UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended MARCH 31, 2007
-------------------------------------------
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
------------------ ------------------
COMMISSION FILE NUMBER 0-23970
FALCONSTOR SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0216135
(State of Incorporation) (I.R.S. Employer Identification No.)
2 HUNTINGTON QUADRANGLE
MELVILLE, NEW YORK 11747
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: 631-777-5188
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act.
Large Accelerated Filer |_| Accelerated Filer |X| Non-Accelerated Filer |_|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
The number of shares of Common Stock issued and outstanding as of April
25, 2007 was 50,099,066 and 49,233,866 , which includes redeemable common
shares.
1
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
Page
PART I. Financial Information 3
Item 1. Condensed Consolidated Financial Statements 3
Condensed Consolidated Balance Sheets at March 31, 2007
(unaudited) and December 31, 2006 3
Unaudited Condensed Consolidated Statements of Operations
for the three months ended March 31, 2007 and 2006 4
Unaudited Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 2007 and 2006 5
Notes to the Unaudited Condensed Consolidated
Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Qualitative and Quantitative Disclosures about Market Risk 21
Item 4. Controls and Procedures 22
PART II. Other Information 22
Item 1. Legal Proceedings 22
Item 1A. Risk Factors 22
Item 5. Other Information 24
Item 6. Exhibits 25
2
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2007 December 31, 2006
---------------- -----------------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents ............................ $ 20,613,005 $ 15,605,329
Marketable securities ................................ 31,672,638 25,354,259
Accounts receivable, net of allowances of $7,240,375
and $6,016,298, respectively ....................... 19,568,956 24,134,257
Prepaid expenses and other current assets ............ 1,435,385 1,244,937
------------- -------------
Total current assets ............................. 73,289,984 66,338,782
Property and equipment, net of accumulated depreciation
of $11,022,889 and $10,221,780, respectively ......... 6,197,554 5,960,317
Goodwill ............................................... 3,512,796 3,512,796
Other intangible assets, net ........................... 404,587 407,316
Other assets ........................................... 1,936,471 2,011,433
------------- -------------
Total assets ..................................... $ 85,341,392 $ 78,230,644
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ..................................... $ 1,404,441 $ 1,432,510
Accrued expenses ..................................... 5,258,556 6,505,536
Deferred revenue ..................................... 13,715,851 11,466,552
------------- -------------
Total current liabilities ........................ 20,378,848 19,404,598
Other long-term liabilities ............................ 137,317 137,317
Deferred revenue ....................................... 4,035,984 3,645,482
------------- -------------
Total liabilities ................................ 24,552,149 23,187,397
Commitments and contingencies
Stockholders' equity:
Convertible preferred stock - $.001 par value,
2,000,000 shares authorized ........................ -- --
Common stock - $.001 par value, 100,000,000 shares
authorized, 50,083,892 and 49,085,539 shares
issued, respectively and 49,218,692 and
48,220,339 shares outstanding, respectively ........ 50,084 49,086
Additional paid-in capital ........................... 105,599,197 99,282,308
Accumulated deficit .................................. (38,588,432) (38,033,857)
Common stock held in treasury, at cost (865,200
shares at both March 31, 2007 and December 31, 2006) (5,780,163) (5,780,163)
Accumulated other comprehensive loss, net ............ (491,443) (474,127)
------------- -------------
Total stockholders' equity ....................... 60,789,243 55,043,247
------------- -------------
Total liabilities and stockholders' equity ....... $ 85,341,392 $ 78,230,644
============= =============
See accompanying notes to unaudited condensed consolidated financial statements.
3
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended March 31,
-----------------------------
2007 2006
------------- -------------
Revenues:
Software license revenue ....................... $ 10,437,505 $ 5,676,689
Maintenance revenue ............................ 4,333,539 2,591,003
Software services and other revenue ............ 1,569,634 940,628
------------ ------------
16,340,678 9,208,320
------------ ------------
Operating expenses:
Amortization of purchased and capitalized
software ................................... 25,536 151,722
Cost of maintenance, software services and
other revenue .............................. 2,744,288 1,984,597
Software development costs ................... 5,516,185 4,607,103
Selling and marketing ........................ 6,968,751 4,904,005
General and administrative ................... 1,937,780 1,321,294
------------ ------------
17,192,540 12,968,721
------------ ------------
Operating loss ........................... (851,862) (3,760,401)
------------ ------------
Interest and other income, net ................. 499,371 286,651
------------ ------------
Loss before income taxes .................. (352,491) (3,473,750)
------------ ------------
Provision for income taxes ..................... 202,084 163,136
------------ ------------
Net loss ................................. $ (554,575) $ (3,636,886)
============ ============
Basic and diluted net loss per share ........... $ (0.01) $ (0.08)
============ ============
Weighted average basic and diluted shares
outstanding .................................. 48,594,410 48,006,309
============ ============
See accompanying notes to unaudited condensed consolidated financial statements.
4
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended March 31,
-----------------------------
2007 2006
------------- -------------
Cash flows from operating activities:
Net loss ...................................... $ (554,575) $ (3,636,886)
Adjustments to reconcile net loss to net
cash provided by (used in) operating
activities:
Depreciation and amortization ............. 878,940 925,207
Share-based payment compensation .......... 2,190,085 2,264,520
Loss on marketable securities ............. -- 28,855
Provision for returns and doubtful
accounts .............................. 1,192,345 812,887
Changes in operating assets and liabilities:
Accounts receivable ....................... 3,375,343 4,476,931
Prepaid expenses and other current assets . (191,391) (16,290)
Other assets .............................. 45,278 80,767
Accounts payable .......................... (30,299) (205,787)
Accrued expenses .......................... (1,251,837) (441,292)
Deferred revenue .......................... 2,638,305 449,484
------------ ------------
Net cash provided by operating activities . 8,292,194 4,738,396
------------ ------------
Cash flows from investing activities:
Sale of marketable securities ................. 20,545,870 14,733,241
Purchase of marketable securities ............. (26,840,353) (15,745,007)
Purchase of property and equipment ............ (1,039,456) (774,704)
Purchase of software licenses.................. -- (168,000)
Purchase of intangible assets ................. (51,626) (87,990)
------------ ------------
Net cash used in investing activities ..... (7,385,565) (2,042,460)
------------ ------------
Cash flows from financing activities:
Proceeds from exercise of stock options ....... 4,127,801 796,115
------------ ------------
Net cash provided by financing activities . 4,127,801 796,115
------------ ------------
Effect of exchange rate changes on cash and
cash equivalents .............................. (26,754) (12,355)
------------ ------------
Net increase in cash and cash equivalents ....... 5,007,676 3,479,696
Cash and cash equivalents, beginning of period .. 15,605,329 18,796,973
------------ ------------
Cash and cash equivalents, end of period ........ $ 20,613,005 $ 22,276,669
============ ============
Cash paid for income taxes ...................... $ 241,311 $ 25,000
============ ============
The Company did not pay any interest for the three months ended March 31, 2007
and 2006.
See accompanying notes to unaudited condensed consolidated financial statements.
5
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) THE COMPANY AND NATURE OF OPERATIONS
FalconStor Software, Inc., a Delaware Corporation (the "Company"),
develops, manufactures and sells network storage software solutions and provides
the related maintenance, implementation and engineering services.
(b) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
(c) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. The Company's significant estimates include those related to
revenue recognition, accounts receivable allowances, deferred income taxes and
accounting for share-based compensation expense. Actual results could differ
from those estimates.
(d) UNAUDITED INTERIM FINANCIAL INFORMATION
The unaudited interim condensed consolidated financial statements of the
Company as of March 31, 2007, and for the three months ended March 31, 2007 and
2006, included herein have been prepared, without audit, pursuant to the rules
and regulations of the Securities and Exchange Commission ("SEC"). Certain
information and note disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to such rules
and regulations relating to interim financial statements.
In the opinion of management, the accompanying unaudited interim condensed
consolidated financial statements reflect all adjustments, consisting only of
normal recurring adjustments, necessary to present fairly the financial position
of the Company at March 31, 2007, and the results of its operations for the
three months ended March 31, 2007 and 2006. The results of operations of any
interim period are not necessarily indicative of the results of operations to be
expected for the full fiscal year.
(e) CASH EQUIVALENTS AND MARKETABLE SECURITIES
The Company considers all highly liquid investments with maturity of three
months or less when purchased to be cash equivalents. Cash equivalents,
consisting of money market funds and commercial paper, amounted to approximately
$11.6 million and $11.0 million at March 31, 2007 and December 31, 2006,
respectively. Marketable securities at March 31, 2007 and December 31, 2006
amounted to $31.7 million and $25.4 million, respectively, and consisted of
corporate bonds and government securities, which are classified as available for
sale, and accordingly, unrealized gains and losses on marketable securities are
reflected as a component of accumulated other comprehensive loss in
stockholders' equity.
(f) REVENUE RECOGNITION
The Company recognizes revenue from software licenses in accordance with
Statement of Position ("SOP") 97-2, SOFTWARE REVENUE RECOGNITION, as amended by
SOP 98-4 and SOP 98-9, and related interpretations to determine the recognition
of revenue. Accordingly, revenue for software licenses is recognized when
persuasive evidence of an arrangement exists, the fee is fixed and determinable
and the software is delivered and collection of the resulting receivable is
deemed probable. Software delivered to a customer on a trial basis is not
recognized as revenue until a permanent key code is delivered to the customer.
6
Reseller customers typically send the Company a purchase order only when they
have an end user identified. When a customer licenses software together with the
purchase of maintenance, the Company allocates a portion of the fee to
maintenance for its fair value. Software maintenance fees are deferred and
recognized as revenue ratably over the term of the contract. The long-term
portion of deferred revenue relates to maintenance contracts with terms in
excess of one year. The cost of providing technical support is included in cost
of revenues. The Company provides an allowance for software product returns as a
reduction of revenue, based upon historical experience and known or expected
trends.
Revenues associated with software implementation and software engineering
services are recognized as the services are completed. Costs of providing these
services are included in cost of maintenance, software services and other
revenue.
The Company has entered into various distribution, licensing and joint
promotion agreements with OEMs and distributors, whereby the Company has
provided to the reseller a non-exclusive software license to install the
Company's software on certain hardware or to resell the Company's software in
exchange for payments based on the products distributed by the OEM or
distributor. Nonrefundable advances and engineering fees received by the Company
from an OEM are recorded as deferred revenue and recognized as revenue when
related software engineering services, if any, are complete and the software
product master is delivered and accepted.
The Company has transactions in which it purchases hardware and bundles
this hardware with the Company's software and sells the bundled solution to its
customer. Since the software is not essential for the functionality of the
equipment included in the Company's bundled solutions, and both the hardware and
software have stand alone value to the customer, a portion of the contractual
fees is recognized as revenue when the software or hardware is delivered based
on the relative fair value of the delivered element(s).
For the three months ended March 31, 2007, the Company had two customers
that together accounted for 42% of revenues, and three customers that together
accounted for 30% of the accounts receivable balance at March 31, 2007. For the
three months ended March 31, 2006, the Company had one customer that accounted
for 26% of revenues.
(g) PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is recognized
using the straight-line method over the estimated useful lives of the assets (3
to 7 years). Depreciation expense was $801,109 and $736,518 for the three months
ended March 31, 2007 and 2006, respectively. Leasehold improvements are
amortized on a straight-line basis over the term of the respective leases or
over their estimated useful lives, whichever is shorter.
(h) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of the purchase price over the estimated
fair value of net tangible and identifiable intangible assets acquired in
business combinations. Consistent with Financial Accounting Standards Board
("FASB") Statement of Financial Accounting Standards ("SFAS") 142, GOODWILL AND
OTHER INTANGIBLE ASSETS, the Company has not amortized goodwill related to its
acquisitions, but instead tests the balance for impairment. The Company's annual
impairment assessment is performed as of December 31st of each year, and an
assessment is made at other times if events or changes in circumstances indicate
that it is more likely than not that the asset is impaired. Identifiable
intangible assets are amortized over a three-year period using the straight-line
method. Amortization expense was $54,355 and $45,180 for the three months ended
March 31, 2007 and 2006, respectively. The gross carrying amount and accumulated
amortization of other intangible assets as of March 31, 2007 and December 31,
2006 are as follows:
March 31, December 31,
2007 2006
------------ ------------
Customer relationships and purchased technology:
Gross carrying amount .................. $ 216,850 $ 216,850
Accumulated amortization ............... (216,850) (216,850)
----------- -----------
Net carrying amount .................... $ -- $ --
=========== ===========
Patents:
Gross carrying amount .................. $ 1,074,719 $ 1,023,093
Accumulated amortization ............... (670,132) (615,777)
----------- -----------
Net carrying amount .................... $ 404,587 $ 407,316
=========== ===========
7
(i) SOFTWARE DEVELOPMENT COSTS AND PURCHASED TECHNOLOGY
In accordance with the provisions of SFAS No. 86, ACCOUNTING FOR THE COSTS
OF SOFTWARE TO BE SOLD, LEASED OR OTHERWISE MARKETED, costs associated with the
development of new software products and enhancements to existing software
products are expensed as incurred until technological feasibility of the product
has been established. Based on the Company's product development process,
technological feasibility is established upon completion of a working model.
Amortization of software development costs is recorded at the greater of
straight line over three years or the ratio of current revenue of the related
products to total current and anticipated future revenue of these products.
Purchased software technology of $158,042 and $183,578, net of accumulated
amortization of $5,034,389 and $5,008,853 is included in other assets in the
balance sheets as of March 31, 2007 and December 31, 2006, respectively.
Amortization expense was $25,536 and $151,722 for the three months ended March
31, 2007 and 2006, respectively. Amortization of purchased software technology
is recorded at the greater of the straight line basis over the products'
estimated remaining life or the ratio of current period revenue of the related
products to total current and anticipated future revenue of these products.
(j) INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax asserts and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be realized or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. The Company recognizes interest and
penalties accrued related to unrecognized tax benefits as part of income tax
expense in its consolidated statements of operations.
On January 1, 2007, the Company adopted FASB Interpretation No. 48,
ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES, ("FIN 48"). FIN 48 is an
interpretation of FASB Statement No. 109, ACCOUNTING FOR INCOME TAXES, and
addresses the determination of whether tax benefits claimed or expected to be
claimed on a tax return should be recorded in the financial statements. Under
FIN 48, the Company may recognize the tax benefit from an uncertain tax position
only if it meets the "more likely than not" threshold that the position will be
sustained on examination by the taxing authority, based on the technical merits
of the position. The tax benefits recognized in the financial statements from
such a position should be measured based on the largest benefit that has a
greater than fifty percent likelihood of being realized upon ultimate
settlement. FIN 48 also provides guidance on de-recognition, classification,
interest and penalties on income taxes, accounting in interim periods and also
requires increased disclosures. The adoption of FIN 48 did not result in any
adjustment to the recognized benefits from the Company's uncertain tax
positions. See footnote No. 6, "Income Taxes" for additional information.
(k) LONG-LIVED ASSETS
The Company reviews its long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of the asset may
not be recoverable. If the sum of the expected future cash flows, undiscounted
and without interest, is less than the carrying amount of the asset, an
impairment loss is recognized as the amount by which the carrying amount of the
asset exceeds its fair value.
8
(l) SHARE-BASED PAYMENTS
Effective January 1, 2006, the Company adopted the provisions of SFAS No.
123(R), SHARE-BASED PAYMENT, which establishes the accounting for transactions
in which an entity exchanges its equity instruments for goods or services. Under
the provisions of SFAS No. 123(R), share-based compensation expense is measured
at the grant date, based on the fair value of the award, and is recognized as an
expense over the requisite employee service period (generally the vesting
period) for awards expected to vest. The Company estimates the fair value of
share-based payments using the Black-Scholes option-pricing model. Stock option
exercises are expected to be fulfilled with new shares of common stock.
(m) FINANCIAL INSTRUMENTS
As of March 31, 2007 and December 31, 2006, the fair value of the
Company's financial instruments including cash and cash equivalents, accounts
receivable, accounts payable and accrued expenses, approximates book value due
to the short maturity of these instruments.
