Share-Based Payment Arrangements

9 Months Ended

Sep. 30, 2011

Disclosure Of Compensation Related Costs, Share-Based Payments [Abstract]

Share-Based Payment Arrangements

(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 commencing January 11, 2012 at 33%, 33% and 34% annually.

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 1st 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 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 from 217,879 to 2,334,722 shares available for issuance as of July 1, 2011.

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

	Shares		Shares Available		Shares		Last Date for Grant
Name of Plan	Authorized		for Grant		Outstanding		of Shares
FalconStor Software, Inc., 2006 Incentive		12,044,957		2,363,581		7,626,237	May 17, 2016
Stock Plan
FalconStor Software, Inc., 2010 Outside		400,000		330,000		63,400	May 8, 2020
Directors Equity Compensation Plan

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

	Shares Available		Shares
Name of Plan	for Grant		Outstanding
FalconStor Software, Inc., 2000 Stock Option Plan		--		4,930,591
1994 Outside Directors Stock Option Plan		--		110,500
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

All options granted under the Company’s equity plans have terms of ten years.

The following table summarizes stock option activity during the nine months ended September 30, 2011:

						Weighted
				Weighted		Average
				Average		Remaining		Aggregate
	Number of			Exercise		Contractual		Intrinsic
	Options			Price		Life (Years)		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
Granted		167,500		$	3.44
Exercised		(124,598	)	$	2.47
Canceled		(41,910	)	$	9.85
Forfeited		(377,369	)	$	5.49
Options Outstanding at September 30, 2011		13,835,356		$	5.15		6.34	$	1,249,401
Options Exercisable at September 30, 2011		8,148,509		$	6.33		4.50	$	806,078

Stock option exercises are fulfilled with new shares of common stock. The total cash received from stock option exercises for the three months ended September 30, 2011 and 2010 was $307,940 and $129,216, respectively. The total cash received from stock option exercises for the nine months ended September 30, 2011 and 2010 was $860,714 and $378,559, respectively. The total intrinsic value of stock options exercised during the three months ended September 30, 2011 and 2010 was $91,139 and $296,722 respectively. The total intrinsic value of stock options exercised during the nine months ended September 30, 2011 and 2010 was $405,961 and $2,712,673, 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 September 30,
	2011		2010
Cost of revenues - Product	$	1,169	$	9,755
Cost of revenues - Support and Service		111,830		277,839
Research and development costs		235,782		680,179
Selling and marketing		585,814		978,559
General and administrative		501,983		251,615
	$	1,436,578	$	2,197,947

	Nine months ended September 30,
	2011		2010
Cost of revenues - Product	$	2,641	$	23,696
Cost of revenues - Support and Service		385,032		887,930
Research and development costs		1,044,193		2,480,509
Selling and marketing		1,471,093		2,875,275
General and administrative		1,188,919		903,207
	$	4,091,878	$	7,170,617

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 (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 September 30,
	2011		2010
Directors, officers and employees	$	384,578	$	673,891
Non-employee consultants		-		159,263
	$	384,578	$	833,154
	Nine months ended September 30,
		2011		2010
Directors, officers and employees	$	1,106,076	$	2,106,285
Non-employee consultants		21,882		759,603
	$	1,127,958	$	2,865,888

As of September 30, 2011, an aggregate of 2,821,054 shares of restricted stock had been issued, of which, 1,836,769 had vested and 444,645 had been canceled. As of September 30, 2010, an aggregate of 2,637,389 shares of restricted stock had been issued, of which, 1,374,572 had vested and 413,886 had been canceled.

As of September 30, 2011, an aggregate of 90,412 restricted stock units had been issued, of which 73,580 had vested and 2,500 had been canceled. As of September 30, 2010, an aggregate of 90,412 restricted stock units had been issued, of which 43,795 had vested and 1,382 had been canceled.

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

	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
Granted		17,500
Vested		(63,030	)
Forfeited		0
Non-Vested at September 30, 2011		553,972

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 September 30, 2011 and 2010 was $254,335 and $677,307, respectively. The total intrinsic value of restricted stock for which the restrictions lapsed during the nine months ended September 30, 2011 and 2010 was $1,889,847 and $2,745,484, 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 September 30,
	2011			2010
Non-qualified stock options	$	(93,836	)	$	41,981
Restricted stock awards		-			159,263
	$	(93,836	)	$	201,244
	Nine months ended September 30,
		2011			2010
Non-qualified stock options	$	10,353		$	17,208
Restricted stock awards		21,882			759,603
	$	32,235		$	776,811

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 September 30, 2011, there was approximately $8,602,654 of total unrecognized compensation cost related to the Company’s unvested options and restricted shares granted under the Company’s equity plans.