(2) Share-Based Payment Arrangements

3 Months Ended

Mar. 31, 2013

Notes to Financial Statements

(2) Share-Based Payment Arrangements

(2) Share-Based Payment Arrangements

The following table summarizes the plans under which the Company was able to grant equity compensation as of March 31, 2013:

	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	2,365,421	7,220,990	May 17, 2016

The following table summarizes the Company’s equity plans that have expired but that still have equity awards outstanding as of March 31, 2013:

	Shares Available	Shares
Name of Plan	for Grant	Outstanding
FalconStor Software, Inc., 2000 Stock Option Plan	--	2,062,787
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
FalconStor Software, Inc, 2010 Outside Directors Equity Compensation Plan	--	90,300

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

The following table summarizes stock option activity during the three months ended March 31, 2013:

			Weighted
		Weighted	Average
		Average	Remaining	Aggregate
	Number of	Exercise	Contractual	Intrinsic
	Options	Price	Life  (Years)	Value
Options Outstanding at December 31, 2012	11,360,842	$4.66
Granted	70,000	$2.31
Exercised	(310,000)	$2.25
Forfeited	(224,795)	$4.56
Expired	(20,000)	$3.96
Options Outstanding at March 31, 2013	10,876,047	$4.72	6.13	$       1,136,141
Options Exercisable at March 31, 2013	7,567,615	$5.52	5.17	$          340,020

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, 2013 and 2012 was $697,500 and $202,865, respectively. The total intrinsic value of stock options exercised during the three months ended March 31, 2013 and 2012 was $121,819 and $78,253, 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 March 31,
	2013	2012
Cost of revenues - Product	$              49	$              49
Cost of revenues - Support and Service	50,256	70,969
Research and development costs	134,910	318,958
Selling and marketing	284,038	486,625
General and administrative	421,482	571,701
	$     890,735	$  1,448,302

The Company has the ability to issue both restricted stock awards 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 March 31,
	2013	2012
Directors, officers and employees	$       63,197	$     277,417
Non-employee consultants	-	-
	$       63,197	$     277,417

As of March 31, 2013, an aggregate of 2,876,068 shares of restricted stock awards had been issued, of which, 2,280,407 had vested and 477,631 had been forfeited. As of March 31, 2012, an aggregate of 2,821,054 shares of restricted stock awards had been issued, of which, 2,139,137 had vested and 458,139 had been forfeited.

As of March 31, 2013, there were no restricted stock units outstanding. As of March 31, 2012, an aggregate of 90,412 restricted stock units had been issued, of which 78,555 had vested and 11,347 had been canceled.

         The following table summarizes the activity for restricted stock awards during the three months ended March 31, 2013:

	Number of
	Restricted Stock
	Awards
Non-Vested at December 31, 2012	171,190
Granted	-
Vested	(48,570)
Forfeited	(4,590)
Non-Vested at March 31, 2013	118,030

Restricted stock awards 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 March 31, 2013 and 2012 was $121,136 and $860,147, respectively.

Options granted to officers, employees and directors during fiscal 2013 and 2012 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/(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:

	Three months ended March 31,
	2013	2012
Non-qualified stock options	$                 -	$       55,192
Restricted stock awards	-	-
	$                 -	$       55,192

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 March 31, 2013, there was approximately $4,449,496 of total unrecognized compensation cost related to the Company’s unvested options, and restricted shares granted under the Company’s equity plans.