(n) FOREIGN CURRENCY
Assets and liabilities of foreign operations are translated at rates of
exchange at the end of the period, while results of operations are translated at
average exchange rates in effect for the period. Unrealized gains and losses
from the translation of foreign assets and liabilities are classified as a
separate component of stockholders' equity. Realized gains and losses from
foreign currency transactions are included in the statements of operations
within interest and other income, net. Such amounts have historically not been
material.
(o) EARNINGS PER SHARE (EPS)
Basic EPS is computed based on the weighted average number of shares of
common stock outstanding. Diluted EPS is computed based on the weighted average
number of common shares outstanding increased by dilutive common stock
equivalents. Due to the net loss for the three months ended March 31, 2007 and
2006, all common stock equivalents were excluded from diluted net loss per share
for the periods. As of March 31, 2007, potentially dilutive common stock
equivalents included 10,029,155 stock options and shares of restricted stock
outstanding and 750,000 warrants outstanding (such warrants become exercisable
only if certain performance targets are met by the grantee).
The following represents a reconciliation of the numerators and
denominators of the basic and diluted earnings per share ("EPS") computation:
Three Months Ended March 31, 2007 Three Months Ended March 31, 2006
Net Income Shares Per Share Net Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
------------ ------------- --------- ------------ ------------- ---------
Basic EPS $ (554,575) 48,594,410 $ (0.01) $(3,636,886) 48,006,309 $ (0.08)
======== ========
Effect of dilutive securities:
Stock Options -- --
----------- ---------- -------- ----------- ---------- --------
Diluted EPS $ (554,575) 48,594,410 $ (0.01) $(3,636,886) 48,006,309 $ (0.08)
=========== ========== ======== =========== ========== ========
9
(p) COMPREHENSIVE INCOME (LOSS)
The Company's comprehensive income (loss) is as follows:
Three Months Ended March 31,
2007 2006
---- ----
Net loss $ (554,575) $(3,636,886)
----------- -----------
Other comprehensive income (loss):
Foreign currency translation
adjustments (41,212) 11,439
Unrealized gains on investments 23,896 10,879
----------- -----------
Other comprehensive income (loss) (17,316) 22,318
----------- -----------
Comprehensive loss $ (571,891) $(3,614,568)
=========== ===========
(q) NEW ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB issued SFAS No. 159, THE FAIR VALUE OPTION FOR
FINANCIAL ASSETS AND FINANCIAL LIABILITIES - INCLUDING AN AMENDMENT OF FASB
STATEMENT NO. 115. SFAS No. 159 permits entities to choose to measure eligible
items at fair value at specified election dates and to report unrealized gains
and losses on items for which the fair value option has been elected in earnings
at each subsequent reporting date. SFAS No. 159 is effective for fiscal years
beginning after November 15, 2007. The Company is currently evaluating the
impact of the provisions of SFAS No. 159 on its consolidated financial position,
results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS
("SFAS No. 157") to clarify the definition of fair value, establish a framework
for measuring fair value and expand the disclosures on fair value measurements.
SFAS No. 157 defines fair value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date (an exit price). SFAS No. 157 also
stipulates that, as a market-based measurement, fair value should be determined
based on the assumptions that market participants would use in pricing the asset
or liability, and establishes a fair value hierarchy that distinguishes between
(a) market participant assumptions developed based on market data obtained from
sources independent of the reporting entity (observable inputs) and (b) the
reporting entity's own assumptions about market participant assumptions
developed based on the best information available in the circumstances
(unobservable inputs). SFAS No. 157 becomes effective for the Company in its
fiscal year beginning January 1, 2008. The Company is currently evaluating the
impact of the provisions of SFAS No. 157 on its consolidated financial position,
results of operations or cash flows.
(2) SHARE-BASED PAYMENT ARRANGEMENTS
As of May 1, 2000, the Company adopted the FalconStor Software, Inc. 2000
Stock Option Plan (the "2000 Plan"). The 2000 Plan is administered by the Board
of Directors and, as amended, provides for the grant of options to purchase up
to 14,162,296 shares of Company common stock to employees, consultants and
non-employee directors. Options may be incentive ("ISO") or non-qualified. ISOs
granted must have exercise prices at least equal to the fair value of the common
stock on the date of grant, and have terms not greater than ten years, except
those to an employee who owns stock with greater than 10% of the voting power of
all classes of stock of the Company, in which case they must have an option
price at least 110% of the fair value of the stock, and expire no later than
five years from the date of grant. Non-qualified options granted must have
exercise prices not less than eighty percent of the fair value of the common
stock on the date of grant, and have terms not greater than ten years. All
options granted under the 2000 Plan must be granted before May 1, 2010.
On May 14, 2004, the Company adopted the FalconStor Software, Inc. 2004
Outside Directors Stock Option Plan (the "2004 Plan"). The 2004 Plan is
administered by the Board of Directors and provides for the granting of options
to non-employee directors of the Company to purchase up to 300,000 shares of
Company common stock. Exercise prices of the options must be equal to the fair
market value of the common stock on the date of grant. Options granted have
terms of ten years. All options granted under the 2004 Plan must be granted
within three years of the adoption of the 2004 Plan.
10
On May 17, 2006, the Company adopted the FalconStor Software, Inc. 2006
Incentive Stock Plan (the "2006 Plan"). The 2006 Plan is administered by the
Board of Directors and provides for the grant of incentive and nonqualified
stock options, and restricted stock, to employees, officers, consultants and
advisors of the Company. Initially, a maximum of 1,500,000 of the authorized but
unissued or treasury shares of the common stock of the Company could be issued
upon the grant of restricted stock or upon the exercise of options granted under
the 2006 Plan. Exercise prices of the options must be equal to the fair market
value of the common stock on the date of grant. Options granted have terms of
not greater than ten years. All options and shares of restricted stock granted
under the 2006 Plan must be granted within ten years of the adoption of the 2006
Plan.
On May 8, 2007, the Company's stockholders approved an amendment to the
Company's 2006 Plan. The amendment relates to the number of shares available to
be issued under the 2006 Plan upon the exercise of stock options and upon the
grant of shares with such restrictions as determined by the Company. The 2006
Plan was amended so that if, on July 1st of any calendar year in which the Plan
is in effect (the "Calculation Date"), the number of shares of stock with
respect to which options may be granted is less than five percent (5%) of the
number of outstanding shares of stock, the number of shares of stock available
for issuance under the Plan shall be increased so that the number equals five
percent (5%) of the shares of stock outstanding on the Calculation Date, but in
no event shall the number of shares of stock subject to the Plan in the
aggregate exceed twenty million shares, subject to adjustment as provided in the
2006 Plan.
On May 8, 2007, the Company's stockholders adopted the FalconStor
Software, Inc. 2007 Outside Directors Equity Compensation Plan (the "2007
Plan"). The 2007 Plan is administered by the Board of Directors and provides for
the issuance of up to 300,000 shares of Company common stock upon the vesting of
options or upon the grant of shares with such restrictions as determined by the
Board of Directors to the non-employee directors of the Company. Exercise prices
of the options must be equal to the fair market value of the common stock on the
date of grant. Options granted have terms of ten years. Shares of restricted
stock have the terms and conditions set by the Board of Directors and are
forfeitable until the terms of the grant have been satisfied.
The following table summarizes stock option activity during the three months
ended March 31, 2007:
Weighted
Weighted Average
Average Remaining Aggregate
Number of Exercise Contractual Intrinsic
Options Price Life (Years) Value
------------ ------------ ------------ -----------
Outstanding at December 31, 2006 10,835,975 $ 5.62
Granted 64,000 $ 8.75
Exercised (998,353) $ 4.13
Canceled (97,467) $ 6.95
---------- ----------
Outstanding at March 31, 2007 9,804,155 $ 5.77 6.45 $45,595,769
========== ========== ========== ===========
Options exercisable at March 31, 2007 7,008,546 $ 5.21 5.57 $36,541,063
---------- ---------- ---------- -----------
Stock option exercises are fulfilled with new shares of common stock. The
total cash received from stock option exercises for the three months ended March
31, 2007 and 2006 was $4,127,802 and $796,115, respectively. The total intrinsic
value of stock options exercised during the three months ended March 31, 2007
and 2006 was $6,309,312 and $1,474,427, respectively.
The Company recognized share-based compensation expense for awards issued
under the Company's stock option plans in the following line items in the
condensed consolidated statements of operations:
11
Three Months Ended Three Months Ended
March 31, March 31,
2007 2006
------------------ ------------------
Cost of maintenance, software services and other revenue $ 284,849 $ 343,390
Software development costs 923,656 1,054,961
Selling and marketing 718,917 660,852
General and administrative 262,663 205,317
---------- ----------
$2,190,085 $2,264,520
========== ==========
The Company did not recognize any tax benefits related to share-based
compensation expense during the three months ended March 31, 2007 and 2006.
In 2006, the Company granted options to purchase an aggregate of 25,000
shares of common stock to certain non-employee consultants in exchange for
professional services. The aggregate fair value of these options as determined
using the Black-Scholes method was $199,353 as of March 31, 2007, and is being
expensed over the periods the services are provided. The related cumulative
expense amounted to $38,763 through March 31, 2007, of which $20,849 was
recognized during the three months ended March 31, 2007.
In 2006, the Company granted 225,000 shares of restricted stock to certain
officers and employees at an average fair value per share at date of grant of
$7.06 per share. As of March 31, 2007, no restricted shares have vested or been
forfeited. There were no restricted shares issued or outstanding as of March 31,
2006.
Options granted during both fiscal 2007 and 2006 have exercise prices
equal to the fair market value of the stock on the date of grant, a contractual
term of ten years, a vesting period of three years and an estimated forfeiture
rate of 23%. The Company estimates expected volatility based primarily on
historical daily price changes of the Company's stock and other factors. The
risk-free interest rate is based on the United States treasury yield curve in
effect at the time of grant.
As of March 31, 2007, there was approximately $9,841,427 of total
unrecognized compensation cost related to the Company's unvested options and
restricted shares granted under the Company's stock plans.
In September 2003, the Company entered into a worldwide OEM agreement with
a major technology company (the "OEM"), and granted to the OEM warrants to
purchase 750,000 shares of the Company's common stock with an exercise price of
$6.18 per share. A portion of the warrants may vest annually subject to the
OEM's achievement of pre-defined and mutually agreed upon sales objectives over
a three-year period beginning June 1, 2004. If the OEM generates cumulative
revenues to the Company in the mid-eight figure dollar range from reselling the
Company's products then all the warrants granted will vest. Any warrants that do
not vest by the end of the three-year period will expire. If and when it is
probable that all or a portion of the warrants will vest, the then fair value of
the warrants earned will be recorded as a reduction of revenue. Subsequently,
each quarter the Company will apply variable accounting to adjust such amount to
reflect the fair value of the warrants until they vest. As of March 31, 2007,
the Company had not generated any revenues from this OEM and accordingly no
warrants had vested.
(3) SEGMENT REPORTING
The Company is organized in a single operating segment for purposes of
making operating decisions and assessing performance. Revenues from the United
States to customers in the following geographical areas for the three months
ended March 31, 2007 and 2006 and the location of long-lived assets as of March
31, 2007 and December 31, 2006 are summarized as follows:
12
Three Months Ended March 31,
2007 2006
------------- --------------
United States $11,744,748 $ 6,294,997
Asia 1,885,764 1,382,348
Other international 2,710,166 1,530,975
----------- -----------
Total revenues $16,340,678 $ 9,208,320
=========== ===========
March 31, December 31,
2007 2006
------------- --------------
Long-lived assets:
United States $10,296,033 $10,113,633
Asia 1,429,281 1,498,534
Other international 326,094 279,695
----------- -----------
Total long-lived assets $12,051,408 $11,891,862
=========== ===========
(4) STOCK REPURCHASE PROGRAM
On October 25, 2001, the Company announced that its Board of Directors
authorized the repurchase of up to two million shares of the Company's
outstanding common stock. The repurchases may be made from time to time in open
market transactions in such amounts as determined at the discretion of the
Company's management. The terms of the stock repurchases will be determined by
management based on market conditions. There were no stock repurchases during
the three months ended March 31, 2007 and 2006. As of March 31, 2007, the
Company had repurchased a total of 865,200 shares for $5,780,164.
(5) COMMITMENTS AND CONTINGENCIES
The Company has an operating lease covering its corporate office facility
that expires in February 2012. The Company also has several operating leases
related to offices in foreign countries. The expiration dates for these leases
range from 2007 through 2015. The following is a schedule of future minimum
lease payments for all operating leases as of March 31, 2007:
2007............................................ $1,482,676
2008............................................ 1,600,757
2009............................................ 1,622,221
2010............................................ 1,426,182
2011............................................ 1,369,059
Thereafter...................................... 713,441
----------
$8,214,336
==========
We are subject to various legal proceedings and claims, asserted or
unasserted, which arise in the ordinary course of business. While the outcome of
any such matters cannot be predicted with certainty, such matters are not
expected to have a material adverse effect on our financial condition or
operating results.
(6) INCOME TAXES
For the three months ended March 31, 2007 and 2006, the Company's
provision for income taxes consists of U.S. and foreign taxes in amounts
necessary to align its year-to-date tax provision with the effective tax rate
the Company expects to achieve for the full year, including U.S. federal
alternative minimum taxes and state minimum taxes that are expected to be
incurred (despite the Company's pre-tax book loss) primarily as a result of the
limitations on its ability to utilize net operating losses under the alternative
minimum tax system and the non-deductibility of certain share-based compensation
13
expense for income tax purposes that has been recognized for financial statement
purposes. For the three months ended March 31, 2007, the Company's income tax
provision also includes discrete items for (i) $57,058 related to state income
taxes incurred in periods prior to 2007, and (ii) $120,000 related to a change
in the Company's estimate of amounts due in certain foreign jurisdictions for
periods prior to 2007, based upon the Company's evaluation of information
obtained in 2007.
As of December 31, 2006, the Company reported deferred tax assets and a
corresponding full valuation allowance, of $50.2 million. As of January 1, 2007,
the Company revised the recorded amounts of certain deferred tax assets (and
corresponding valuation allowance) to be $14.3 million, primarily due to the
limitations on the Company's ability to utilize certain deferred tax assets
relating to net operating losses acquired in the Company's 2001 reverse merger
transaction. During the three months ended March 31, 2007, the Company's gross
deferred tax assets increased for, among other things, approximately $1.9
million related to compensation deductions from exercises of employee and
consultant stock options.
At March 31, 2007 and December 31, 2006, the Company maintained a full
valuation allowance against its deferred tax assets due to the Company's prior
history of pre-tax losses and uncertainty about the timing of and ability to
generate taxable income, in the future. In the event that the Company (1)
generates taxable income and (2) its forecasts indicate that it is
more-likely-than-not that it will recover a portion of its deferred tax assets
in the future, the Company will likely reverse a portion of its deferred tax
asset valuation allowance. If the entire deferred tax asset were realized,
approximately $5.5 million (related to the tax effects of excess compensation
deductions from exercises of employee and consultant stock options) would be
allocated to paid-in-capital, with the remainder reducing income tax expense. In
determining the period in which related tax benefits are realized for book
purposes, excess share-based payment deductions, and deductions from
discontinued operations included in net operating losses are realized after
regular net operating losses are exhausted.
The Company's total unrecognized tax benefits as of January 1, 2007 were
$4.4 million, which, if recognized, would effect the Company's effective tax
rate. Total accrued interest and penalties as of January 1, 2007 were $22,193.
The Company does not expect that its unrecognized tax benefits will
significantly change within the next 12 months. The Company files a consolidated
U.S. Income tax return and tax returns in various state and local jurisdictions.
The returns filed in various state and local jurisdictions may be filed on a
separate company, combined or consolidated basis depending on the legal
requirements of the taxing jurisdiction. The Company's subsidiaries also file
tax returns in various foreign jurisdictions. In addition to the U.S., the
Company's major taxing jurisdictions include China, Japan, Taiwan, Korea, United
Kingdom, Germany, France and Australia. There have not been any past tax
examinations nor are there any current tax examinations in progress.
