(2) Share-Based Payment Arrangements

9 Months Ended

Sep. 30, 2013

Notes to Financial Statements

(2) Share-Based Payment Arrangements

On May 9, 2013, the Company’s stockholders adopted the FalconStor Software, Inc. 2013 Outside Directors Equity Compensation Plan (the “2013 Plan”). The 2013 Plan is administered by the Board of Directors and provides for the issuance of up to 400,000 shares of Company’s 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 the plans under which the Company was able to grant equity compensation as of September 30, 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	13,455,546	3,480,696	7,314,498	May 17, 2016
FalconStor Software, Inc., 2013 Outside Directors Equity
Compensation Plan	400,000	350,000	50,000	May 9, 2016

On July 1, 2013, the total shares available for issuance under the FalconStor Software, Inc., 2006 Incentive Stock Plan (the “2006 Plan”) totaled 1,169,323. 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, 2013, the total number of outstanding shares of the Company’s common stock totaled 48,014,717. Pursuant to the 2006 Plan, as amended, the total shares available for issuance under the 2006 Plan thus increased by 1,231,413 shares from 1,169,323 to 2,400,736 shares available for issuance as of July 1, 2013.

The following table summarizes the Company’s equity plans that have expired but that still have equity awards outstanding as of September 30, 2013:

	Shares Available	Shares
Name of Plan	for Grant	Outstanding
FalconStor Software, Inc., 2000 Stock Option Plan	--	1,562,727
2004 Outside Directors Stock Option Plan	--	190,000
FalconStor Software, Inc., 2007 Outside Directors Equity	--	170,000
Compensation Plan
FalconStor Software, Inc., 2010 Outside Directors Equity	--	50,500
Compensation Plan

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

The following table summarizes stock option activity during the nine months ended September 30, 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
Granted	1,812,000	$1.38
Exercised	-	$0.00
Forfeited	(1,334,592)	$4.04
Expired	(152,500)	$5.44
Options Outstanding at June 30, 2013	11,200,955	$4.25	5.93	$            15,505
Granted	15,000	$1.15
Exercised	-	$0.00
Forfeited	(2,473,830)	$3.46
Expired	(10,000)	$6.30
Options Outstanding at September 30, 2013	8,732,125	$4.47	5.77	$              2,550
Options Exercisable at September 30, 2013	5,854,660	$5.68	4.17	$                      -

Stock option exercises are fulfilled with new shares of common stock. There were no stock option exercises for the three months ended September 30, 2013 and 2012. The total cash received from stock option exercises for the nine months ended September 30, 2013 and 2012 was $697,500 and $624,155, respectively. The total intrinsic value of stock options exercised during the nine months ended September 30, 2013 and 2012 was $121,819 and $266,862, 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 for the three and nine months ended September 30, 2013 and 2012:

	Three months ended September 30,		Nine months ended September 30,
	2013	2012	2013	2012
Cost of revenues - Product	$                 82	$               113	$               181	$               212
Cost of revenues - Support and Service	7,990	53,314	112,182	103,158
Research and development costs	69,542	127,982	291,480	572,170
Selling and marketing	(56,838)	388,167	215,352	1,272,823
General and administrative	142,636	486,202	675,747	1,645,793
	$        163,412	$     1,055,778	$     1,294,942	$     3,594,156

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 September 30,		Nine months ended September 30,
	2013	2012	2013	2012
Directors, officers and employees	$          82,689	$          82,284	$        178,437	$        489,864
Non-employee consultants	-	13,488	-	13,488
	$          82,689	$          95,772	$        178,437	$        503,352

As of September 30, 2013, an aggregate of 3,426,068 shares of restricted stock awards had been issued, of which, 2,342,837 had vested and 477,631 had been forfeited. As of September 30, 2012, an aggregate of 2,876,068 shares of restricted stock awards had been issued, of which, 2,219,456 had vested and 472,539 had been forfeited.

As of September 30, 2013 and 2012, an aggregate of 90,412 restricted stock units had been issued, of which 79,065 had vested and 11,347 had been canceled.

The following table summarizes the activity for restricted stock awards during the three and nine months ended September 30, 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
Granted	50,000
Vested	(45,410)
Forfeited	-
Non-Vested at June 30, 2013	122,620
Granted	500,000
Vested	(17,020)
Forfeited	-
Non-Vested at September 30, 2013	605,600

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 September 30, 2013 and 2012 was $17,585 and $53,312, respectively. The total intrinsic value of restricted stock for which the restrictions lapsed during the nine months ended September 30, 2013 and 2012 was $203,082 and $1,092,051, 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 September 30,		Nine months ended September 30,
	2013	2012	2013	2012
Non-qualified stock options	$        36,942	$         (15,527)	$    36,942	$             14,403
Restricted stock awards	-	13,488	-	13,488
	$        36,942	$           (2,039)	$    36,942	$             27,891

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 September 30, 2013, there was approximately $2,861,722 of total unrecognized compensation cost related to the Company’s unvested options and restricted shares granted under the Company’s equity plans.