan. During 2010, there were 154,333 RSAs granted under the 2007 Plan. The RSA's granted to non-officer employees vested on the first anniversary of the grant date. The RSA's granted to officers provided for vesting on the earliest of (i) the second anniversary of the grant date; (ii) FDA marketing approval for SURFAXIN®; or (iii) the effective date of a strategic alliance or collaboration agreement as determined by the Board of Directors. These RSAs vested on March 6, 2012 upon the issuance of FDA marketing approval for SURFAXIN. As of December 31, 2011 and 2010, there were 128,334 and 154,333 unvested restricted stock awards outstanding, respectively.

A summary of stock option activity under our long-term incentive plans during the periods ended December 31, 2011 and 2010, respectively, is presented below:

(in thousands, except for weighted-average data)

Stock Options	Price Per Share (range)		Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (In Yrs)


Outstanding at December 31, 2009	$	7.35– $156.45		1,065		$	56.46

Granted	$	2.55 – $5.85		20			3.19
Exercised		–		–			–
Forfeited or expired	$	5.40 – $137.55		(142	)		51.93
Outstanding at December 31, 2010	$	2.55 – $156.45		943		$	56.06

Granted	$	1.58 – $3.41		1,771		$	1.84
Exercised		–		–			–
Forfeited or expired	$	1.83 – $137.55		(276	)	$	44.95
Outstanding at December 31, 2011	$	1.58 – $156.45		2,438		$	17.97	8.1

Exercisable at December 31, 2011	$	2.55 – $156.45		667		$	60.73	4.2

Based upon application of the Black-Scholes option-pricing formula described below, the weighted-average grant-date fair value of options and awards granted during the years ended December 31, 2011 and 2010 was $1.45 and $2.48, respectively. There were no options exercised during the years ended December 31, 2011 and 2010, respectively. The total intrinsic value of options outstanding, vested and exercisable as of December 31, 2011 is $1,155, $0 and $0, respectively.

A summary of nonvested shares issuable upon exercise of outstanding options and changes during 2011 is presented below:

(shares in thousands)	Option Shares			Weighted- Average Grant- Date Fair Value

Non-vested at December 31, 2010		64		$	10.05
Granted		1,771			1.84
Vested		(59	)		10.86
Forfeited		(5	)		7.43
Non-vested at December 31, 2011		1,771		$	1.85

The following table provides detail with regard to options outstanding, vested and exercisable at December 31, 2011:

(shares in thousands)				Outstanding			Vested and Exercisable
Price per share		Shares		Weighted- Average Price per Share		Weighted- Average Remaining Contractual Life	Shares		Weighted- Average Price per Share		Weighted- Average Remaining Contractual Life
$	1.58 - $3.60		1,783	$	1.85	9.58 Years		13	$	3.08	8.84 Years
$	3.61 – $10.95		12	$	9.69	6.66 Years		12	$	9.73	7.85 Years
$	10.96 – $156.45		643	$	62.78	4.05 Years		642	$	62.87	4.21 Years
			2,438					667

Stock-Based Compensation

We recognized stock-based compensation expense in accordance ASC Topic 718 for the years ended December 31, 2011 and 2010, of $0.9 million and $1.4 million, respectively.

Stock-based compensation expense was classified as follows:

	December 31,
(in thousands)	2011		2010

Research and development	$	289	$	479
General and administrative		578		931
Total	$	867	$	1,410

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing formula that uses assumptions noted in the following table. Expected volatilities are based upon the historical volatility of our common stock and other factors. We also use historical data and other factors to estimate option exercises, employee terminations and forfeiture rates within the valuation model. The risk-free interest rates are based upon the U.S. Treasury yield curve in effect at the time of the grant.

	December 31,
	2011	2010

Weighted average expected volatility	113%	112%
Weighted average expected term	4.8 years	4.9 years
Weighted average risk-free interest rate	1.08%	1.47%
Expected dividends	–	–

The total fair value of the underlying shares of the options vested during 2011 and 2010, equals $0.6 million and $1.5 million, respectively. As of December 31, 2011, there was $2.5 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average vesting period of 2.7 years.