Accordingly, as of January 1, 2007, the Company remains subject to examination
in all tax jurisdictions for all periods since inception.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS CONTAINS "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING
OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES
EXCHANGE ACT OF 1934. THESE FORWARD-LOOKING STATEMENTS CAN BE IDENTIFIED BY THE
USE OF PREDICTIVE, FUTURE-TENSE OR FORWARD-LOOKING TERMINOLOGY, SUCH AS
"BELIEVES," "ANTICIPATES," "EXPECTS," "ESTIMATES," "PLANS," "MAY," "INTENDS,"
"WILL," OR SIMILAR TERMS. INVESTORS ARE CAUTIONED THAT ANY FORWARD-LOOKING
STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND INVOLVE SIGNIFICANT
RISKS AND UNCERTAINTIES, AND THAT ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. THE FOLLOWING DISCUSSION
SHOULD BE READ TOGETHER WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND NOTES TO
THOSE FINANCIAL STATEMENTS INCLUDED ELSEWHERE IN THIS REPORT.
OVERVIEW
Our results for the first quarter of 2007 showed strong growth from the
same period in the prior year. Both our revenues and our gross margins
increased.
Revenues for the first quarter of 2007 increased 77% to $16.3 million
compared with revenues in the first quarter of 2006. Revenues from both our OEM
partners and our resellers increased from the same period last year.
Due to typical industry seasonality, our revenues were down from the
fourth quarter of 2006. This decrease was anticipated, as our first quarter
revenues have historically declined from our fourth quarter revenues. We are
pleased that revenues for the first quarter of 2007 were higher than revenues
for the first, second or third quarters of 2006. We believe this shows continued
momentum for our products and services.
EMC Corporation accounted for 26% of our revenues, and Sun Microsystems
accounted for 16% of our revenues, in the first quarter of 2007. We anticipate
that each of these customers will account for 10% or more of our revenues during
2007. EMC has consistently contributed 20% or more of our revenues for a
significant period of time. Sun's revenue contribution has fluctuated on a
quarterly basis, but their announcement regarding their VTL strategy in the
fourth quarter of 2006, and the announcement in April 2007 that Sun will carry
our full product line, gives us reason to believe that their contribution to our
revenues will remain at or above the 10% level.
We continue to monitor our channel sales operations to determine whether
changes or additional resources will help to continue or to accelerate the
positive momentum. We anticipate that we will need to add resources to our sales
and marketing team to realize the full potential of our existing opportunities,
to establish our visibility in the marketplace, and to generate additional
business prospects.
In addition to increased revenues, the other indicators we use to assess
our performance and growth continued to be positive.
While we had an operating loss for the three months ended March 31, 2007,
including $2.2 million of share-based compensation expense related to SFAS No.
123(R), the loss was significantly lower than in the same period in 2006, and
cash flows from operations in the first quarter of 2007 were again positive. We
continue to believe that our ability to fund our own growth internally bodes
well for our long-term success.
Deferred revenue at March 31, 2007 increased 76%, compared with the
balance at March 31, 2006. We consider the continued growth of our deferred
revenue as an important indicator of the success of our products. We believe
that support and maintenance renewals, which comprise the majority of our
deferred revenue, are expressions of satisfaction with our products and our
support organization from our end users.
Operating expenses increased by $4.2 million, or 33%, over the same period
in 2006. Operating expenses include $2.2 million in share-based compensation
expense for the first quarter of 2007, and $2.3 million in share-based
compensation expense for the first quarter of 2006. We are pleased that our
revenues, on both an absolute and a percentage basis, continue to grow at a
higher rate than our expenses.
15
Our gross margins increased to 83% for the first quarter of 2007 from 77%
for the first quarter of 2006. Share-based compensation expense within cost of
maintenance, software services and other revenue was 2% of revenue in the first
quarter of 2007 and 4% in the first quarter of 2006.
We plan to continue adding research and development, sales and support
personnel, both in the United States and worldwide, as necessary. We also plan
to continue investing in infrastructure, including both equipment and property.
We continue to operate the business with the goal of long-term growth. We
believe that our ability to continue to refine our existing products and
features and to introduce new products and features will be the primary driver
of additional growth among existing resellers, OEMs and end users, and will
drive our strategy to attempt to engage additional OEM partners and to expand
the FalconStor product lines offered by these OEMs.
RESULTS OF OPERATIONS - FOR THE THREE MONTHS ENDED MARCH 31, 2007 COMPARED WITH
THE THREE MONTHS ENDED MARCH 31, 2006.
Revenues for the three months ended March 31, 2007 increased 77% to $16.3
million compared with $9.2 million for the three months ended March 31, 2006.
Our operating expenses increased 33% from $13 million for the three months ended
March 31, 2006 to $17.2 million for the three months ended March 31, 2007.
Included in our operating expenses for the three months ended March 31, 2007 and
2006 was $2.2 and $2.3 million, respectively, of share-based compensation
expense related to stock-based compensation in accordance with SFAS No. 123(R).
Net loss for the three months ended March 31, 2007 was $0.6 million compared
with net loss of $3.6 million for the three months ended March 31, 2006. The
increase in revenues was due to significant increases in software license
revenue and maintenance revenue as well as moderate increases in software
services and other revenue. Revenue contribution from our OEM partners increased
in absolute dollars and as a percentage of our total revenue for the quarter
ended March 31, 2007 as compared with the same period in 2006. Revenue from
resellers and distributors also increased in absolute dollars for the three
months ended March 31, 2007 as compared with the same period in 2006. Expenses
increased in all aspects of our business to support our growth. During the three
months ended March 31, 2007, we continued to increase the number of employees
and to invest in our infrastructure by purchasing additional computers and
related equipment. We increased the number of employees from 308 as of March 31,
2006 to 364 employees as of March 31, 2007.
REVENUES
SOFTWARE LICENSE REVENUE
Software license revenue is comprised of software licenses sold through
our OEMs, value-added resellers and distributors to end-users and, to a lesser
extent, directly to end users. These revenues are recognized when, among other
requirements, we receive a customer purchase order or a royalty report
summarizing software licenses sold and the software and permanent key codes are
delivered to the customer. We sometimes receive nonrefundable royalty advances
and engineering fees from some of our OEM partners. These arrangements are
evidenced by a signed customer contract, and the revenue is recognized when the
software product master is delivered and accepted, and the engineering services,
if any, have been performed.
Software license revenue increased 84% from $5.7 million for the three
months ended March 31, 2006 to $10.4 million for the three months ended March
31, 2007. Increased market acceptance and demand for our products and increased
sales from our OEM partners were the primary drivers of the increase in software
license revenue. Software license revenue increased from both our OEM partners
and from our resellers. Revenue from our OEM partners increased as a percentage
of total revenue. We expect our software license revenue to continue to grow and
the percentage of future software license revenue derived from our OEM partners
to increase.
16
MAINTENANCE, SOFTWARE SERVICES AND OTHER REVENUE
Maintenance, software services and other revenues are comprised of
software maintenance and technical support, professional services primarily
related to the implementation of our software, engineering services, and sales
of computer hardware. Revenue derived from maintenance and technical support
contracts is deferred and recognized ratably over the contractual maintenance
term. Professional services revenue is recognized in the period that the related
services are performed. Revenue from engineering services is primarily related
to customizing software product masters for some of our OEM partners. Revenue
from engineering services is recognized in the period the services are
completed. In the first quarter of 2007 we increased the amount of hardware we
bundled with our software as compared with the first quarter of 2006. A portion
of the contractual fees is recognized as revenue when the hardware or software
is delivered to the customer based on the relative fair value of the delivered
element(s). Maintenance, software services and other revenue increased 67% to
$5.9 million for the three months ended March 31, 2007 from $3.5 million for the
three months ended March 31, 2006.
The major factor behind the increase in maintenance, software services and
other revenue was an increase in the number of maintenance and technical support
contracts we sold. As we are in business longer, and as we license more software
from our continued customer base and product offerings expansion, we expect
these revenues will continue to increase. The majority of our new customers
purchase maintenance and support and most customers renew their maintenance and
support after their initial contracts expire. Maintenance revenue increased $1.7
million from $2.6 million for the three months ended March 31, 2006 to $4.3
million for the three months ended March 31, 2007. Software services and other
revenue increased approximately $0.6 million from $0.9 million for the three
months ended March 31, 2006 to $1.6 million for the three months ended March 31,
2007. We expect maintenance, software services and other revenues to continue to
increase.
COST OF REVENUES
AMORTIZATION OF PURCHASED AND CAPITALIZED SOFTWARE
To remain successful in the network storage solutions market, we must
continually upgrade our software by enhancing the existing features of our
products and by adding new features and products. We often evaluate whether to
develop these new offerings in-house or whether we can achieve a greater return
on investment by purchasing or licensing software from third parties. Based on
our evaluations we have purchased or licensed various software for resale since
2001. As of March 31, 2007, we had $0.2 million of purchased software licenses,
net of accumulated amortization of $5.0 million that are being amortized over
three years. For the three months ended March 31, 2007, we recorded $26,000 of
amortization related to these purchased software licenses. As of March 31, 2006,
we had $0.4 million of purchased software licenses, net of accumulated
amortization of $4.8 million and recorded approximately $0.2 million of
amortization for the three months ended March 31, 2006 related to these
purchased software licenses. We will continue to evaluate third party software
licenses and may make additional purchases from time to time, which would impact
the amount we record as amortization expense in future periods.
COST OF MAINTENANCE, SOFTWARE SERVICES AND OTHER REVENUE
Cost of maintenance, software services and other revenues consists
primarily of personnel and other costs associated with providing software
implementations, technical support under maintenance contracts, training, and
share-based compensation expense associated with SFAS No. 123(R). Cost of
maintenance, software services and other revenues also includes the cost of
hardware purchased that was resold. Cost of maintenance, software services and
other revenues for the three months ended March 31, 2007 increased by 38% to
$2.7 million compared with $2.0 million for the three months ended March 31,
2006. The increase in cost of maintenance, software services and other revenue
was principally due to the increased cost of hardware resulting from the higher
number of transactions in which we bundled this purchased hardware with our
software and sold the bundled solution during the three months ended March 31,
2007 as compared with the same period in 2006. Additionally, cost of
maintenance, software services and other revenue increased due to an increase in
personnel. As a result of our increased sales of maintenance and support
contracts, we hired additional employees to provide technical support. Our cost
of maintenance, software services and other revenue will continue to grow in
absolute dollars as our revenue increases.
17
Gross profit for the three months ended March 31, 2007 was $13.6 million
or 83% of revenue compared with $7.1 million or 77% of revenue for the three
months ended March 31, 2006. The increase in our gross margin was primarily due
to the increase of our revenue combined with our continued focus on our cost
structure. Share-based compensation expense included in the cost of maintenance,
software services and other revenue decreased slightly in absolute dollars for
the three months ended March 31, 2007 compared with the same period in 2006.
Share-based compensation expense was equal to 2% and 4% of revenue for the three
months ended March 31, 2007 and 2006, respectively.
SOFTWARE DEVELOPMENT COSTS
Software development costs consist primarily of personnel costs for
product development personnel, share-based compensation expense associated with
SFAS No. 123(R), and other related costs associated with the development of new
products, enhancements to existing products, quality assurance and testing.
Software development costs increased 20% to $5.5 million for the three months
ended March 31, 2007 from $4.6 million for the three months ended March 31,
2006. The major contributing factors to the increase in software development
costs were higher salary costs and personnel related costs as a result of
increased headcount to enhance and test our core network storage software
product, as well as to develop new innovative features and options during the
three months ended March 31, 2007 as compared with the same period in 2006.
Share-based compensation expense included in software development costs
decreased slightly in absolute dollars for the three months ended March 31, 2007
compared with the same period in 2006. Share-based compensation expense included
in software development costs was equal to 6% and 11% of revenue for the three
months ended March 31, 2007 and 2006, respectively. We intend to continue
recruiting and hiring product development personnel to support our software
development process.
SELLING AND MARKETING
Selling and marketing expenses consist primarily of sales and marketing
personnel and related costs, share-based compensation expense associated with
SFAS No. 123(R), travel, public relations expense, marketing literature and
promotions, commissions, trade show expenses, and the costs associated with our
foreign sales offices. Selling and marketing expenses increased 42% to $7.0
million for the three months ended March 31, 2007 from $4.9 million for the
three months ended March 31, 2006. The increase in selling and marketing
expenses was primarily due to higher commissions paid as a result of our 77%
increase in revenue during the three months ended March 31, 2007 as compared
with the same period in 2006. In addition, higher salary costs and personnel
related costs as a result of increased sales and marketing headcount during the
three months ended March 31, 2007 as compared with the same period in 2006
contributed to the overall increase. Share-based compensation expense included
in sales and marketing increased slightly in absolute dollars for the three
months ended March 31, 2007 compared with the same period in 2006. Share-based
compensation expense included in selling and marketing expenses was equal to 4%
and 7% of revenue for the three months ended March 31, 2007 and 2006,
respectively. In addition, we continued to hire new sales and sales support
personnel and to expand our worldwide presence to accommodate our anticipated
revenue growth. We believe that to continue to grow sales, our sales and
marketing expenses will continue to increase.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of personnel costs
of general and administrative functions, share-based compensation expense
associated with SFAS No. 123(R), public company related costs, directors and
officers insurance, legal and professional fees, and other general corporate
overhead costs. General and administrative expenses increased 47% to $1.9
million for the three months ended March 31, 2007 from $1.3 million for the
three months ended March 31, 2006. The increase in general and administrative
expenses was primarily due to higher professional fees related to the
implementation of FIN No. 48 and other tax related planning during the three
months ended March 31, 2007 as compared with the same period in 2006.
Share-based compensation expense included in general and administrative
increased slightly in absolute dollars for the three months ended March 31, 2007
compared with the same period in 2006. Share-based compensation expense included
in general and administrative expenses was equal to 2% and 2% of revenue for the
three months ended March 31, 2007 and 2006, respectively. Additionally, as our
revenue and number of employees increase, our legal and professional fees and
other general corporate overhead costs have increased and are likely to continue
to increase.
18
INTEREST AND OTHER INCOME
We invest our cash, cash equivalents and marketable securities in
government securities and other low risk investments. Interest and other income
increased to $0.5 million for the three months ended March 31, 2007 compared
with $0.3 million for the three months ended March 31, 2006. This increase is
primarily due to higher interest rates and increased cash balances as of March
31, 2007 as compared with the same period in 2006, which resulted in a higher
average cash balance invested at greater interest rates.
INCOME TAXES
For the three months ended March 31, 2007 and 2006, our provision for
income taxes consisted of U.S. and foreign taxes in amounts necessary to align
our year-to-date tax provision with the effective rate that we expect to achieve
for the full year. Our provision for income taxes for the three months ended
March 31, 2007 consists primarily of foreign taxes and U.S. federal alternative
minimum taxes and state minimum taxes that are expected to be incurred (despite
our pre-tax book loss) primarily as a result of the limitations on our ability
to utilize net operating losses under the alternative minimum tax system, and
the non-deductibility of certain share-based compensation expenses for income
tax purposes that have been recognized for financial statement purposes. For the
three months ended March 31, 2007, our income tax provision also includes
discrete items for (i) $57,058 related to state income taxes incurred in periods
prior to 2007, and (ii) $120,000 related to a change in our estimate of amounts
due in certain foreign jurisdictions for periods prior to 2007, based upon our
evaluation of information obtained in 2007.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our critical accounting policies and estimates are those related to
revenue recognition, accounts receivable allowances, deferred income taxes and
accounting for share-based compensation expense.
REVENUE RECOGNITION. We recognize revenue in accordance with the
provisions of Statement of Position 97-2, SOFTWARE REVENUE RECOGNITION, as
amended. Software license revenue is recognized only when pervasive evidence of
an arrangement exists and the fee is fixed and determinable, among other
criteria. An arrangement is evidenced by a signed customer contract for
nonrefundable royalty advances received from OEMs or a customer purchase order
or a royalty report summarizing software licenses sold for each software license
resold by an OEM, distributor or solution provider to an end user. The software
license fees are fixed and determinable as our standard payment terms range from
30 to 90 days, depending on regional billing practices, and we have not provided
any of our customers extended payment terms. When a customer licenses software
together with the purchase of maintenance, we allocate a portion of the fee to
maintenance for its fair value based on the contractual maintenance renewal
rate.
