(2) Share-Based Payment Arrangements

On January 11, 2011, the Company entered into a Stand-Alone Stock Option Agreement (“McNiel Option Agreement”) with James P. McNiel, the Company’s President and Chief Executive Officer. The McNiel Option Agreement, which was approved by stockholders on May 9, 2011, provides for the grant to Mr. NcNiel of options to purchase up to 1,220,000 shares of the Company’s common stock at an exercise price of $3.22 per share, which vest over a three-year period at 33%, 33% and 34% annually.

The following table summarizes the plans under which the Company was able to grant equity compensation as of June 30, 2011:

Name of Plan	Shares Authorized	Shares Available for Grant	Shares Outstanding	Last Date for Grant of Shares
Name of Plan	Shares Authorized	Shares Available for Grant	Shares Outstanding	Last Date for Grant of Shares

FalconStor Software, Inc., 2006 Incentive Stock Plan	9,928,114	217,879	7,759,724	May 17, 2016

FalconStor Software, Inc., 2010 Outside Directors Equity Compensation Plan	400,000	330,000	63,400	May 8, 2020

On July 1, 2011, the total shares available for issuance under the FalconStor Software, Inc., 2006 Incentive Stock Plan (the “2006 Plan”) totaled 2,334,722. Pursuant to the 2006 Plan, if, on July 1^st of any calendar year in which the 2006 Plan is in effect, the number of shares of stock as to which options, restricted shares and restricted stock units may be granted under the 2006 Plan is less than five percent (5%) of the number of outstanding shares of stock, then the number of shares of stock available for issuance under the 2006 Plan is automatically increased so that the number equals five percent (5%) of the shares of stock outstanding. In no event shall the number of 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 July 1, 2011, the total number of outstanding shares of the Company’s common stock totaled 46,694,436. Pursuant to the 2006 Plan, as amended, the total shares available for issuance under the 2006 Plan thus increased by 2,116,843 shares to 2,334,722 shares available for issuance as of July 1, 2011.

The following table summarizes the plans that have expired but still have equity awards outstanding as of June 30, 2011:

Name of Plan	Shares Available for Grant	Shares Outstanding

FalconStor Software, Inc., 2000 Stock Option Plan	--	5,204,011

1994 Outside Directors Stock Option Plan	--	125,500

2004 Outside Directors Stock Option Plan	--	250,000

FalconStor Software, Inc., 2007 Outside Directors Equity	--	188,600
Compensation Plan

Stand-Alone Stock Option Agreement between	--	1,220,000
the Company and James P. McNiel

Options granted under all of the Company’s Plans have terms of ten years.

The following table summarizes stock option activity during the six months ended June 30, 2011:

	Number of Options	Weighted Average Exercise Price	Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value






Options Outstanding at December 31, 2010	12,192,884	$5.58

Granted	725,000	$3.66
Exercised	(159,355)	$2.93
Canceled	(234,653)	$6.45
Forfeited	(355,226)	$3.82

Options Outstanding at March 31, 2011	12,168,650	$5.53	5.99	$ 8,620,896


Granted	2,436,500	$3.68
Exercised	(35,640)	$2.40
Canceled	(122,357)	$10.55
Forfeited	(235,420)	$6.31

Options Outstanding at June 30, 2011	14,211,733	$5.17	6.51	$ 9,999,450

Options Exercisable at June 30, 2011	8,316,557	$6.37	4.66	$ 3,877,054

Stock option exercises are fulfilled with new shares of common stock. The total cash received from stock option exercises for the three months ended June 30, 2011 and 2010 was $85,421 and $34,322, respectively. The total cash received from stock option exercises for the six months ended June 30, 2011 and 2010 was $552,774 and $249,343, respectively. The total intrinsic value of stock options exercised during the three months ended June 30, 2011 and 2010 was $56,526 and $201,744 respectively. The total intrinsic value of stock options exercised during the six months ended June 30, 2011 and 2010 was $314,822 and $2,415,951, respectively.

