Quarterly report pursuant to Section 13 or 15(d)

STOCK-BASED COMPENSATION

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STOCK-BASED COMPENSATION
 9 Months Ended
Sep. 30, 2011
STOCK-BASED COMPENSATION
7. 
STOCK-BASED COMPENSATION
 
In connection with the Acquisition, the Company assumed options to purchase 49,159 shares of common stock at exercise prices ranging from $1.53 to $1,072.53.

Following the Acquisition, option grants to directors and employees will be made under the Novelos Therapeutics 2006 Stock Incentive Plan (the “2006 Plan”).  On May 18, 2011, the Board of Directors approved certain amendments to the 2006 Plan and on June 30, 2011, the Company’s stockholders ratified those amendments.  A total of 7,000,000 shares of common stock are reserved for issuance under the 2006 Plan for grants of incentive or nonqualified stock options, rights to purchase restricted and unrestricted shares of common stock, stock appreciation rights and performance share grants.  A committee of the board of directors determines exercise prices, vesting periods and any performance requirements on the date of grant, subject to the provisions of the 2006 Plan.  Options are granted at or above the fair market value of the common stock at the grant date and expire on the tenth anniversary of the grant date.  Vesting periods are generally between one and four years.  Options granted pursuant to the 2006 Plan generally will become fully vested upon a termination event occurring within one year following a change in control, as defined.  A termination event is defined as either termination of employment or services other than for cause or constructive termination of employees or consultants resulting from a significant reduction in either the nature or scope of duties and responsibilities, a reduction in compensation or a required relocation.  As of September 30, 2011, there are an aggregate of 3,476,112 shares available for grant under the 2006 Plan.

The following table summarizes amounts charged to expense for stock-based compensation related to employee and director stock option grants and stock-based compensation recorded in connection with stock options granted to non-employee consultants:

   
Nine Months Ended
September 30,
    
Cumulative
Development
Stage from
November 7,
 2002 (date of
inception) to
September 30,
2011
  
 
  
2011
    
2010
        
 
  
 
    
 
        
Employee and director stock option grants:
  
 
    
 
        
     Research and development
   $ 121,393     $ 52,492     $ 419,779  
     General and administrative
     349,781       278,694       1,927,084  
 
     471,174       331,186       2,346,863  
Non-employee consultant stock option grants:
                        
     Research and development
     46,851       —       46,851  
     General and administrative
     137,631       —       209,355  
 
     184,482       —       256,206  
 
                        
Total stock-based compensation
   $ 655,656     $ 331,186     $ 2,603,069  
 

 
On May 18, 2011, the Company cancelled 100,000 options originally granted on April 25, 2011 with an exercise price of $3.00 per share and issued 100,000 replacement stock option awards with an exercise price of $1.40.  The cancellation and replacement constituted a modification to the terms of the award and additional stock-based compensation was measured as the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.  Accordingly, incremental stock-based compensation expense of $4,494 was recorded during the second quarter of 2011 in connection with the modification.

The Company granted 3,496,400 stock options to employees and non-employees during the nine months ended September 30, 2011 under the 2006 Plan.   The Company issued options to purchase a total of 200,000 shares of common stock to non-employees outside of any formalized plan, but 100,000 were forfeited as a result of the cancellation and replacement as described above.  Exercise prices for all grants of options to purchase common stock made during the nine months ended September 30, 2011 were equal to the market value of the Company’s common stock on the date of grant.

Assumptions Used In Determining Fair Value

Valuation and amortization method. The fair value of each stock award is estimated on the grant date using the Black-Scholes option-pricing model.  The estimated fair value of employee stock options is amortized to expense using the straight-line method over the vesting period.  The estimated fair value of the non-employee options is amortized to expense over the period during which a non-employee is required to provide services for the award (usually the vesting period).

Volatility. The Company estimates volatility based on an average of (1) the Company’s historical volatility since its common stock has been publicly traded and (2) review of volatility estimates of publicly held drug development companies with similar market capitalizations.  The Company utilizes this average approach since its historical volatility would not necessarily be indicative of its expected future volatility due to the significant change in the stage of development that occurred in connection with the Acquisition.

Risk-free interest rate. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant commensurate with the expected term assumptions for the option awards.