ACCOUNTS RECEIVABLE. We review accounts receivable to determine which are
doubtful of collection. In making the determination of the appropriate allowance
for uncollectible accounts and returns, we consider historical return rates,
specific past due accounts, analysis of our accounts receivable aging, customer
payment terms, historical collections, write-offs and returns, changes in
customer demand and relationships, concentrations of credit risk and customer
credit worthiness. Historically, we have experienced a somewhat consistent level
of write-offs and returns as a percentage of revenue due to our customer
relationships, contract provisions and credit assessments. Changes in the
product return rates, credit worthiness of customers, general economic
conditions and other factors may impact the level of future write-offs, revenues
and our general and administrative expenses.
DEFERRED INCOME TAXES. Consistent with the provisions of Statement of
Financial Accounting Standards No. 109, we regularly estimate our ability to
recover deferred income taxes, and report such assets at the amount that is
determined to be more-likely-than-not recoverable. This evaluation considers
several factors, including an estimate of the likelihood of generating
sufficient taxable income in future periods over which temporary differences
reverse, the expected reversal of deferred tax liabilities, past and projected
taxable income, and available tax planning strategies. As of March 31, 2007,
based primarily upon our cumulative losses, a valuation allowance has been
recorded against our deferred tax assets. In the event that evidence becomes
available in the future to indicate that our deferred taxes will likely be
19
recoverable (e.g., taxable income generated in and projected for future
periods), our estimate of the recoverability of deferred taxes may change,
resulting in a reversal of a portion of such valuation allowance. If the entire
deferred tax assets were realized, approximately $5.5 million (related to the
tax effects of excess compensation deductions from exercises of employee and
consultant stock options) would be allocated to paid-in-capital with the
remainder reducing income tax expense.
ACCOUNTING FOR SHARE-BASED PAYMENTS. As discussed further in "Notes to
Unaudited Condensed Consolidated Financial Statements - Note (2) SHARE-BASED
PAYMENTS," we adopted SFAS No. 123(R) on January 1, 2006 using the modified
prospective method.
We have used and expect to continue to use the Black-Scholes
option-pricing model to compute the estimated fair value of share-based
compensation expense. The Black-Scholes option-pricing model includes
assumptions regarding dividend yields, expected volatility, expected option term
and risk-free interest rates. The assumptions used in computing the fair value
of share-based compensation expense reflect our best estimates, but involve
uncertainties relating to market and other conditions, many of which are outside
of our control. We estimate expected volatility based primarily on historical
daily price changes of our stock and other factors. Additionally, we estimate
forfeiture rates based primarily upon historical experiences, adjusted when
appropriate for known events or expected trends. If other assumptions or
estimates had been used, the share-based compensation expense that was recorded
for the three months ended March 31, 2007 and 2006 could have been materially
different. Furthermore, if different assumptions or estimates are used in future
periods, share-based compensation expense could be materially impacted in the
future. During the three months ended March 31, 2007 and 2006, the total
compensation costs recognized relating to share-based compensation expense in
our financial statements totaled $2.2 million and $2.3 million, respectively.
Total compensation cost related to unvested share-based payment awards not yet
recognized as of March 31, 2007 is $9.8 million.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB issued Statement of Financial Accounting
Standard ("SFAS") No. 159, THE FAIR VALUE OPTION FOR FINANCIAL ASSETS AND
FINANCIAL LIABILITIES - INCLUDING AN AMENDMENT OF FASB STATEMENT NO. 115. SFAS
No. 159 permits entities to choose to measure eligible items at fair value at
specified election dates and report unrealized gains and losses on items for
which the fair value option has been elected in earnings at each subsequent
reporting date. SFAS No. 159 is effective for fiscal years beginning after
November 15, 2007. We are currently evaluating the impact of the provisions of
SFAS No. 159 on our consolidated financial position, results of operations or
cash flows.
In September 2006, the FASB issued SFAS No. 157, FAIR VALUE MEASUREMENTS
("SFAS No. 157") to clarify the definition of fair value, establish a framework
for measuring fair value and expand the disclosures on fair value measurements.
SFAS No. 157 defines fair value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date (an exit price). SFAS No. 157 also
stipulates that, as a market-based measurement, fair value should be determined
based on the assumptions that market participants would use in pricing the asset
or liability, and establishes a fair value hierarchy that distinguishes between
(a) market participant assumptions developed based on market data obtained from
sources independent of the reporting entity (observable inputs) and (b) the
reporting entity's own assumptions about market participant assumptions
developed based on the best information available in the circumstances
(unobservable inputs). SFAS No. 157 becomes effective for the Company in its
fiscal year beginning January 1, 2008. We are currently evaluating the impact of
the provisions of SFAS No. 157 on our consolidated financial position, results
of operations or cash flows.
LIQUIDITY AND CAPITAL RESOURCES
Our total cash and cash equivalents and marketable securities balance as
of March 31, 2007 increased by $11.3 million compared with December 31, 2006.
Our cash and cash equivalents totaled $20.6 million and marketable securities
totaled $31.7 million at March 31, 2007. As of March 31, 2006, we had
approximately $22.3 million in cash and cash equivalents and $18.8 million in
marketable securities.
We continued to invest in our infrastructure to support our long-term
growth during the three months ended March 31, 2007. We made investments in
property and equipment and we increased the number of employees during the first
quarter of 2007. As we continue to grow, we will continue to make investments in
property and equipment and will need to continue to increase our headcount.
20
In October 2001, our Board of Directors authorized the repurchase of up to
two million shares of our outstanding common stock. Since October 2001, 865,200
shares have been repurchased at an aggregate purchase price of $5.8 million. We
did not repurchase any shares during the three months ended March 31, 2007 and
2006.
Net cash provided by operating activities totaled $8.3 million for the
three months ended March 31, 2007, compared with $4.7 million for the same
period in 2006. Net cash provided by operating activities of $8.3 million was
primarily derived from: (i) a decrease in accounts receivable of $4.6 million;
(ii) an increase in deferred revenue of $2.6 million; (iii) non-cash charges of
$0.9 million for depreciation and amortization; and (iv) $2.2 million related to
share-based compensation expense. These amounts were partially offset by: (i)
our net loss of $0.6 million for the three months ended March 31, 2007; and (ii)
a decrease in accrued expenses and accounts payable of $1.3 million. The cash
provided by operating activities for the three months ended March 31, 2006 was
mainly comprised of: (i) a decrease in accounts receivable of $5.3 million; (ii)
an increase in deferred revenue of $0.5 million; (iii) non-cash charges of $0.9
million for depreciation and amortization; and (iv) $2.3 million related to
share-based compensation expense. These amounts were partially offset by: (i)
our net loss of $3.6 million for the three months ended March 31, 2006; and (ii)
a decrease in accrued expenses and accounts payable of $0.6 million.
Net cash used in investing activities was $7.4 million for the three
months ended March 31, 2007, due primarily to: (i) net purchases of marketable
securities of $6.3 million; and (ii) purchases of property and equipment of $1.0
million. Net cash used in investing activities was $2.0 million for the three
months ended March 31, 2006, due primarily to: (i) net purchases of marketable
securities of $1.0 million; (ii) purchases of property and equipment of $0.8
million; and (iii) purchases of software licenses and intangible assets of $0.3
million.
Net cash provided from financing activities was $4.1 million for the three
months ended March 31, 2007. We received proceeds from the exercise of stock
options of $4.1 million. Net cash provided by financing activities was $0.8
million for the three months ended March 31, 2006. This amount was related to
proceeds from the exercise of stock options of $0.8 million.
We currently do not have any debt and our only material cash commitments
are related to our office leases. We have an operating lease covering our
corporate office facility that expires in February 2012. We also have several
operating leases related to offices in foreign countries. The expiration dates
for these leases range from 2007 through 2015. Refer to Note 5 of the notes to
our unaudited condensed consolidated financial statements.
We believe that our current balance of cash, cash equivalents and
marketable securities, and expected cash flows from operations will be
sufficient to meet our cash requirements for at least the next twelve months.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISKS. Our return on our investments in cash, cash equivalents and
marketable securities is subject to interest rate risks. We regularly assess
these risks and have established policies and business practices to manage the
market risk of our marketable securities. If interest rates were to change by
10% from the levels at March 31, 2007, the effect on our financial results would
be insignificant.
FOREIGN CURRENCY RISK. We have several offices outside the United States.
Accordingly, we are subject to exposure from adverse movements in foreign
currency exchange rates. The effect of foreign currency exchange rate
fluctuations have not been material since our inception. If foreign currency
exchange rates were to change by 10% from the levels at March 31, 2007, the
effect on our other comprehensive income would be insignificant. We do not use
derivative financial instruments to limit our foreign currency risk exposure.
21
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
our principal executive officer and principal financial officer, we have
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this report, and,
based on their evaluation, our principal executive officer and principal
financial officer have concluded that these controls and procedures are
effective. No changes in the Company's internal controls over financial
reporting occurred during the quarter ended March 31, 2007, that have materially
affected, or are reasonably likely to materially affect, the Company's internal
controls over financial reporting.
Disclosure controls and procedures are procedures that are designed to ensure
that information required to be disclosed by us in the reports that we file or
submit under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by us in the reports that we
file under the Exchange Act is accumulated and communicated to our management,
including our principal executive officer and principal financial officer, as
appropriate to allow timely decisions regarding required disclosure.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are subject to various legal proceedings and claims, asserted or unasserted,
which arise in the ordinary course of business. While the outcome of any such
matters cannot be predicted with certainty, we believe that such matters will
not have a material adverse effect on our financial condition or operating
results.
ITEM 1A. RISK FACTORS
We are affected by risks specific to us as well as factors that affect all
businesses operating in a global market. The significant factors known to us
that could materially adversely affect our business, financial condition, or
operating results are set forth in Item 1A to our Annual Report on Form 10-K for
the year ended December 31, 2006 (the "2006 10-K"). The information below sets
forth additional risk factors or risk factors that have had material changes
since the 2006 10-K, and should be read in conjunction with Item 1A of the 2006
10-K.
WE ARE DEPENDENT ON CERTAIN KEY CUSTOMERS AND A SIGNIFICANT PORTION OF OUR
RECEIVABLES IS CONCENTRATED WITH TWO CUSTOMERS.
We tend to have one or more customers account for 10% or more of our
revenues during each fiscal quarter. For the quarter ended March 31, 2007, we
had one customer who accounted for 26% of our revenues and one customer who
accounted for 16% of our revenues. While we believe that we will continue to
receive revenue from these customers, our agreements do not have any minimum
sales requirements and we cannot guarantee continued revenue. If our contracts
with either of these customers terminate, or if the volume of sales from these
customers significantly declines, it would have a material adverse effect on our
operating results.
In addition, as of March 31, 2007, two customers accounted for a total of
24% of our outstanding receivables, 13% and 11%, respectively. While we
currently have no reason to question the collectibility of these receivables, a
business failure or reorganization by either of these customers could harm our
ability to collect these receivables and could damage our cash flow.
22
OUR FUTURE QUARTERLY RESULTS MAY FLUCTUATE SIGNIFICANTLY, WHICH COULD CAUSE
OUR STOCK PRICE TO DECLINE.
Our previous results are not necessarily indicative of our future
performance and our future quarterly results may fluctuate significantly.
Historically, information technology spending has been higher in the
fourth and second quarters of each calendar year, and somewhat slower in the
other quarters, particularly the first quarter. Our quarterly results reflected
this seasonality in 2006 and in the first quarter of 2007, and we anticipate
that our quarterly results for the remainder of 2007 will show the effects of
seasonality as well.
Our future performance will depend on many factors, including:
o the timing of securing software license contracts and the delivery of
software and related revenue recognition;
o the seasonality of information technology, including network storage
products spending;
o the average unit selling price of our products;
o existing or new competitors introducing better products at competitive
prices before we do;
o our ability to manage successfully the complex and difficult process of
qualifying our products with our customers;
o new products or enhancements from us or our competitors;
o import or export restrictions on our proprietary technology; and
o personnel changes.
Many of our expenses are relatively fixed and difficult to reduce or
modify. As a result, the fixed nature of our expenses will magnify any adverse
effect of a decrease in revenue on our operating results.
OUR STOCK PRICE MAY BE VOLATILE
The market price of our common stock has been volatile in the past and may
be volatile in the future. For example, during the trailing twelve months ended
March 31, 2007, the closing market price of our common stock as quoted on the
NASDAQ Global Market fluctuated between $6.06 and $11.23 per share and
subsequent to March 31, 2007 the closing market price had a high of $12.10 per
share. The market price of our common stock may be significantly affected by the
following factors:
o actual or anticipated fluctuations in our operating results;
o failure to meet financial estimates;
o changes in market valuations of other technology companies, particularly
those in the network storage software market;
o announcements by us or our competitors of significant technical
innovations, acquisitions, strategic partnerships, joint ventures or
capital commitments;
o loss of one or more key OEM customers; and
o departures of key personnel.
The stock market has experienced extreme volatility that often has been
unrelated to the performance of particular companies. These market fluctuations
may cause our stock price to fall regardless of our performance.
23
WE HAVE A SIGNIFICANT NUMBER OF OUTSTANDING OPTIONS, RESTRICTED SHARES AND
WARRANTS, THE EXERCISE OF WHICH WOULD DILUTE THE THEN-EXISTING STOCKHOLDERS'
PERCENTAGE OWNERSHIP OF OUR COMMON STOCK.
As of March 31, 2007, we had an aggregate of 10,779,155 outstanding
options and outstanding restricted shares and warrants to purchase our common
stock. The weighted average exercise price of the outstanding options and
warrants is $5.80 per share. We also have 828,040 shares of our common stock
reserved for issuance under our stock plans with respect to options (or
restricted stock) that have not been granted. In addition to the 828,040 shares
of our common stock reserved for future issuance as of March 31, 2007, the
stockholders of the Company approved the 2007 Outside Directors Equity
Compensation Plan that authorized a maximum of 300,000 shares of common stock
for future issuance upon the grant of restricted shares or options on May 8,
2007.
The exercise of all of the outstanding options and warrants and/or the
grant and exercise of additional options or restricted stock would dilute the
then-existing stockholders' percentage ownership of common stock, and any sales
in the public market of the common stock issuable upon such exercise could
adversely affect prevailing market prices for the common stock. Moreover, the
terms upon which we would be able to obtain additional equity capital could be
adversely affected because the holders of such securities can be expected to
exercise or convert them at a time when we would, in all likelihood, be able to
obtain any needed capital on terms more favorable than those provided by such
securities.
UNKNOWN FACTORS
Additional risks and uncertainties of which we are unaware or which
currently we deem immaterial also may become important factors that affect us.
ITEM 5. OTHER INFORMATION
On May 8, 2007, the Company's Stockholders approved an amendment to the
FalconStor Software, Inc., 2006 Incentive Stock Plan (the "2006 Plan"). This
amendment provides that if, on July 1st of any calendar year in which the 2006
Plan is in effect (the "Calculation Date"), the number of shares of Stock with
respect to which options may be granted is less than five percent (5%) of the
number of outstanding shares of Stock, the number of shares of Stock available
for issuance under the 2006 Plan shall be increased so that the number equals
five percent (5%) of the shares of Stock subject to the 2006 Plan in the
aggregate exceed twenty million shares, subject to adjustment as provided in the
2006 Plan.
On May 8, 2007, the Company's Stockholders approved the FalconStor
Software, Inc., 2007 Outside Directors Equity Compensation Plan (the "2007
Plan"). Under the 2007 Plan, beginning with the 2007 Annual Meeting of
Stockholders, each non-employee Director will receive an annual grant of 5,000
options to purchase Company Common Stock and 5,000 shares of restricted Company
Common Stock.
On May 8, 2007, the Company's Board of Directors approved a cash
compensation plan for the Company's non-employee Directors. The plan provides
for annual Director fees of $26,500. The chairperson of the Audit Committee will
receive an additional $10,000 per annum and the chairpersons of any other
committees will receive an additional $5,000 per annum. Non-employee Directors
will also receive $3,000 per annum for each committee on which they serve in a
capacity other than chairperson. Cash fees will be paid quarterly in arrears.