The Company recognized share-based compensation expense for all awards issued under the Company’s stock equity plans in the following line items in the condensed consolidated statements of operations:

	Three months ended June 30,
	2011	2010
Cost of revenues - Product	$ 741	$ 7,009
Cost of revenues - Support and Service	129,714	290,145
Research and development costs	329,369	760,358
Selling and marketing	462,555	875,947
General and administrative	417,974	336,886

	$ 1,340,353	$ 2,270,345


	Six months ended June 30,
	2011	2010
Cost of revenues - Product	$ 1,473	$ 13,941
Cost of revenues - Support and Service	273,201	610,091
Research and development costs	808,411	1,800,330
Selling and marketing	885,279	1,896,716
General and administrative	686,936	651,592

	$ 2,655,300	$ 4,972,670

The Company has the ability to issue both restricted stock and restricted stock units. The fair value of the restricted stock awards and restricted stock units are expensed at either (i) the fair value per share at date of grant (outside directors, officers and employees), or (ii) the fair value per share as of each reporting period (non-employee consultants). A summary of the total stock-based compensation expense related to restricted stock awards and restricted stock units, which is included in the Company’s total share-based compensation expense for each respective period, is as follows:

	Three months ended June 30,
	2011	2010
Outside directors, officers and employees	$ 326,964	$ 662,617
Non-employee consultants	19,290	186,004

	$ 346,254	$ 848,621


	Six months ended June 30,
	2011	2010
Outside directors, officers and employees	$ 721,498	$ 1,432,394
Non-employee consultants	21,882	600,340

	$ 743,380	$ 2,032,734

As of June 30, 2011, an aggregate of 2,803,554 shares of restricted stock had been issued, of which, 1,776,429 had vested and 444,645 had been canceled. As of June 30, 2010, an aggregate of 2,493,154 shares of restricted stock had been issued, of which, 1,154,082 had vested and 407,186 had been canceled.

As of June 30, 2011, an aggregate of 90,412 restricted stock units had been issued, of which 70,890 had vested and 2,500 had been canceled. As of June 30, 2010, an aggregate of 90,412 restricted stock units had been issued, of which 40,495 had vested and 1,382 had been canceled.

The following table summarizes restricted stock and restricted stock units activity during the six months ended June 30, 2011:

			Number of Restricted Stock Awards / Units
			Number of Restricted Stock Awards / Units

Non-Vested at December 31, 2010			839,422

Granted			90,000
Vested			(293,225)
Forfeited			(25,755)

Non-Vested at March 31, 2011			610,442

Granted			54,682
Vested			(64,217)
Forfeited			(1,405)

Non-Vested at June 30, 2011			599,502

Restricted stock and restricted stock units are fulfilled with new shares of common stock. The total intrinsic value of restricted stock for which the restrictions lapsed during the three months ended June 30, 2011 and 2010 was $266,019 and $528,971, respectively. The total intrinsic value of restricted stock for which the restrictions lapsed during the six months ended June 30, 2011 and 2010 was $1,635,512 and $2,068,177, respectively.

Options granted to officers, employees and directors during fiscal 2011 and 2010 have exercise prices equal to the fair market value of the stock on the date of grant, a contractual term of ten years, and a vesting period generally of three years.

Options granted to non-employee consultants have exercise prices equal to the fair market value of the stock on the date of grant and a contractual term of ten years. Restricted stock awards granted to non-employee consultants have a contractual term equal to the lapse of restriction(s) of each specific award. Vesting periods for share-based awards granted to non-employee consultants range from immediate vesting to three years depending on service requirements. A summary of the total stock-based compensation expense related to share-based awards granted to non-employee consultants, which is included in the Company’s total share-based compensation expense for each respective period, is as follows:

	Three months ended June 30,
	2011	2010
Non-qualified stock options	$ 17,286	$ (27,579)
Restricted stock awards	19,290	186,004

	$ 36,576	$ 158,425


	Six months ended June 30,
	2011	2010
Non-qualified stock options	$ 104,189	$ (24,773)
Restricted stock awards	21,882	600,340

	$ 126,071	$ 575,567

The Company estimates expected volatility based primarily on historical daily volatility of the Company’s stock and other factors, if applicable. The risk-free interest rate is based on the United States treasury yield curve in effect at the time of grant. The expected option term is the number of years that the Company estimates that options will be outstanding prior to exercise. The expected term of the awards issued since January 1, 2008, was determined based upon an estimate of the expected term of “plain vanilla” options as prescribed in SEC Staff Accounting Bulletin (“SAB”) No. 110.

As of June 30, 2011, there was approximately $9,924,238 of total unrecognized compensation cost related to the Company’s unvested options and restricted shares granted under the Company’s equity plans.