Expected term. The expected term of stock options granted is based on an estimate of when options will be exercised in the future.  As the Company has had a significant change in its business operations as result of the Acquisition and the historical experience is not indicative of the expected behavior in the future, the Company applied the simplified method of estimating the expected term of the options.  The expected term, calculated under the simplified method, is applied to groups of stock options that have similar contractual terms.  Using this method, the expected term is determined using the average of the vesting period and the contractual life of the stock options granted.  The Company applied the simplified method to non-employees who have a truncation of term based on termination of service and utilizes the contractual life of the stock options granted for those non-employee grants which do not have a truncation of service.

Forfeitures.   Stock-based compensation expense is recorded only for those awards that are expected to vest.  FASB ASC Topic 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  The term “forfeitures” is distinct from “cancellations” or “expirations” and represents only the unvested portion of the surrendered option.  An annual forfeiture rate of 0% was applied to all unvested options as of September 30, 2011 as the historical experience of forfeitures is not representative of expected future forfeiture rates as a result of the significant changes in the business operations as a result of the Acquisition.  This analysis will be re-evaluated semi-annually and the forfeiture rate will be adjusted as necessary.  Ultimately, the actual expense recognized over the vesting period will be for only those shares that vest.

 
The following table summarizes weighted-average values and assumptions used for options granted to employees, directors and consultants in the periods indicated:
 
   
Nine Months
Ended
September 30,
2011
  
Volatility
     110 %
Risk-free interest rate
     1.84% – 3.17 %
Expected life (years)
     5.5 – 6.25  
Dividend
     0 %
Weighted-average exercise price
   $ 1.45  
Weighted-average grant-date fair value
   $ 1.22  

There were no options granted during the three months ended September 30, 2011 or during the three or nine months ended September 30, 2010.

A summary of stock option activity under stock option plans for the nine months ended September 30, 2011 is as follows:

   
Number of
Shares
Issuable Upon
Exercise of 
Outstanding
Options
    
Weighted
Average
Exercise Price
    
Weighted
Average
Remaining
Contracted
Term in
Years
    
Aggregate
Intrinsic
Value
  
Outstanding at December 31, 2010
    
769,189
    
$
2.69
                  
Granted
    
—
                          
Canceled
    
(769,189
)
  
$
2.69
                  
Outstanding at March 31, 2011
 
 
—
                        
 
Options acquired in connection with a business combination
    
49,159
    
$
100.52
                  
Granted
 
 
3,696,400
    
$
1.45
                
 
Canceled
    
(12,921
)
  
$
112.21
                  
Forfeited
    
(100,000
)
  
$
3.00
                  
Outstanding at June 30, 2011
 
 
3,632,638
    
$
2.35
                
 
Granted
    
—
    
$
—
                  
Canceled
    
—
    
$
—
                  
Outstanding at September 30, 2011
    
3,632,638
                          
                                 
Unvested, September 30, 2011
    
3,299,953
    
$
1.53
      
9.63
    
$
—
  
Vested, September 30, 2011
    
332,685
    
$
10.47
      
9.25
    
$
—
  
Exercisable at September 30, 2011
    
332,685
    
$
10.47
      
9.25
    
$
—
  

The aggregate intrinsic value of options outstanding is calculated based on the positive difference between the closing market price of the Company’s common stock at the end of the respective period and the exercise price of the underlying options.  There were no options exercised during the nine months ended September 30, 2011. Shares of common stock issued upon the exercise of options are from authorized but unissued shares.

As of September 30, 2011, there was $2,728,294 of total unrecognized compensation cost related to unvested stock-based compensation arrangements.  Of this total amount, the Company expects to recognize $281,357, $1,125,400, $858,452, $387,397 and $75,688 during 2011, 2012, 2013, 2014 and 2015, respectively.  The Company expects 3,299,953 of unvested options to vest in the future.  The weighted-average grant-date fair value of vested and unvested options outstanding at September 30, 2011 was $1.44 and $1.17, respectively.

On October 6, 2011, the Company granted 70,000 stock options with an exercise price of $1.05, which was equal to the closing price of the Company’s common stock on the date of grant, to a non-employee in exchange for certain consulting services.  The grant-date fair value using the Black-Scholes option pricing model was $0.85 per share, or $59,500.