On May 8, 2007, the annual cash compensation for each of Wayne Lam, James
Weber and Bernard Wu, all of whom are executive officers of the Company, was
increased to $250,000. None of such individuals has an employment agreement with
the Company.
24
ITEM 6. EXHIBITS
4.1 FalconStor Software, Inc., 2006 Incentive Stock Plan, as amended and
restated
4.2 FalconStor Software, Inc., 2007 Outside Directors Equity Compensation Plan
31.1 Certification of the Chief Executive Officer
31.2 Certification of the Chief Financial Officer
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. ss. 1350)
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (18 U.S.C. ss. 1350)
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FALCONSTOR SOFTWARE, INC.
/s/ James Weber
--------------------------------------
James Weber
Chief Financial Officer, Vice President and Treasurer
(principal financial and accounting officer)
May 9, 2007
26
Exhibit 4.1
AMENDED AND RESTATED
FALCONSTOR SOFTWARE, INC.
2006 INCENTIVE STOCK PLAN
1. PURPOSE OF THE PLAN.
This 2006 Incentive Stock Plan (the "Plan") is intended as an incentive,
to retain in the employ of and as directors, officers, consultants, advisors and
employees to FalconStor Software, Inc., a Delaware corporation (the "Company"),
and any Subsidiary of the Company, within the meaning of Section 424(f) of the
United States Internal Revenue Code of 1986, as amended (the "Code"), persons of
training, experience and ability, to attract new directors, officers,
consultants, advisors and employees whose services are considered valuable, to
encourage the sense of proprietorship and to stimulate the active interest of
such persons in the development and financial success of the Company and its
Subsidiaries.
It is further intended that certain options granted pursuant to the Plan
shall constitute incentive stock options within the meaning of Section 422 of
the Code (the "Incentive Options") while certain other options granted pursuant
to the Plan shall be nonqualified stock options (the "Nonqualified Options").
Incentive Options and Nonqualified Options are hereinafter referred to
collectively as "Options."
The Company intends that the Plan meet the requirements of Rule 16b-3
("Rule 16b-3") promulgated under the Securities Exchange Act of 1934, as amended
(the "Exchange Act") and that transactions of the type specified in
subparagraphs (c) to (f) inclusive of Rule 16b-3 by officers and directors of
the Company pursuant to the Plan will be exempt from the operation of Section
16(b) of the Exchange Act. Further, the Plan is intended to satisfy the
performance-based compensation exception to the limitation on the Company's tax
deductions imposed by Section 162(m) of the Code with respect to those Options
for which qualification for such exception is intended. In all cases, the terms,
provisions, conditions and limitations of the Plan shall be construed and
interpreted consistent with the Company's intent as stated in this Section 1.
2. ADMINISTRATION OF THE PLAN.
The Board of Directors of the Company (the "Board") shall appoint and
maintain as administrator of the Plan a Committee (the "Committee") consisting
of two or more directors who are "Non-Employee Directors" (as such term is
defined in Rule 16b-3) and "Outside Directors" (as such term is defined in
Section 162(m) of the Code), which shall serve at the pleasure of the Board. The
Committee, subject to Sections 3, 5 and 6 hereof, shall have full power and
authority to designate recipients of Options and restricted stock ("Restricted
Stock") and to determine the terms and conditions of the respective Option and
Restricted Stock agreements (which need not be identical) and to interpret the
provisions and supervise the administration of the Plan. The Committee shall
have the authority, without limitation, to designate which Options granted under
the Plan shall be Incentive Options and which shall be Nonqualified Options. To
the extent any Option does not qualify as an Incentive Option, it shall
constitute a separate Nonqualified Option.
Subject to the provisions of the Plan, the Committee shall interpret the
Plan and all Options and Restricted Stock granted under the Plan, shall make
such rules as it deems necessary for the proper administration of the Plan,
shall make all other determinations necessary or advisable for the
administration of the Plan and shall correct any defects or supply any omission
or reconcile any inconsistency in the Plan or in any Options or Restricted Stock
granted under the Plan in the manner and to the extent that the Committee deems
desirable to carry into effect the Plan or any Options or Restricted Stock. The
act or determination of a majority of the Committee shall be the act or
determination of the Committee and any decision reduced to writing and signed by
all of the members of the Committee shall be fully effective as if it had been
made by a majority at a meeting duly held. Subject to the provisions of the
Plan, any action taken or determination made by the Committee pursuant to this
and the other Sections of the Plan shall be conclusive on all parties.
In the event that for any reason the Committee is unable to act or if the
Committee at the time of any grant, award or other acquisition under the Plan
does not consist of two or more Non-Employee Directors, or if there shall be no
such Committee, then the Plan shall be administered by the Board, and references
herein to the Committee (except in the proviso to this sentence) shall be deemed
to be references to the Board, and any such grant, award or other acquisition
may be approved or ratified in any other manner contemplated by subparagraph (d)
of Rule 16b-3; provided, however, that grants to the Company's Chief Executive
Officer or to any of the Company's other four most highly compensated officers
that are intended to qualify as performance-based compensation under Section
162(m) of the Code may only be granted by the Committee.
3. DESIGNATION OF OPTIONEES AND GRANTEES.
The persons eligible for participation in the Plan as recipients of
Options (the "Optionees") or Restricted Stock (the "Grantees" and together with
Optionees, the "Participants") shall include directors, officers and employees
of the Company or any subsidiary and consultants subject to their meeting the
eligibility requirements of Rule 701 promulgated under the Securities Act of
1933, as amended (the "Securities Act"), provided that Incentive Options may
only be granted to employees of the Company and any Subsidiary. In selecting
Participants, and in determining the number of shares to be covered by each
Option or shares of Restricted Stock granted to Participants, the Committee may
consider any factors it deems relevant, including without limitation, the office
or position held by the Participant or the Participant's relationship to the
Company, the Participant's degree of responsibility for and contribution to the
growth and success of the Company or any Subsidiary, the Participant's length of
service, promotions and potential. A Participant who has been granted an Option
or Restricted Stock hereunder may be granted an additional Option or Options, or
Restricted Stock if the Committee shall so determine.
4. STOCK RESERVED FOR THE PLAN.
An initial total of 1,500,000 shares of the Company's Common Stock, par
value $0.001 per share (the "Stock"), shall be subject to the Plan. Subject to
adjustment as provided in Section 8 hereof, if on July 1st of any calendar year
in which the Plan is in effect (the "Calculation Date") the number of shares of
Stock with respect to which Options may be granted is less than five percent
(5%) of the number of outstanding shares of Stock, the number of shares of Stock
available for issuance under the Plan shall be increased so that the number
equals five percent (5%) of the shares of Stock outstanding on the Calculation
Date, but in no event shall the total number of shares of Stock subject to the
Plan in the aggregate exceed twenty million shares, subject to adjustment as
provided in Section 8 hereof. The maximum number of shares of Stock that may be
subject to Options granted under the Plan to any individual in any calendar year
shall not exceed three hundred thousand shares and the method of counting such
shares shall conform to any requirements applicable to performance-based
compensation under Section 162(m) of the Code, if qualification as
performance-based compensation under Section 162(m) of the Code is intended. The
shares of Stock subject to the Plan shall consist of unissued shares, treasury
shares or previously issued shares held by any Subsidiary of the Company, and
such amount of shares of Stock shall be and is hereby reserved for such purpose.
Any of such shares of Stock that may remain unissued and that are not subject to
outstanding Options at the termination of the Plan shall cease to be reserved
for the purposes of the Plan, but until termination of the Plan the Company
shall at all times reserve a sufficient number of shares of Stock to meet the
requirements of the Plan. Should any Option or share of Restricted Stock expire
or be canceled prior to its exercise or vesting in full or should the number of
shares of Stock to be delivered upon the exercise or vesting in full of an
Option or share of Restricted Stock be reduced for any reason, the shares of
Stock theretofore subject to such Option or share of Restricted Stock may be
subject to future Options or shares of Restricted Stock under the Plan, except
where such reissuance is inconsistent with the provisions of Section 162(m) of
the Code where qualification as performance-based compensation under Section
162(m) of the Code is intended.
5. TERMS AND CONDITIONS OF OPTIONS.
Options granted under the Plan shall be subject to the following
conditions and shall contain such additional terms and conditions, not
inconsistent with the terms of the Plan, as the Committee shall deem desirable:
(a) OPTION PRICE. The purchase price of each share of Stock
purchasable under an Incentive Option shall be determined by the Committee at
the time of grant, but shall not be less than 100% of the Fair Market Value (as
defined below) of such share of Stock on the date the Option is granted;
provided, however, that with respect to an Optionee who, at the time such
Incentive Option is granted, owns (within the meaning of Section 424(d) of the
Code) more than 10% of the total combined voting power of all classes of stock
of the Company or of any Subsidiary, the purchase price per share of Stock shall
be at least 110% of the Fair Market Value per share of Stock on the date of
grant. The purchase price of each share of Stock purchasable under a
Nonqualified Option shall not be less than 100% of the Fair Market Value of such
share of Stock on the date the Option is granted. The exercise price for each
Option shall be subject to adjustment as provided in Section 8 below. "Fair
Market Value" means the closing price on the date of grant on the principal
securities exchange on which shares of Stock are listed (if the shares of Stock
are so listed), or on the NASDAQ Stock Market (if the shares of Stock are
regularly quoted on the NASDAQ Stock Market), or, if not so listed or regularly
quoted, the mean between the closing bid and asked prices of publicly traded
shares of Stock in the over the counter market, or, if such bid and asked prices
shall not be available, as reported by any nationally recognized quotation
service selected by the Company, or as determined by the Committee in a manner
consistent with the provisions of the Code. Anything in this Section 5(a) to the
contrary notwithstanding, in no event shall the purchase price of a share of
Stock be less than the minimum price permitted under the rules and policies of
any national securities exchange on which the shares of Stock are listed.
(b) OPTION TERM. The term of each Option shall be fixed by the
Committee, but no Option shall be exercisable more than ten years after the date
such Option is granted and in the case of an Incentive Option granted to an
Optionee who, at the time such Incentive Option is granted, owns (within the
meaning of Section 424(d) of the Code) more than 10% of the total combined
voting power of all classes of stock of the Company or of any Subsidiary, no
such Incentive Option shall be exercisable more than five years after the date
such Incentive Option is granted.
(c) EXERCISABILITY. Subject to Section 5(j) hereof, Options shall be
exercisable at such time or times and subject to such terms and conditions as
shall be determined by the Committee at the time of grant; provided, however,
that in the absence of any Option vesting periods designated by the Committee at
the time of grant, Options shall vest and become exercisable as to one-third of
the total amount of shares subject to the Option on each of the first, second
and third anniversaries of the date of grant; and provided further that no
Options shall be exercisable until such time as any vesting limitation required
by Section 16 of the Exchange Act, and related rules, shall be satisfied if such
limitation shall be required for continued validity of the exemption provided
under Rule 16b-3(d)(3).
Notwithstanding any provision in this Plan, in the event there is a Change
of Control (as defined below), the Company shall, at no cost to the Participant,
replace any and all stock options granted by the Company and held by the
Participant at the time of the Change of Control, whether or not vested, with an
equal number of unrestricted and fully vested stock options to purchase shares
of the Company's Common Stock (the "Option Replacement"). With respect to the
Option Replacement, all options will become fully vested. Alternatively, in the
event of a Change of Control, in lieu of the Option Replacement, a Participant
may, subject to Board approval at the time, elect to surrender the Participant's
rights to such options, and upon such surrender, the Company shall pay to the
Participant an amount in cash per stock option (whether vested or unvested) then
held, which is the difference between the full exercise price of each option
surrendered and the greater of (i) the average price per share paid in
connection with the acquisition of control of the Company if such control was
acquired by the payment of cash or the then fair market value of the
consideration paid for such shares if such control was acquired for
consideration other than cash, (ii) the price per share paid in connection with
any tender offer for shares of the Company's Common Stock leading to control, or
(iii) the mean between the high and low selling price of such stock on the
Nasdaq National Market or other market on which the Company's Common Stock is
then traded on the date of the Change of Control.
For purposes of the Plan, a Change in Control shall be deemed to have occurred
if:
(i) An acquisition (other than directly from the Company) of
any voting securities of the Company (the "Voting Securities") by any "Person"
(as the term "person" is used for purposes of Section 13(d) or 14(d) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act")), immediately
after which such Person has "Beneficial Ownership" (within the meaning of Rule
13d-3 promulgated under the Exchange Act) of more than fifty percent (50%) of
(1) the then-outstanding shares of common stock of the Company (or any other
securities into which such shares of common stock are changed or for which such
shares of common stock are exchanged) (the "Shares") or (2) the combined voting
power of the Company's then-outstanding Voting Securities; PROVIDED, HOWEVER,
that in determining whether a Change in Control has occurred pursuant to this
paragraph (a), the acquisition of Shares or Voting Securities in a "Non-Control
Acquisition" (as hereinafter defined) shall not constitute a Change in Control.
A "Non-Control Acquisition" shall mean an acquisition by (i) an employee benefit
plan (or a trust forming a part thereof) maintained by (A) the Company or (B)
any corporation or other Person the majority of the voting power, voting equity
securities or equity interest of which is owned, directly or indirectly, by the
Company (for purposes of this definition, a "Related Entity"), (ii) the Company
or any Related Entity, or (iii) any Person in connection with a "Non-Control
Transaction" (as hereinafter defined);
(ii) The individuals who, as of the Effective Date, are
members of the board of directors of the Company (the "Incumbent Board"), cease
for any reason to constitute at least a majority of the members of the board of
directors of the Company or, following a Merger (as hereinafter defined), the
board of directors of (x) the corporation resulting from such Merger (the
"Surviving Corporation"), if fifty percent (50%) or more of the combined voting
power of the then-outstanding voting securities of the Surviving Corporation is
not Beneficially Owned, directly or indirectly, by another Person (a "Parent
Corporation") or (y) if there is one or more than one Parent Corporation, the
ultimate Parent Corporation; provided, however, that, if the election, or
nomination for election by the Company's common stockholders, of any new
director was approved by a vote of at least two-thirds of the Incumbent Board,
such new director shall, for purposes of the Plan, be considered a member of the
Incumbent Board; and provided, further, however, that no individual shall be
considered a member of the Incumbent Board if such individual initially assumed
office as a result of an actual or threatened solicitation of proxies or
consents by or on behalf of a Person other than the board of directors of the
Company (a "Proxy Contest"), including by reason of any agreement intended to
avoid or settle any Proxy Contest; or
(iii) The consummation of:
(a) A merger, consolidation or reorganization (1) with
or into the Company or (2) in which securities of the Company are issued (a
"Merger"), unless such Merger is a "Non-Control Transaction." A "Non-Control
Transaction" shall mean a Merger in which:
(i) the stockholders of the Company immediately
before such Merger own directly or indirectly immediately
following such Merger at least fifty percent (50%) of the
combined voting power of the outstanding voting securities of
(x) the Surviving Corporation, if there is no Parent
Corporation or (y) if there is one or more than one Parent
Corporation, the ultimate Parent Corporation;
(ii) the individuals who were members of the
Incumbent Board immediately prior to the execution of the
agreement providing for such Merger constitute at least a
majority of the members of the board of directors of (x) the
Surviving Corporation, if there is no Parent Corporation, or
(y) if there is one or more than one Parent Corporation, the
ultimate Parent Corporation; and
(iii) no Person other than (1) the Company, (2)
any Related Entity, or (3) any employee benefit plan (or any
trust forming a part thereof) that, immediately prior to the
Merger, was maintained by the Company or any Related Entity,
or (4) any Person who, immediately prior to the Merger had
Beneficial Ownership of twenty percent (20%) or more of the
then outstanding Shares or Voting Securities, has Beneficial
Ownership, directly or indirectly, of twenty percent (20%) or
more of the combined voting power of the outstanding voting
securities or common stock of (x) the Surviving Corporation,
if fifty percent (50%) or more of the combined voting power of
the then outstanding voting securities of the Surviving
Corporation is not Beneficially Owned, directly or indirectly
by a Parent Corporation, or (y) if there is one or more than
one Parent Corporation, the ultimate Parent Corporation;
(b) A complete liquidation or dissolution of the
Company; or
(c) The sale or other disposition of all or
substantially all of the assets of the Company and its subsidiaries taken as a
whole to any Person (other than (x) a transfer to a Related Entity, (y) a
transfer under conditions that would constitute a Non-Control Transaction, with
the disposition of assets being regarded as a Merger for this purpose or (z) the
distribution to the Company's stockholders of the stock of a Related Entity or
any other assets).
