(8) Share-Based Payment Arrangements

12 Months Ended

Dec. 31, 2012

Notes to Financial Statements

(8) Share-Based Payment Arrangements

(8) Share-Based Payment Arrangements

The following table summarizes the plans under which the Company was able to grant equity compensation as of December 31, 2012:

	Shares	Shares Available	Shares	Last Date for Grant
Name of Plan	Authorized	for Grant	Outstanding	of Shares
FalconStor Software, Inc., 2006 Incentive Stock Plan	12,224,133	2,246,036	7,388,945	May 17, 2016
FalconStor Software, Inc., 2010 Outside Directors Equity	400,000	280,000	90,300	March 25, 2013
Compensation Plan

On July 1, 2012, the total shares available for issuance under the FalconStor Software, Inc., 2006 Incentive Stock Plan (the “2006 Plan”) totaled 2,197,887. Pursuant to the 2006 Plan, as amended, 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, 2012, the total number of outstanding shares of the Company’s common stock totaled 47,541,262. Pursuant to the 2006 Plan, as amended, the total shares available for issuance under the 2006 Plan thus increased by 179,176 shares from 2,197,887 to 2,377,063 shares available for issuance as of July 1, 2012.

The following table summarizes the Company’s equity plans that have expired but that still have equity awards outstanding as of December 31, 2012:

	Shares Available	Shares
Name of Plan	for Grant	Outstanding
FalconStor Software, Inc., 2000 Stock Option Plan	--	2,432,787
1994 Outside Directors Stock Option Plan	--	40,000
2004 Outside Directors Stock Option Plan	--	190,000
FalconStor Software, Inc., 2007 Outside Directors Equity	--	170,000
Compensation Plan
Stand-Alone Stock Option Agreement between	--	1,220,000
the Company and James P. McNiel

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

A summary of the Company’s stock option activity for 2012 is as follows:

			Weighted
		Weighted	Average
		Average	Remaining	Aggregate
	Number of	Exercise	Contractual	Intrinsic
	Options	Price	Life  (Years)	Value
Options Outstanding at December 31, 2011	14,456,722	$4.95
Granted	2,042,700	$2.45
Exercised	(321,260)	$2.30
Forfeited	(3,550,825)	$4.79
Expired	(1,266,495)	$4.62
Options Outstanding at December 31, 2012	11,360,842	$4.66	6.46	$          497,695
Options Exercisable at December 31, 2012	7,299,451	$5.60	5.21	$            88,120
Options Expected to Vest after December 31, 2012 (1)	3,338,779	$3.00	8.67	$          311,277
(1) Options expected to vest after December 31, 2012 reflect an estimated forfeiture rate

Stock option exercises are fulfilled with new shares of common stock. The total cash received from stock option exercises for the years ended December 31, 2012, 2011 and 2010 was $738,184, $920,106 and $409,889, respectively. The total intrinsic value of stock options exercised during the years ended December 31, 2012, 2011 and 2010 was $273,935, $422,136 and $2,881,294, 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 consolidated statement of operations:

	Years ended December 31,
	2012	2011	2010
Cost of revenues - Product	$           262	$        2,960	$      31,779
Cost of revenues - Support and Service	172,707	461,735	1,117,550
Research and development costs	727,826	1,302,129	2,987,146
Selling and marketing	1,677,469	2,023,370	3,379,518
General and administrative	2,036,505	1,727,864	1,169,576
	$ 4,614,769	$ 5,518,058	$ 8,685,569

The Company did not recognize any tax benefits related to share-based compensation expense during the years ended December 31, 2012, 2011 and 2010.

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 year, is as follows:

	Years ended December 31,
	2012	2011	2010
Directors, officers and employees	$    584,959	$ 1,358,107	$ 2,524,914
Non-employee consultants	13,488	21,882	760,661
	$    598,447	$ 1,379,989	$ 3,285,575

As of December 31, 2012, an aggregate of 2,876,068 shares of restricted stock had been issued, of which, 2,231,837 had vested and 473,041 had been forfeited. As of December 31, 2011, an aggregate of 2,821,054 shares of restricted stock had been issued, of which, 1,854,007 had vested and 446,990 had been forfeited. As of December 31, 2010, an aggregate of 2,658,872 shares of restricted stock had been issued, of which, 1,446,082 had vested and 417,485 had been forfeited.

As of December 31, 2012, an aggregate of 90,412 restricted stock units had been issued, of which, 79,065 had vested and 11,347 had been forfeited. As of December 31, 2011, an aggregate of 90,412 restricted stock units had been issued, of which, 73,580 had vested and 11,000 had been forfeited. As of December 31, 2010, an aggregate of 90,412 restricted stock units had been issued, of which, 43,975 had vested and 2,500 had been forfeited.

A summary of the Company’s restricted stock activity for 2012 is as follows:

	Number of
	Restricted Stock
	Awards / Units
Non-Vested at December 31, 2011	525,889
Granted	55,014
Vested	(383,315)
Forfeited	(26,398)
Non-Vested at December 31, 2012	171,190

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 years ended December 31, 2012, 2011 and 2010 was $1,119,103, $1,941,382 and $2,950,735, respectively.

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/(benefit) 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:

	Years ended December 31,
	2012	2011	2010
Non-qualified stock options	$      13,999	$        2,487	$      58,524
Restricted stock awards	13,488	21,882	760,661
	$      27,487	$      24,369	$    819,185

The Company estimates the fair value of share-based payments using the Black-Scholes option-pricing model. The Company believes that this valuation technique and the approach utilized to develop the underlying assumptions are appropriate in estimating the fair value of the Company’s share-based payments granted during the years ended December 31, 2012, 2011 and 2010. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by the employees who receive equity awards.

 The per share weighted average fair value of share-based payments granted during the years ended December 31, 2012, 2011 and 2010 was $1.36, $2.11 and $1.95, respectively. In addition, to the exercise and grant date prices of the awards, certain weighted average assumptions that were used to estimate the fair value of share-based payment grants in the respective periods are listed in the table below:

	Years ended December 31,
	2012	2011	2010
Expected dividend yield	0%	0%	0%
Expected volatility	60 - 61%	56 - 61%	54 - 60%
Risk-free interest rate	0.7 - 1.2%	1.0 - 2.5%	1.6 - 3.0%
Expected term (years)	5.5	5.5	5.5
Discount for post-vesting restrictions	N/A	N/A	N/A

Options granted to officers, employees and directors during fiscal 2012, 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. Based on each respective group’s historical vesting experience and expected trends, the estimated forfeiture rate for officers, employees, and directors, as adjusted, for both fiscal 2012 and 2011 was 11%, 24% and 0%, respectively. For fiscal year 2010, the estimated forfeiture rate for officers, employees, and directors, as adjusted, was 11%, 24% and 9%, respectively.

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 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 December 31, 2012, there was approximately $5,476,063 total unrecognized compensation cost related to the Company’s unvested stock options, restricted stock and restricted stock unit awards granted under the Company’s stock plans. The unrecognized compensation cost is expected to be recognized over a weighted-average period of 1.76 years.

As of December 31, 2012, the Company had 14,058,068 shares of common stock reserved for issuance upon the exercise of stock options, restricted stock and restricted stock units.