Share-Based Payment Arrangements

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



Name of Plan	Shares Authorized	Shares Available for Grant	Shares Outstanding	Last Date for Grant of Shares
FalconStor Software, Inc., 2006 Incentive Stock Plan	13,455,546	4,191,329	6,603,865	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, 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, 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 December 31, 2013:



Name of Plan	Shares Available for Grant	Shares Outstanding

FalconStor Software, Inc., 2000 Stock Option Plan	—	1,140,667

2004 Outside Directors Stock Option Plan	—	145,000

FalconStor Software, Inc., 2007 Outside Directors Equity Compensation Plan	—	160,000

FalconStor Software, Inc., 2010 Outside Directors Equity Compensation Plan	—	50,500

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 2013 is as follows:



	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value
Options Outstanding at December 31, 2012	11,360,842		$	4.66	6.46	$	497,695
Granted	2,034,500		$	1.43
Exercised	(310,000	)	$	2.25
Forfeited	(5,178,050	)	$	4.13
Expired	(362,860	)	$	6.69
Options Outstanding at December 31, 2013	7,544,432		$	4.16	6.28	$	3,000
Options Exercisable at December 31, 2013	4,836,007		$	5.41	4.87	$	—
Options Expected to Vest after December 31, 2013 (1)	1,895,898		$	1.93	8.80	$	2,100
(1) Options expected to vest after December 31, 2013 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, 2013, 2012 and 2011 was $697,500, $738,184 and $920,106, respectively. The total intrinsic value of stock options exercised during the years ended December 31, 2013, 2012 and 2011 was $121,819, $273,935 and $422,136, 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,
	2013		2012		2011
Cost of revenues - Product	$	181	$	262	$	2,960
Cost of revenues - Support and Service	136,975		172,707		461,735
Research and development costs	363,296		727,826		1,302,129
Selling and marketing	397,967		1,677,469		2,023,370
General and administrative	807,010		2,036,505		1,727,864
	$	1,705,429	$	4,614,769	$	5,518,058

The Company did not recognize any tax benefits related to share-based compensation expense during the years ended December 31, 2013, 2012 and 2011.

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,
	2013		2012		2011
Directors, officers and employees	$	257,843	$	584,959	$	1,358,107
Non-employee consultants	—		13,488		21,882
	$	257,843	$	598,447	$	1,379,989

As of December 31, 2013, an aggregate of 3,426,068 shares of restricted stock had been issued, of which, 2,342,837 had vested and 477,631 had been forfeited. 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, 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 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.

A summary of the Company’s restricted stock activity for 2013 is as follows:



	Number of Restricted Stock Awards

Non-Vested at December 31, 2012	171,190

Granted	550,000
Vested	(111,000	)
Forfeited	(4,590	)

Non-Vested at December 31, 2013	605,600

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, 2013, 2012 and 2011 was $202,797, $1,119,103 and $1,941,382, 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,
	2013		2012		2011
Non-qualified stock options	$	37,379	$	13,999	$	2,487
Restricted stock awards	—		13,488		21,882
	$	37,379	$	27,487	$	24,369

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, 2013, 2012 and 2011. 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, 2013, 2012 and 2011 was $0.84, $1.36 and $2.11, 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,
	2013	2012	2011
Expected dividend yield	0%	0%	0%
Expected volatility	61 - 64%	60 - 61%	56 - 61%
Risk-free interest rate	0.84 - 1.64%	0.7 - 1.2%	1.0 - 2.5%
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 2013, 2012, and 2011 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 fiscal 2013 was 30%, 30% and 0%, respectively. For both fiscal years 2012 and 2011, the estimated forfeiture rate for officers, employees, and directors, as adjusted, was 11%, 24% and 0%, respectively. The impact of the change in the forfeiture rates from 2012 to 2013 was a reduction to share-based compensation expense of $84,008.

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, 2013, there was approximately $2,148,113 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 1.88 years.

As of December 31, 2013, the Company had 12,691,361 shares of common stock reserved for issuance upon the exercise of stock options, restricted stock and restricted stock units.