Notwithstanding the foregoing, a Change in Control shall not be deemed to occur
solely because any Person (the "Subject Person") acquired Beneficial Ownership
of more than the permitted amount of the then outstanding Shares or Voting
Securities as a result of the acquisition of Shares or Voting Securities by the
Company which, by reducing the number of Shares or Voting Securities then
outstanding, increases the proportional number of shares Beneficially Owned by
the Subject Persons; PROVIDED, that if a Change in Control would occur (but for
the operation of this sentence) as a result of the acquisition of Shares or
Voting Securities by the Company and, after such share acquisition by the
Company, the Subject Person becomes the Beneficial Owner of any additional
Shares or Voting Securities and such Beneficial Ownership increases the
percentage of the then outstanding Shares or Voting Securities Beneficially
Owned by the Subject Person, then a Change in Control shall occur.
(d) METHOD OF EXERCISE. Options to the extent then exercisable may
be exercised in whole or in part at any time during the option period, by giving
written notice to the Company specifying the number of shares of Stock to be
purchased, accompanied by payment in full of the purchase price, in cash, or by
check or such other instrument as may be acceptable to the Committee. As
determined by the Committee, in its sole discretion, at or after grant, payment
in full or in part may be made at the election of the Optionee (i) in the form
of Stock owned by the Optionee (based on the Fair Market Value of the Stock
which is not the subject of any pledge or security interest, (ii) in the form of
shares of Stock withheld by the Company from the shares of Stock otherwise to be
received with such withheld shares of Stock having a Fair Market Value equal to
the exercise price of the Option, or (iii) by a combination of the foregoing,
such Fair Market Value determined by applying the principles set forth in
Section 5(a), provided that the combined value of all cash and cash equivalents
and the Fair Market Value of any shares surrendered to the Company is at least
equal to such exercise price and except with respect to (ii) above, such method
of payment will not cause a disqualifying disposition of all or a portion of the
Stock received upon exercise of an Incentive Option. Notwithstanding the
forgoing, an Optionee may not take any actions that are prohibited by the
Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated by the
Securities and Exchange Commission or any agency thereunder. An Optionee shall
have the right to dividends and other rights of a stockholder with respect to
shares of Stock purchased upon exercise of an Option at such time as the
Optionee (i) has given written notice of exercise and has paid in full for such
shares, and (ii) has satisfied such conditions that may be imposed by the
Company with respect to the withholding of taxes.
(e) NON-TRANSFERABILITY OF OPTIONS. Options are not transferable and
may be exercised solely by the Optionee during his lifetime or after his death
by the person or persons entitled thereto under his will or the laws of descent
and distribution. The Committee, in its sole discretion, may permit a transfer
of a Nonqualified Option to (i) a trust for the benefit of the Optionee, (ii) a
member of the Optionee's immediate family (or a trust for his or her benefit) or
(iii) pursuant to a domestic relations order. Any attempt to transfer, assign,
pledge or otherwise dispose of, or to subject to execution, attachment or
similar process, any Option contrary to the provisions hereof shall be void and
ineffective and shall give no right to the purported transferee.
(f) TERMINATION BY DEATH. Unless otherwise determined by the
Committee, if any Optionee's employment with or service to the Company or any
Subsidiary terminates by reason of death, the Option may thereafter be
exercised, to the extent then exercisable (or on such accelerated basis as the
Committee shall determine at or after grant), by the legal representative of the
estate or by the legatee of the Optionee under the will of the Optionee, for a
period of one (1) year after the date of such death (or, if later, such time as
the Option may be exercised pursuant to Section 14(d) hereof) or until the
expiration of the stated term of such Option as provided under the Plan,
whichever period is shorter.
(g) TERMINATION BY REASON OF DISABILITY. Unless otherwise determined
by the Committee, if any Optionee's employment with or service to the Company or
any Subsidiary terminates by reason of total and permanent disability, any
Option held by such Optionee may thereafter be exercised, to the extent it was
exercisable at the time of termination due to disability (or on such accelerated
basis as the Committee shall determine at or after grant), but may not be
exercised after three (3) months after the date of such termination of
employment or service (or, if later, such time as the Option may be exercised
pursuant to Section 14(d) hereof) or the expiration of the stated term of such
Option, whichever period is shorter; PROVIDED, HOWEVER, that, if the Optionee
dies within such three (3) month period, any unexercised Option held by such
Optionee shall thereafter be exercisable to the extent to which it was
exercisable at the time of death for a period of one (1) year after the date of
such death (or, if later, such time as the Option may be exercised pursuant to
Section 14(d) hereof) or for the stated term of such Option, whichever period is
shorter.
(h) TERMINATION BY REASON OF RETIREMENT. Unless otherwise determined
by the Committee, if any Optionee's employment with or service to the Company or
any Subsidiary terminates by reason of Normal or Early Retirement (as such terms
are defined below), any Option held by such Optionee may thereafter be exercised
to the extent it was exercisable at the time of such Retirement (or on such
accelerated basis as the Committee shall determine at or after grant), but may
not be exercised after three (3) months after the date of such termination of
employment or service (or, if later, such time as the Option may be exercised
pursuant to Section 14(d) hereof) or the expiration of the stated term of such
Option, whichever date is earlier; provided, however, that, if the Optionee dies
within such three (3) month period, any unexercised Option held by such Optionee
shall thereafter be exercisable, to the extent to which it was exercisable at
the time of death, for a period of one (1) year after the date of such death
(or, if later, such time as the Option may be exercised pursuant to Section
14(d) hereof) or for the stated term of such Option, whichever period is
shorter.
For purposes of this paragraph (h), "Normal Retirement" shall mean
retirement from active employment with the Company or any Subsidiary on or after
the normal retirement date specified in the applicable Company or Subsidiary
pension plan or if no such pension plan, age 65, and "Early Retirement" shall
mean retirement from active employment with the Company or any Subsidiary
pursuant to the early retirement provisions of the applicable Company or
Subsidiary pension plan or if no such pension plan, age 55.
(i) OTHER TERMINATION. Unless otherwise determined by the Committee
upon grant, if any Optionee's employment with or service to the Company or any
Subsidiary terminates for any reason other than death, disability or Normal or
Early Retirement, the Option shall thereupon terminate, except that the portion
of any Option that was exercisable on the date of such termination of employment
or service may be exercised for the lesser of thirty (30) days after the date of
termination or the balance of such Option's term if the Optionee's employment or
service with the Company or any Subsidiary or Affiliate is terminated by the
Company or such Subsidiary without cause (the determination as to whether
termination was for cause to be made by the Committee). The transfer of an
Optionee from the employ of or service to the Company to the employ of or
service to a Subsidiary, or vice versa, or from one Subsidiary to another, shall
not be deemed to constitute a termination of employment or service for purposes
of the Plan.
(j) LIMIT ON VALUE OF INCENTIVE OPTION. The aggregate Fair Market
Value, determined as of the date the Incentive Option is granted, of Stock for
which Incentive Options are exercisable for the first time by any Optionee
during any calendar year under the Plan (and/or any other stock option plans of
the Company or any Subsidiary) shall not exceed $100,000.
(k) GRANTS TO FOREIGN EMPLOYEES. The terms of grants to foreign
employees may vary from the terms of this Section 5 provided that the terms
shall only be more restrictive than any term in this Section 5.
(l) DIVIDEND EQUIVALENTS. Simultaneously with the grant of any
Option and under such terms and conditions as the Committee deems appropriate
and subject to Section 12 herein, the Committee may grant special dividend
equivalent rights ("Dividend Equivalents") which amount shall be determined by
multiplying the number of shares of Stock subject to an Option by the per-share
cash dividend, or the per-share fair market value (as determined by the
Committee) of any dividend in consideration other than cash, paid by the Company
on its Stock on a dividend payment date (other than the regular quarterly cash
dividends of the Company). Unless otherwise determined by the Committee at
grant, the Dividend Equivalents (i) shall have the same vesting schedule, if
any, as the Options to which the Dividend Equivalents relate and (ii) shall be
payable upon exercise of the Options to which the Dividend Equivalents relate.
At the discretion of the Committee, Dividend Equivalents shall be credited to
accounts on the Company's records for purposes of the Plan. Dividend Equivalents
may be accrued as a cash obligation, or may be converted to shares of Stock for
the Participant. The Committee shall determine whether any deferred Dividend
Equivalents will accrue interest. The Committee may provide that an Optionee may
use Dividend Equivalents to pay the Purchase Price. Dividend Equivalents may be
payable in cash or shares of Stock or in a combination of the two, as determined
by the Committee.
6. TERMS AND CONDITIONS OF RESTRICTED STOCK.
Restricted Stock may be granted under this Plan aside from, or in
association with, any other award and shall be subject to the following
conditions and shall contain such additional terms and conditions (including
provisions relating to the acceleration of vesting of Restricted Stock upon a
Change of Control), not inconsistent with the terms of the Plan, as the
Committee shall deem desirable:
(a) GRANTEE RIGHTS. A Grantee shall have no rights to an award of
Restricted Stock unless and until Grantee accepts the award within the period
prescribed by the Committee and, if the Committee shall deem desirable, makes
payment to the Company in cash, or by check or such other instrument as may be
acceptable to the Committee. After acceptance and issuance of a certificate or
certificates, as provided for below, the Grantee shall have the rights of a
stockholder with respect to Restricted Stock subject to the non-transferability
and forfeiture restrictions described in Section 6(d) below.
(b) ISSUANCE OF CERTIFICATES. The Company shall issue in the
Grantee's name a certificate or certificates for the shares of Common Stock
associated with the award promptly after the Grantee accepts such award.
(c) DELIVERY OF CERTIFICATES. Unless otherwise provided, any
certificate or certificates issued evidencing shares of Restricted Stock shall
not be delivered to the Grantee until such shares are free of any restrictions
specified by the Committee at the time of grant.
(d) FORFEITABILITY, NON-TRANSFERABILITY OF RESTRICTED STOCK. Shares
of Restricted Stock are forfeitable until the terms of the Restricted Stock
grant have been satisfied. Shares of Restricted Stock are not transferable until
the date on which the Committee has specified such restrictions have lapsed.
Unless otherwise provided by the Committee at or after grant, distributions in
the form of dividends or otherwise of additional shares or property in respect
of shares of Restricted Stock shall be subject to the same restrictions as such
shares of Restricted Stock.
(e) CHANGE OF CONTROL. Upon the occurrence of a Change in Control as
defined in Section 5(c), the Committee may accelerate the vesting of outstanding
Restricted Stock, in whole or in part, as determined by the Committee, in its
sole discretion.
(f) TERMINATION OF EMPLOYMENT. Unless otherwise determined by the
Committee at or after grant, in the event the Grantee ceases to be an employee
or otherwise associated with the Company for any other reason, all shares of
Restricted Stock theretofore awarded to him which are still subject to
restrictions shall be forfeited and the Company shall have the right to complete
a blank stock power. The Committee may provide (on or after grant) that
restrictions or forfeiture conditions relating to shares of Restricted Stock
will be waived in whole or in part in the event of termination resulting from
specified causes, and the Committee may in other cases waive in whole or in part
restrictions or forfeiture conditions relating to Restricted Stock.
7. TERM OF PLAN.
No Option or shares of Restricted Stock shall be granted pursuant to the
Plan on or after the date that is ten years from the effective date of the Plan,
but Options or shares of Restricted Stock theretofore granted may extend beyond
that date.
8. CAPITAL CHANGE OF THE COMPANY.
In the event of any merger, reorganization, consolidation,
recapitalization, stock dividend, stock split or other equity restructuring or
change in corporate structure affecting the Stock, the Committee shall make an
appropriate and equitable adjustment in the number and kind of shares reserved
for issuance under the Plan and in the number and option price of shares subject
to outstanding Options granted under the Plan, to the end that after such event
each Optionee's proportionate interest shall be maintained (to the extent
possible) as immediately before the occurrence of such event. The Committee
shall, to the extent feasible, make such other adjustments as may be required
under the tax laws so that any Incentive Options previously granted shall not be
deemed modified within the meaning of Section 424(h) of the Code. Appropriate
adjustments shall also be made in the case of outstanding Restricted Stock
granted under the Plan.
The adjustments described above will be made only to the extent consistent
with continued qualification of the Option under Section 422 of the Code (in the
case of an Incentive Option) and Section 409A of the Code.
9. PURCHASE FOR INVESTMENT/CONDITIONS.
Unless the Options and shares covered by the Plan have been registered
under the Securities Act, or the Company has determined that such registration
is unnecessary, each person exercising or receiving Options or Restricted Stock
under the Plan may be required by the Company to give a representation in
writing that he is acquiring the securities for his own account for investment
and not with a view to, or for sale in connection with, the distribution of any
part thereof. The Committee may impose any additional or further restrictions on
awards of Options or Restricted Stock as shall be determined by the Committee at
the time of award.
10. TAXES.
(a) The Company may make such provisions as it may deem appropriate,
consistent with applicable law, in connection with any Options or Restricted
Stock granted under the Plan with respect to the withholding of any taxes
(including income or employment taxes) or any other tax matters.
(b) If any Grantee, in connection with the acquisition of Restricted
Stock, makes the election permitted under Section 83(b) of the Code (that is, an
election to include in gross income in the year of transfer the amounts
specified in Section 83(b)), such Grantee shall notify the Company of the
election with the Internal Revenue Service pursuant to regulations issued under
the authority of Code Section 83(b).
(c) If any Grantee shall make any disposition of shares of Stock
issued pursuant to the exercise of an Incentive Option under the circumstances
described in Section 421(b) of the Code (relating to certain disqualifying
dispositions), such Grantee shall notify the Company of such disposition within
ten (10) days hereof.
11. EFFECTIVE DATE OF PLAN.
The Plan shall be effective on April 3, 2006; provided, however, that if,
and only if, certain options are intended to qualify as Incentive Stock Options,
the Plan must subsequently be approved by majority vote of the Company's
stockholders no later than April 3, 2007, and further, that in the event certain
Option grants hereunder are intended to qualify as performance-based
compensation within the meaning of Section 162(m) of the Code, the requirements
as to shareholder approval set forth in Section 162(m) of the Code are
satisfied.
12. AMENDMENT AND TERMINATION.
The Board may amend, suspend, or terminate the Plan, except that no
amendment shall be made that would impair the rights of any Participant under
any Option or Restricted Stock theretofore granted without the Participant's
consent, and except that no amendment shall be made which, without the approval
of the stockholders of the Company would:
(a) materially increase the number of shares that may be issued
under the Plan, except as is provided in Section 8;
(b) materially increase the benefits accruing to the Participants
under the Plan;
(c) materially modify the requirements as to eligibility for
participation in the Plan;
(d) decrease the exercise price of an Incentive Option to less than
100% of the Fair Market Value per share of Stock on the date of grant thereof or
the exercise price of a Nonqualified Option to less than 100% of the Fair Market
Value per share of Stock on the date of grant thereof;
(e) extend the term of any Option beyond that provided for in
Section 5(b); or
(f) except as otherwise provided in Sections 5(c), 5(l) and 8
hereof, reduce the exercise price of outstanding Options or effect repricing
through cancellations and re-grants of new Options.
Subject to the forgoing, the Committee may amend the terms of any Option
theretofore granted, prospectively or retrospectively, but no such amendment
shall impair the rights of any Optionee without the Optionee's consent.
It is the intention of the Board that the Plan comply strictly with the
provisions of Section 409A of the Code and Treasury Regulations and other
Internal Revenue Service guidance promulgated thereunder (the "Section 409A
Rules") and the Committee shall exercise its discretion in granting awards
hereunder (and the terms of such awards), accordingly. The Plan and any grant of
an award hereunder may be amended from time to time (without, in the case of an
award, the consent of the Participant) as may be necessary or appropriate to
comply with the Section 409A Rules.
