STOCK OPTION PLANS

12 Months Ended

Dec. 31, 2011

Notes to Financial Statements

Note 9. STOCK OPTIONS

In 1997, the Company adopted its 1997 Long-Term Incentive and Stock Option Plan (the “1997 Plan”). The Company may not grant any additional shares under the 1997 Plan.

In connection with the Company’s strategic merger with ChoiceTel in 2002, the Company assumed options to purchase 86,567 shares of Common Stock or all outstanding options under the 1999 Sontra Medical, Inc. Stock Option and Incentive Plan (the “1999 Plan”). The Company may not grant any additional shares under the 1999 Plan.

In March 2003, the Company’s shareholders approved its 2003 Stock Option and Incentive Plan (the “2003 Plan”). Pursuant to the 2003 Plan, the Company’s Board of Directors (or committees and/or executive officers delegated by the Board of Directors) may grant incentive and nonqualified stock options, restricted stock and other stock-based awards to the Company’s employees, officers, directors, consultants and advisors. As of December 31, 2011, the maximum aggregate number of shares that may be authorized for issuance under the 2003 Plan for all periods is 1,600,000 shares.

In May 2008, the Company’s shareholders approved the Echo Therapeutics, Inc. 2008 Equity Compensation Plan (the “2008 Plan”). The 2008 Plan provides for grants of incentive stock options to employees and nonqualified stock options and restricted Common Stock to employees, consultants and non-employee directors of the Company. On July 12, 2010, the shareholders of the Company voted in favor of the Board of Directors’ recommendation to increase the number of shares authorized for issuance under the 2008 Plan from 2,700,000 shares to 4,700,000 shares.

The tables below show the remaining shares available for future grants for each plan and the outstanding shares.

	Stock Option Plans
	1997			1999			2003			2008
Shares Available For Issuance
Total reserved for stock options and restricted stock		150,000			68,138			1,600,000			4,700,000
Net restricted stock issued net of cancellations		-			-			(161,250	)		(1,504,750	)
Stock options granted		(174,482	)		(86,567	)		(1,544,491	)		(1,845,000	)
Add back options cancelled before exercise		146,028			54,750			603,241			216,666
Options cancelled by plan vote		(121,546	)		(36,321	)		-			-
Remaining shares available for future grants		-			-			497,500			1,566,916
Outstanding Options and Restricted Stock													Not Pursuant to a Plan
Total granted		174,482			86,567			1,544,491			1,845,000		3,100,000
Less:  Cancelled restricted stock		-			-			-			-		-
Options cancelled		(146,028	)		(54,750	)		(603,241	)		(216,666	)	(1,383,334	)
Options exercised		(8,454	)		(27,964	)		(270,000	)		(78,334	)	566,666
Net shares outstanding before restricted stock		20,000			3,853			671,250			1,550,000		1,150,050
Net restricted stock issued net of cancellations		-			-			161,250			1,504,750		64,844
Outstanding shares at December 31, 2011		20,000			3,853			832,500			3,054,750		1,241,844

Share-Based Compensation - Options

For options issued and outstanding during the years ended December 31, 2011 and 2010, the Company recorded additional paid-in capital and non-cash compensation expense of $836,866 and $164,810, respectively, each net of estimated forfeitures.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the following table. Expected volatilities are based on historical volatility of the Common Stock using historical periods consistent with the expected term of the options. The Company uses historical data, as well as subsequent events occurring prior to the issuance of the consolidated financial statements, to estimate option exercise and employee termination within the valuation model. The expected term of options granted under the Company’s stock plans, all of which qualify as “plain vanilla,” is based on the average of the contractual term (generally 10 years) and the vesting period (generally 24 to 42 months) as permitted under SEC Staff Accounting Bulletin Nos. 107 and 110. The risk-free rate is based on the yield of a U.S. Treasury security with a term consistent with the option. Restricted stock grants are valued based on the closing market price for the Company’s Common Stock on the grant date.

The assumptions used principally for options granted to employees in the years ended December 31, 2011 and 2010 were as follows:

	2011			2010
Risk-free interest rate		1.80% - 3.47	%		2.43% - 3.96	%
Expected dividend yield		—			—
Expected term (employee grants)	6.5 years			6.75 years
Forfeiture rate (excluding fully vested options)		15	%		0%-37	%
Expected volatility		137% - 142	%		142% - 150	%

A summary of option activity under the Company’s stock plans and options granted to officers of the Company outside any plan as of December 31, 2011 and changes during the year then ended is presented below:

Options	Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term	Aggregate Intrinsic Value
Outstanding at January 1, 2011		3,029,030		$	0.87
Granted		1,375,000		$	3.11
Exercised		(835,334	)	$	0.74
Forfeited or expired		(173,593	)	$	3.34
Outstanding at December 31, 2011		3,395,103		$	1.68	7.11 years	$	3,592,355
Exercisable at December 31, 2011		2,200,099		$	0.93	6.10 years	$	3,381,738

The weighted-average grant-date fair value of options granted during the year ended December 31, 2011 was $2.21 per share. As of December 31, 2011, there was approximately $2,362,000 of total unrecognized compensation expense related to non-vested share-based option arrangements. With the exception of the unrecognized share-based compensation related to certain restricted stock grants to officers and employees that contain performance conditions related to United States Food and Drug Administration (FDA) approval for Symphony or the sale of the Company, unrecognized compensation is expected to be recognized over the next 12 months.

Share-Based Compensation – Restricted Stock

For restricted stock issued and outstanding during the years ended December 31, 2011 and 2010, the Company incurred non-cash compensation expense of $323,463 and $393,249, respectively, each net of estimated forfeitures.

As of December 31, 2011, the Company had outstanding restricted stock grants of 1,819,594 shares with a weighted-average grant-date value of $1.72. Of the outstanding restricted stock grants, 11,250 shares have not yet vested. A summary of the status of the Company’s nonvested restricted stock grants as of December 31, 2011 and changes during the year ended December 31, 2011 is presented below.

Non-vested Shares	Shares			Weighted- Average Grant-Date Fair Value
Non-vested at January 1, 2011		1,629,594		$	1.12
Granted		680,000		$	3.38
Vested		(65,000	)	$	2.82
Forfeited		(425,000	)	$	1.02
Non-vested at December 31, 2011		1,819,594		$	1.72

      Of the 1,819,594 shares of non-vested restricted stock, vesting criteria are as follows:

·   1,559,594 shares of restricted stock vest upon the FDA approval of Symphony or the sale of the Company;

·   220,000 shares of restricted stock vest upon the sale of the Company; and

·   40,000 shares of restricted stock vest over 4 years, at each of the anniversary dates of the grants.

       As of December 31, 2011, there was approximately $3,456,000 of total unrecognized compensation expense related to non-vested share-based restricted stock arrangements granted under the Company’s stock plans. As of December 31, 2011, the Company cannot estimate the timing of completion of the performance vesting requirements required by certain of these restricted stock grant arrangements. Compensation expense related to the Restricted Share Grants will be recognized when the Company concludes that achievement of the performance vesting conditions is probable.