13. GOVERNMENT REGULATIONS.
The Plan, and the grant and exercise of Options or Restricted Stock
hereunder, and the obligation of the Company to sell and deliver shares under
such Options and Restricted Stock shall be subject to all applicable laws, rules
and regulations, and to such approvals by any governmental agencies, national
securities exchanges and interdealer quotation systems as may be required.
14. GENERAL PROVISIONS.
(a) CERTIFICATES. All certificates for shares of Stock delivered
under the Plan shall be subject to such stop transfer orders and other
restrictions as the Committee may deem advisable under the rules, regulations
and other requirements of the Securities and Exchange Commission, or other
securities commission having jurisdiction, any applicable Federal or state
securities law, any stock exchange or interdealer quotation system upon which
the Stock is then listed or traded and the Committee may cause a legend or
legends to be placed on any such certificates to make appropriate reference to
such restrictions.
(b) EMPLOYMENT MATTERS. Neither the adoption of the Plan nor any
grant or award under the Plan shall confer upon any Participant who is an
employee of the Company or any Subsidiary any right to continued employment or,
in the case of a Participant who is a director, continued service as a director,
with the Company or a Subsidiary, as the case may be, nor shall it interfere in
any way with the right of the Company or any Subsidiary to terminate the
employment of any of its employees, the service of any of its directors or the
retention of any of its consultants or advisors at any time.
(c) LIMITATION OF LIABILITY. No member of the Committee, or any
officer or employee of the Company acting on behalf of the Committee, shall be
personally liable for any action, determination or interpretation taken or made
in good faith with respect to the Plan, and all members of the Committee and
each and any officer or employee of the Company acting on their behalf shall, to
the extent permitted by law, be fully indemnified and protected by the Company
in respect of any such action, determination or interpretation.
(d) REGISTRATION OF STOCK. Notwithstanding any other provision in
the Plan, no Option may be exercised unless and until the Stock to be issued
upon the exercise thereof has been registered under the Securities Act of 1933,
as amended, and applicable state securities laws, or are, in the opinion of
counsel to the Company, exempt from such registration in the United States. The
Company shall not be under any obligation to register under applicable federal
or state securities laws any Stock to be issued upon the exercise of an Option
granted hereunder in order to permit the exercise of an Option and the issuance
and sale of the Stock subject to such Option, although the Company may in its
sole discretion register such Stock at such time as the Company shall determine.
If the Company chooses to comply with such an exemption from registration, the
Stock issued under the Plan may, at the direction of the Committee, bear an
appropriate restrictive legend restricting the transfer or pledge of the Stock
represented thereby, and the Committee may also give appropriate stop transfer
instructions with respect to such Stock to the Company's transfer agent.
15. NON-UNIFORM DETERMINATIONS.
The Committee's determinations under the Plan, including, without
limitation, (i) the determination of the Participants to receive awards, (ii)
the form, amount and timing of such awards, (iii) the terms and provisions of
such awards and (ii) the agreements evidencing the same, need not be uniform and
may be made by it selectively among Participants who receive, or who are
eligible to receive, awards under the Plan, whether or not such Participants are
similarly situated.
16. GOVERNING LAW.
The validity, construction, and effect of the Plan and any rules and
regulations relating to the Plan shall be determined in accordance with the
internal laws of the State of Delaware, without giving effect to principles of
conflicts of laws, and applicable federal law.
FalconStor Software, Inc.
April 3, 2006
Amended May 8, 2007
Exhibit 4.2
FALCONSTOR SOFTWARE, INC.
2007 OUTSIDE DIRECTORS EQUITY COMPENSATION PLAN
1. PURPOSE. The FalconStor Software, Inc. 2007 Outside Directors Equity
Compensation Plan (the "Plan") is established effective as of the 26th day
of March, 2007, (the "Effective Date") to create additional incentive for
the non employee directors of FalconStor Software, Inc., a Delaware
corporation, and any successor corporation thereto (collectively referred
to as the "Company") to promote the financial success and progress of the
Company and any present or future parent and/or subsidiary corporations of
the Company. For purposes of the Plan, a parent corporation and a
subsidiary corporation shall be as defined in sections 424(e) and 424(f)
of the Internal Revenue Code of 1986, as amended (the "Code").
2. ADMINISTRATION. The Plan shall be administered by the Board of Directors
of the Company (the "Board") and/or by a duly appointed committee of the
Board having such powers as shall be specified by the Board. Any
subsequent references herein to the Board shall also mean the committee if
such committee has been appointed and, unless the powers of the committee
have been specifically limited, the committee shall have all of the powers
of the Board granted herein, including, without limitation, the power to
terminate or amend the Plan at any time subject to the terms of the Plan
and any applicable limitations imposed by law. The Board shall have no
authority, discretion or power to select the non-employee directors of the
Company who will receive options or be granted shares of restricted stock
under the Plan, to set the exercise price of the options granted under the
Plan, to determine the number of shares of common stock to be granted
under option or the time at which such options are to be granted, to
establish the duration of option grants, to determine the number of shares
of restricted stock to be granted or the time at which such shares of
restricted stock are to be granted or to alter other terms or conditions
specified in the Plan, except in the sense of administering the Plan
subject to the provisions of the Plan. All questions of interpretation of
the Plan, of any options granted under the Plan (an "Option") or of any
restricted stock granted under the plan ("Restricted Stock" and together
with the Options, an "Award") shall be determined by the Board, and such
determinations shall be final and binding upon all persons having an
interest in the Plan and/or any Award. Any officer of the Company shall
have the authority to act on behalf of the Company with respect to any
matter, right, obligation, or election which is the responsibility of or
which is allocated to the Company herein, provided the officer has
apparent authority with respect to such matter, right, obligation, or
election.
3. ELIGIBILITY AND TYPE OF AWARDS. Awards may be granted only to directors of
the Company who, at the time of such grant, are not employees of the
Company or of any parent or subsidiary corporation of the Company
("Outside Directors"). Options granted to Outside Directors shall be
nonqualified stock options; that is, options that are not treated as
having been granted under section 422(b) of the Code. A person granted an
Option is hereinafter referred to as an "Optionee". A person granted
Restricted Stock is hereinafter referred to as a "Grantee" (and together
with the Optionees, the "Participants"). Notwithstanding anything
contained herein, no Participant may take any action that is prohibited by
the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated
by the Securities and Exchange Commission or any other agency thereunder.
4. SHARES SUBJECT TO AWARDS. Options shall be for the purchase of shares of
authorized but unissued common stock or treasury shares of common stock of
the Company (the "Stock"), subject to adjustment as provided in paragraph
8 below. The maximum number of shares of Stock which may be issued or
granted under the Plan shall be Three Hundred Thousand (300,000) shares.
Should any Option or share of Restricted Stock expire or be canceled prior
to its exercise or vesting in full or should the number of shares of Stock
to be delivered upon the exercise or vesting in full of an Option or share
of Restricted Stock be reduced for any reason, the shares of Stock
theretofore subject to such Option or share of Restricted Stock may be
subject to future Options or shares of Restricted Stock under the Plan.
5. TERMS, CONDITIONS AND FORM OF OPTIONS. Options granted pursuant to the
Plan shall be evidenced by written agreements specifying the number of
shares of Stock covered thereby, in substantially the form attached hereto
as Exhibit A (the "Option Agreement"), which written agreement may
incorporate all or any of the terms of the Plan by reference and shall
comply with and be subject to the following terms and conditions:
a. AUTOMATIC GRANT OF OPTIONS. Subject to execution by an Outside
Director of an appropriate Option Agreement, Options shall be
granted automatically and without further action of the Board, as
follows:
i. Each person who is newly elected or appointed as an Outside
Director on or after the Effective Date shall be granted an
Option on the day of such initial election or appointment to
purchase Fifty Thousand (50,000) shares of Stock.
ii. On the date of each Annual Meeting of Stockholders of the
Company occurring after the Effective Date, each Outside
Director shall be granted an Option to purchase Five Thousand
(5,000) shares of Stock; provided, however, that in the event
an Outside Director was elected or appointed as an Outside
Director and was granted an Option pursuant to the provisions
of subparagraph 5(a)(i) above within six months prior to the
Annual Meeting of Stockholders, that Outside Director shall be
ineligible to receive an Option with respect to such Annual
Meeting of Stockholders.
iii. On the date of the 2007 Annual Meeting of Stockholders, each
Outside Director who served as the Chairperson of any
committee of the Company's Board of Directors for at least six
months during the Company's most recently concluded fiscal
year shall be granted an Option to purchase Five Thousand
(5,000) shares of Stock. In the event an Outside Director
served as the Chairperson for two or more Committees, such
Outside Director shall be granted an option to purchase Five
Thousand (5,000) shares of Stock for each committee for which
the Outside Director served as Chairperson.
iv. Notwithstanding the foregoing, any person may elect not to
receive an Option to be granted pursuant to this paragraph
5(a) by delivering written notice of such election to the
Board no later than the day prior to the date on which such
Option would otherwise be granted. A person so declining an
Option shall receive no payment or other consideration in lieu
of such declined Option. A person who has declined an Option
may revoke such election by delivering written notice of such
revocation to the Board no later than the day prior to the
date on which such Option would be granted pursuant to
paragraph 5(a).
v. Notwithstanding any other provision of the Plan to the
contrary, no Option shall be granted to any individual on a
day when he or she is no longer serving as an Outside Director
of the Company.
b. OPTION EXERCISE PRICE. The exercise price per share of Stock subject
to an Option shall be the fair market value of a share of the Stock
on the close of business on the date of the granting of the Option.
Where there is a public market for the common stock of the Company,
the fair market value per share of Stock shall be the mean of the
bid and asked prices of the common stock of the Company on the date
of the granting of the Option, as reported in the Wall Street
Journal (or, if not so reported, as otherwise reported by the
National Association of Securities Dealers Automated Quotation
("Nasdaq") System) or, in the event the common stock of the Company
is listed on the Nasdaq Global Market or a securities exchange, the
fair market value per share of Stock shall be the closing price on
such Global Market or exchange on the date of granting of the
Option, as reported in the Wall Street Journal. If the date of the
granting of an Option does not fall on a day on which the common
stock of the Company is trading on Nasdaq, the Nasdaq Global Market
or securities exchange, the date on which the Option exercise price
shall be established shall be the last day on which the common stock
of the Company was so traded prior to the date of the granting
Option.
c. EXERCISE PERIOD AND EXERCISABILITY OF OPTIONS. An Option granted
pursuant to the Plan shall be exercisable for a term of ten years.
Options granted pursuant to the Plan shall first become exercisable
on the day (the "Initial Vesting Date") which is one year from the
date on which the Option was granted. The Option shall first be
exercisable on and after the Initial Vesting Date and prior to
termination of the Option in an amount equal to the number of Option
Shares multiplied by the Vested Ratio (as hereinafter defined) as
set forth below, less the number of shares previously acquired upon
exercise of any portion of the Option.
The "Vested Ratio" shall mean, on any relevant date, except as otherwise
provided herein, the ratio determined as follows:
Vested Ratio
------------
(i) Prior to Initial Vesting Date: 0
On Initial Vesting Date, 1/3
provided the Optionee's Service has not
terminated prior to such date:
Plus
----
(ii) For each full year
of the Optionee's continuous Service
from the Initial Vesting Date until the
Vested Ratio equals 1/1, an additional: 1/3
For purposes of the Plan, "Service" shall mean the Optionee's service with the
Company, whether in the capacity of an employee, a director or a consultant. The
Optionee's Service shall not be deemed to have terminated merely because of a
change in the capacity in which the Optionee renders Service to the Company,
provided that there is no interruption or termination of the Optionee's Service.
d. TERMINATION OF OPTIONEE. In the event of an Optionee's termination
of Service for any reason other than as a result of death or
disability of the Optionee, in which case all Options that have
become vested will remain exercisable for the earlier of 36 months
or the expiration date of the Options, all Options that have not
become vested and exercisable as of the date of such cessation of
Service shall be forfeited and to the extent that such Options have
become vested and exercisable as of such date, such Options must be
exercised, if at all, within ninety (90) days after the Optionee's
termination of Service, after which time such Options shall
automatically terminate; provided, however, in the event an Optionee
ceases being a director because the Optionee's Service was
terminated for cause, all Options granted hereunder (whether vested
or unvested) shall terminate immediately.
e. PAYMENT OF OPTION EXERCISE. Payment of the exercise price for the
number of shares of Stock being purchased pursuant to any Option
shall be made (i) in cash, by check, or cash equivalent, (ii) by the
assignment of the proceeds of a sale of some or all of the shares
being acquired upon the exercise of an Option (including, without
limitation, through an exercise complying with the provisions of
Regulation T as promulgated from time to time by the Board of
Governors of the Federal Reserve System), (iii) by the delivery to
the Company of shares of Stock which have been owned by the holder
of the Option for more than six months and which have an aggregate
value equal to such exercise price, or (iv) by any combination
thereof. The Company reserves, at any and all times, the right, in
the Company's sole and absolute discretion, to establish, decline to
approve and/or terminate any program and/or procedure for the
exercise of Options by means of an assignment of the proceeds of a
sale of some or all the shares of Stock to be acquired upon such
exercise or the delivery of previously owned shares of Stock.
f. TRANSFER OF CONTROL. Notwithstanding any provision in this Plan, in
the event there IS a Change of Control (as defined below), the
Company shall, at no cost to the Participant, replace any and all
stock options granted by the Company and held by the Participant at
the time of the Change of Control, whether or not vested, with an
equal number of unrestricted and fully vested stock options to
purchase shares of the Company's Common Stock (the "Option
Replacement"). With respect to the Option Replacement, all options
will become fully vested. Alternatively, in the event of a Change of
Control, in lieu of the Option Replacement, a Participant may,
subject to Board approval at the time, elect to surrender the
Participant's rights to such options, and upon such surrender, the
Company shall pay to the Participant an amount in cash per stock
option (whether vested or unvested) then held, which is the
difference between the full exercise price of each option
surrendered and the greater of (i) the average price per share paid
in connection with the acquisition of control of the Company if such
control was acquired by the payment of cash or the then fair market
value of the consideration paid for such shares if such control was
acquired for consideration other than cash, (ii) the price per share
paid in connection with any tender offer for shares of the Company's
Common Stock leading to control, or (iii) the mean between the high
and low selling price of such stock on the Nasdaq Global Market or
other market on which the Company's Common Stock is then traded on
the date of the Change of Control.
For purposes of the Plan, a Change in Control shall be deemed
to have occurred if:
i. An acquisition (other than directly from the Company) of any
voting securities of the Company (the "Voting Securities") by
any "Person" (as the term "person" is used for purposes of
Section 13(d) or 14(d) of the Securities Exchange Act of 1934,
as amended (the "Exchange Act")), immediately after which such
Person has "Beneficial Ownership" (within the meaning of Rule
13d-3 promulgated under the Exchange Act) of more than fifty
percent (50%) of (1) the then-outstanding shares of common
stock of the Company (or any other securities into which such
shares of common stock are changed or for which such shares of
common stock are exchanged) (the "Shares") or (2) the combined
voting power of the Company's then-outstanding Voting
Securities; provided, however, that in determining whether a
Change in Control has occurred pursuant to this paragraph (i),
the acquisition of Shares or Voting Securities in a
"Non-Control Acquisition" (as hereinafter defined) shall not
constitute a Change in Control. A "Non-Control Acquisition"
shall mean an acquisition by (a) an employee benefit plan (or
a trust forming a part thereof) maintained by (A) the Company
or (B) any corporation or other Person the majority of the
voting power, voting equity securities or equity interest of
which is owned, directly or indirectly, by the Company (for
purposes of this definition, a "Related Entity"), (b) the
Company or any Related Entity, or (c) any Person in connection
with a "Non-Control Transaction" (as hereinafter defined);
ii. The individuals who, as of the Effective Date, are members of
the board of directors of the Company (the "Incumbent Board"),
cease for any reason to constitute at least a majority of the
members of the board of directors of the Company or, following
a Merger (as hereinafter defined), the board of directors of
(x) the corporation resulting from such Merger (the "Surviving
Corporation"), if fifty percent (50%) or more of the combined
voting power of the then-outstanding voting securities of the
Surviving Corporation is not Beneficially Owned, directly or
indirectly, by another Person (a "Parent Corporation") or (y)
if there is one or more than one Parent Corporation, the
ultimate Parent Corporation; provided, however, that, if the
election, or nomination for election by the Company's common
stockholders, of any new director was approved by a vote of at
least two-thirds of the Incumbent Board, such new director
shall, for purposes of the Plan, be considered a member of the
Incumbent Board; and provided, further, however, that no
individual shall be considered a member of the Incumbent Board
if such individual initially assumed office as a result of an
actual or threatened solicitation of proxies or consents by or
on behalf of a Person other than the board of directors of the
Company (a "Proxy Contest"), including by reason of any
agreement intended to avoid or settle any Proxy Contest; or
iii. The consummation of:
1. A merger, consolidation or reorganization (1) with or
into the Company or (2) in which securities of the
Company are issued (a "Merger"), unless such Merger is a
"Non-Control Transaction." A "Non-Control Transaction"
shall mean a Merger in which:
a. the stockholders of the Company immediately before
such Merger own directly or indirectly immediately
following such Merger at least fifty percent (50%)
of the combined voting power of the outstanding
voting securities of (x) the Surviving
Corporation, if there is no Parent Corporation or
(y) if there is one or more than one Parent
Corporation, the ultimate Parent Corporation;
b. the individuals who were members of the Incumbent
Board immediately prior to the execution of the
agreement providing for such Merger constitute at
least a majority of the members of the board of
directors of (x) the Surviving Corporation, if
there is no Parent Corporation, or (y) if there is
one or more than one Parent Corporation, the
ultimate Parent Corporation; and
c. (no Person other than (1) the Company, (2) any
Related Entity, or (3) any employee benefit plan
(or any trust forming a part thereof) that,
immediately prior to the Merger, was maintained by
the Company or any Related Entity, or (4) any
Person who, immediately prior to the Merger had
Beneficial Ownership of twenty percent (20%) or
more of the then outstanding Shares or Voting
Securities, has Beneficial Ownership, directly or
indirectly, of twenty percent (20%) or more of the
combined voting power of the outstanding voting
securities or common stock of (x) the Surviving
Corporation, if fifty percent (50%) or more of the
combined voting power of the then outstanding
voting securities of the Surviving Corporation is
not Beneficially Owned, directly or indirectly by
a Parent Corporation, or (y) if there is one or
more than one Parent Corporation, the ultimate
Parent Corporation;
2. A complete liquidation or dissolution of the Company; or
3. The sale or other disposition of all or substantially
all of the assets of the Company and its subsidiaries
taken as a whole to any Person (other than (x) a
transfer to a Related Entity, (y) a transfer under
conditions that would constitute a Non-Control
Transaction, with the disposition of assets being
regarded as a Merger for this purpose or (z) the
distribution to the Company's stockholders of the stock
of a Related Entity or any other assets).
Notwithstanding the foregoing, a Change in Control shall not be deemed to
occur solely because any Person (the "Subject Person") acquired Beneficial
Ownership of more than the permitted amount of the then outstanding Shares
or Voting Securities as a result of the acquisition of Shares or Voting
Securities by the Company which, by reducing the number of Shares or
Voting Securities then outstanding, increases the proportional number of
shares Beneficially Owned by the Subject Persons; provided, that if a
Change in Control would occur (but for the operation of this sentence) as
a result of the acquisition of Shares or Voting Securities by the Company
and, after such share acquisition by the Company, the Subject Person
becomes the Beneficial Owner of any additional Shares or Voting Securities
and such Beneficial Ownership increases the percentage of the then
outstanding Shares or Voting Securities Beneficially Owned by the Subject
Person, then a Change in Control shall occur.
g. STOCKHOLDER APPROVAL. No Option may be granted pursuant to the Plan
prior to obtaining stockholder approval of the Plan.
h. TRANSFERABILITY OF OPTIONS.
(i) Except as provided in paragraph 5(h)(ii), an Option may be
exercised during the lifetime of the Optionee only by the
Optionee or the Optionee's guardian or legal representative
and may not be assigned or transferred in any manner except by
will or by the laws of descent and distribution.
(ii) Notwithstanding the foregoing, with the consent of the Board,
in its sole discretion, an Optionee may transfer all or a
portion of the Option to: (i) an Immediate Family Member (as
defined below), (ii) a trust for the exclusive benefit of the
Optionee and/or one or more Immediate Family Members, (iii) a
partnership in which the Optionee and/or one or more Immediate
Family Members are the only partners, or (iv) such other
person or entity as the Board may permit (individually, a
"Permitted Transferee"). For purposes of this paragraph
5(h)(ii) "Immediate Family Members" shall mean the Optionee's
spouse, former spouse, children or grandchildren, whether
natural or adopted. As a condition to such transfer, each
Permitted Transferee to whom the Option or any interest
therein is transferred shall agree in writing (in a form
satisfactory to the Company) to be bound by all of the terms
and conditions of the Option Agreement evidencing such Option
and any additional restrictions or conditions as the Company
may require. Following the transfer of an Option, the term
"Optionee" shall refer to the Permitted Transferee, except
that, with respect to any requirements of continued Service or
provision for the Company's tax withholding obligations, such
term shall refer to the original Optionee. The Company shall
have no obligation to notify a Permitted Transferee of any
termination of the transferred Option, including an early
termination resulting from the termination of Service of the
Original Optionee. A Permitted Transferee shall be prohibited
from making a subsequent transfer of a transferred Option
except to the original Optionee or to another permitted
Transferee or as provided in paragraph 5(h)(i).
i. RE-PRICING OF OPTIONS / REPLACEMENT OPTIONS. The Company shall not
re-price any Options or issue any replacement Options unless the
Option re-pricing or Option replacement shall have been approved by
the holders of a majority of the outstanding shares of the Company.
j. DIVIDEND EQUIVALENTS. Simultaneously with the grant of any Option
and under such terms and conditions as the Board deems appropriate
and subject to Section 10 herein, the Board may grant special
dividend equivalent rights ("Dividend Equivalents") which amount
shall be determined by multiplying the number of shares of Stock
subject to an Option by the per-share cash dividend, or the
per-share fair market value (as determined by the Board) of any
dividend in consideration other than cash, paid by the Company on
its Stock on a dividend payment date (other than the regular
quarterly cash dividends of the Company, if any). Unless otherwise
determined by the Board at grant, the Dividend Equivalents (i) shall
have the same vesting schedule, if any, as the Options to which the
Dividend Equivalents relate and (ii) shall be payable upon exercise
of the Options to which the Dividend Equivalents relate. At the
discretion of the Board, Dividend Equivalents shall be credited to
accounts on the Company's records for purposes of the Plan. Dividend
Equivalents may be accrued as a cash obligation, or may be converted
to shares of Stock for the Participant. The Board shall determine
whether any deferred Dividend Equivalents will accrue interest. The
Board may provide that an Optionee may use Dividend Equivalents to
pay the purchase price. Dividend Equivalents may be payable in cash
or shares of Stock or in a combination of the two, as determined by
the Board.
k. TIME FOR GRANTING OPTIONS. All Options shall be granted, if at all,
within three years from the Effective Date.
6. TERMS AND CONDITIONS OF RESTRICTED STOCK: Restricted Stock awarded
pursuant to the Plan shall be evidenced by written agreements specifying
the number of shares of Restricted Stock covered thereby, in substantially
the form attached hereto in Exhibit B (the "Restricted Stock Agreement").
Grants of Restricted Stock shall be subject to the following conditions
and shall contain such additional terms and conditions (including
provisions relating to the acceleration of vesting of Restricted Stock
upon a Change of Control), not inconsistent with the terms of the Plan, as
the Board shall deem desirable:
a AUTOMATIC GRANT OF RESTRICTED STOCK. Subject to execution by an
Outside Director of an appropriate Restricted Stock Agreement,
Restricted Stock shall be granted automatically and without further
action of the Board, as follows:
i. On the date of each Annual Meeting of Stockholders of the
Company occurring after the Effective Date, each Outside
Director shall be granted Five Thousand (5,000) shares of
Restricted Stock; provided, however, that in the event an
Outside Director was elected or appointed as an Outside
Director and was granted an Option pursuant to the provisions
of subparagraph 5(a)(i) above within six months prior to the
Annual Meeting of Stockholders, that Outside Director shall be
ineligible to receive any Restricted Stock with respect to
such Annual Meeting of Stockholders. Such Restricted Stock
shall have the same Vested Ratio as is provided under Section
5(b) hereto.
ii. Notwithstanding any other provision of the Plan to the
contrary, no Restricted Stock shall be granted to any
individual on a day when he or she is no longer serving as an
Outside Director of the Company.
b GRANTEE RIGHTS. A Grantee shall have no rights to an award of
Restricted Stock unless and until Grantee accepts the award within
the period prescribed by the Board. After acceptance and issuance of
a certificate or certificates, as provided for below, the Grantee
shall have the rights of a stockholder with respect to Restricted
Stock subject to the non-transferability and forfeiture restrictions
described in Section 6(e) below.
c ISSUANCE OF CERTIFICATES. The Company shall issue, in the Grantee's
name, a certificate or certificates for the shares of Restricted
Stock associated with the award promptly after the Grantee accepts
such award.
d DELIVERY OF CERTIFICATES. Unless otherwise provided, any certificate
or certificates issued evidencing shares of Restricted Stock shall
not be delivered to the Grantee until such shares are free of any
restrictions specified by the Board at the time of grant.
e FORFEITABILITY, NON-TRANSFERABILITY OF RESTRICTED STOCK. Shares of
Restricted Stock are forfeitable until the terms of the Restricted
Stock grant have been satisfied. Shares of Restricted Stock are not
transferable until the date on which the Board has specified such
restrictions have lapsed. Unless otherwise provided by the Board at
or after grant, distributions in the form of dividends or otherwise
of additional shares or property in respect of shares of Restricted
Stock shall be subject to the same restrictions as such shares of
Restricted Stock.
f TRANSFER OF CONTROL. Upon the occurrence of a Change of Control as
defined in Section 5(f), the Board may accelerate the vesting of
outstanding Restricted Stock, in whole or in part, as determined by
the Board, in its sole discretion.
g TERMINATION OF GRANTEE. In the event the Grantee ceases to be an
Outside Director or otherwise associated with the Company for any
other reason, all shares of Restricted Stock theretofore awarded to
him which are still subject to restrictions shall be forfeited and
the Company shall have the right to complete a blank stock power.
The Board may provide (on or after grant) that restrictions or
forfeiture conditions relating to shares of Restricted Stock will be
waived in whole or in part in the event of termination resulting
from specified causes, and the Board may in other cases waive in
whole or in part restrictions or forfeiture conditions relating to
Restricted Stock.
7. AUTHORITY TO VARY TERMS. The Board shall have the authority from time to
time to vary the terms of the Option and Restricted Stock Agreements
either in connection with the grant of an individual Option or Restricted
Stock or in connection with the authorization of a new standard form or
forms of Awards; provided, however, that the terms and conditions of such
revised or amended standard form or forms of stock option agreement shall
be in accordance with the terms of the Plan. Such authority shall include,
but not be limited to, the authority to grant Options which are
immediately exercisable subject to the Company's right to repurchase any
unvested shares of Stock acquired by the Participant on exercise of an
Option in the event such Participant's service as director of the Company
is terminated for any reason.
8. EFFECT OF CHANGE IN STOCK SUBJECT TO PLAN. Appropriate adjustments shall
be made in the number and class of shares of Stock subject to the Plan,
the number of shares to be granted under the Plan and to any outstanding
Options or shares of Restricted Stock and in the Option exercise price of
any outstanding Options in the event of a stock dividend, stock split,
recapitalization, reverse stock split, combination, reclassification, or
like change in the capital structure of the Company.
9. TERMINATION OR AMENDMENT OF PLAN. The Board, including any duly appointed
committee of the Board, may terminate or amend the Plan at any time;
provided, however, that without the approval of the stockholders of the
Company, there shall be no increase in the total number of shares of Stock
covered by the Plan (except by operation of the provisions of paragraph 8
above). In any event, no amendment may adversely affect any then
outstanding Option, or any unexercised portion thereof, without the
consent of the Participant. It is the intention of the Board that the Plan
comply strictly with the provisions of Section 409A of the Code and
Treasury Regulations and other Internal Revenue Service guidance
promulgated thereunder (the "Section 409A Rules") and the Board shall
exercise its discretion in granting awards hereunder (and the terms of
such awards), accordingly. The Plan and any grant of an award hereunder
may be amended from time to time (without, in the case of an award, the
consent of the Participant) as may be necessary or appropriate to comply
with the Section 409A Rules.
10. TAXES.
a. The Company may make such provisions as it may deem appropriate,
consistent with applicable law, in connection with any Options or
Restricted Stock granted under the Plan with respect to the
withholding of any taxes (including income or employment taxes) or
any other tax matters.
b. If any Grantee, in connection with the acquisition of Restricted
Stock, makes the election permitted under Section 83(b) of the Code
(that is, an election to include in gross income in the year of
transfer the amounts specified in Section 83(b)), such Grantee shall
notify the Company of the election with the Internal Revenue Service
pursuant to regulations issued under the authority of Code Section
83(b).
11. GOVERNMENT REGULATIONS. The Plan, and the grant and exercise of Options or
Restricted Stock hereunder, and the obligation of the Company to sell and
deliver shares under such Options and Restricted Stock shall be subject to
all applicable laws, rules and regulations, and to such approvals by any
governmental agencies, national securities exchanges and interdealer
quotation systems as may be required.
12. GENERAL PROVISIONS.
a. CERTIFICATES. All certificates for shares of Stock delivered under
the Plan shall be subject to such stop transfer orders and other
restrictions as the Board may deem advisable under the rules,
regulations and other requirements of the Securities and Exchange
Commission, or other securities commission having jurisdiction, any
applicable Federal or state securities law, any stock exchange or
interdealer quotation system upon which the Stock is then listed or
traded and the Board may cause a legend or legends to be placed on
any such certificates to make appropriate reference to such
restrictions.
b. EMPLOYMENT MATTERS. Neither the adoption of the Plan nor any grant
or award under the Plan shall confer upon any Participant who is a
director, continued service as a director, with the Company or a
Subsidiary, as the case may be, nor shall it interfere in any way
with the right of the Company or any Subsidiary to terminate the
service of any of its directors at any time.
c. LIMITATION OF LIABILITY. No member of the Board, or any officer or
employee of the Company acting on behalf of the Board, shall be
personally liable for any action, determination or interpretation
taken or made in good faith with respect to the Plan, and all
members of the Board and each and any officer or employee of the
Company acting on their behalf shall, to the extent permitted by
law, be fully indemnified and protected by the Company in respect of
any such action, determination or interpretation.
d. REGISTRATION OF STOCK. Notwithstanding any other provision in the
Plan, no Option may be exercised unless and until the Stock to be
issued upon the exercise thereof has been registered under the
Securities Act of 1933, as amended, and applicable state securities
laws, or are, in the opinion of counsel to the Company, exempt from
such registration in the United States. The Company shall not be
under any obligation to register under applicable federal or state
securities laws any Stock to be issued upon the exercise of an
Option granted hereunder in order to permit the exercise of an
Option and the issuance and sale of the Stock subject to such
Option, although the Company may in its sole discretion register
such Stock at such time as the Company shall determine. If the
Company chooses to comply with such an exemption from registration,
the Stock issued under the Plan may, at the direction of the
Committee, bear an appropriate restrictive legend restricting the
transfer or pledge of the Stock represented thereby, and the Board
may also give appropriate stop transfer instructions with respect to
such Stock to the Company's transfer agent.
13. GOVERNING LAW. The validity, construction, and effect of the Plan and any
rules and regulations relating to the Plan shall be determined in
accordance with the internal laws of the State of Delaware, without giving
effect to principles of conflicts of laws, and applicable federal law.