10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2013

or

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number:  000-23970

FALCONSTOR SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

DELAWARE	77-0216135
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

2 Huntington Quadrangle Melville, New York	11747
(Address of principal executive offices)	(Zip Code)

631-777-5188

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes x  No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes x     No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer ¨	Accelerated filer x
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o    No x

The number of shares of Common Stock outstanding as of July 31, 2013 was 48,014,717.

1

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

FORM 10-Q

 INDEX

		Page
PART I.	Financial Information	3
Item 1.	Condensed Consolidated Financial Statements	3
	Condensed Consolidated Balance Sheets at June 30, 2013 (unaudited) and December 31, 2012	3
	Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2013 and 2012	4
	Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2013 and 2012	5
	Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012	6
	Notes to the Unaudited Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	43
Item 4.	Controls and Procedures	43
PART II.	Other Information	44
Item 1.	Legal Proceedings	44
Item 1A.	Risk Factors	44
Item 5.	Other Information	46
Item 6.	Exhibits	47

2

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	June 30, 2013			December 31, 2012
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	13,293,780		$	18,651,468
Restricted cash		750,000			750,000
Marketable securities		7,838,590			10,530,942
Accounts receivable, net of allowances of $419,332 and  $940,101, respectively		9,737,521			14,130,302
Prepaid expenses and other current assets		2,556,121			2,796,665
Inventory		904,198			642,819
Deferred tax assets, net		407,008			464,031
Total current assets		35,487,218			47,966,227
Property and equipment, net of accumulated depreciation of  $17,260,956 and $16,131,570, respectively		3,930,107			3,980,679
Deferred tax assets, net		86,465			86,465
Software development costs, net		1,245,126			1,161,822
Other assets, net		2,432,546			2,185,148
Goodwill		4,150,339			4,150,339
Other intangible assets, net		178,978			174,426
Total assets	$	47,510,779		$	59,705,106
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	2,076,073		$	2,801,372
Accrued expenses		14,363,908			16,720,582
Deferred revenue, net		17,524,607			17,831,653
Total current liabilities		33,964,588			37,353,607
Other long-term liabilities		2,689,636			2,618,818
Deferred tax liabilities, net		175,647			167,875
Deferred revenue, net		5,174,282			6,311,865
Total liabilities		42,004,153			46,452,165
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.001 par value, 2,000,000 shares authorized Common stock - $.001 par value,      100,000,000 shares authorized, 56,019,952 and 55,615,972 shares issued, respectively and 48,014,717 and 47,610,737 shares outstanding, respectively		56,020			55,616
Additional paid-in capital		164,502,458			162,673,833
Accumulated deficit		(110,497,857	)		(100,910,119	)
Common stock held in treasury, at cost (8,005,235 and 8,005,235 shares, respectively)		(46,916,339	)		(46,916,339	)
Accumulated other comprehensive loss, net		(1,637,656	)		(1,650,050	)
Total stockholders' equity		5,506,626			13,252,941
Total liabilities and stockholders' equity	$	47,510,779		$	59,705,106

See accompanying notes to unaudited condensed consolidated financial statements.

3

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2013			2012			2013			2012
Revenues:
Product revenues	$	6,542,429		$	7,835,568		$	14,301,885		$	18,498,521
Support and services revenues		7,431,710			8,630,633			14,957,071			17,335,752
Total  revenues		13,974,139			16,466,201			29,258,956			35,834,273
Cost of revenues:
Product		963,102			1,787,186			2,262,756			3,807,672
Support and service		2,861,992			3,091,055			5,870,395			6,252,411
Total cost of revenues		3,825,094			4,878,241			8,133,151			10,060,083
Gross profit	$	10,149,045		$	11,587,960		$	21,125,805		$	25,774,190
Operating expenses:
Research and development costs		4,395,823			4,848,500			9,044,432			9,627,675
Selling and marketing		6,879,315			9,189,953			13,719,886			18,874,598
General and administrative		3,361,881			3,018,154			6,608,948			6,129,029
Investigation, litigation, and settlement related costs		62,392			851,123			176,458			(439,797	)
Total operating expenses		14,699,411			17,907,730			29,549,724			34,191,505
Operating loss		(4,550,366	)		(6,319,770	)		(8,423,919	)		(8,417,315	)
Interest and other loss, net		(487,176	)		(105,533	)		(817,966	)		(244,864	)
Loss before income taxes		(5,037,542	)		(6,425,303	)		(9,241,885	)		(8,662,179	)
Provision for income taxes		169,751			195,283			345,853			407,815
Net loss	$	(5,207,293	)	$	(6,620,586	)	$	(9,587,738	)	$	(9,069,994	)
Basic net loss per share	$	(0.11	)	$	(0.14	)	$	(0.20	)	$	(0.19	)
Diluted net loss per share	$	(0.11	)	$	(0.14	)	$	(0.20	)	$	(0.19	)
Weighted average basic shares outstanding		47,996,027			47,472,909			47,929,799			47,258,696
Weighted average diluted shares outstanding		47,996,027			47,472,909			47,929,799			47,258,696

See accompanying notes to unaudited condensed consolidated financial statements.

4

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(UNAUDITED)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2013			2012			2013			2012
Net loss	$	(5,207,293	)	$	(6,620,586	)	$	(9,587,738	)	$	(9,069,994	)
Other comprehensive income (loss), net of taxes (benefits):
Foreign currency translation		(19,737	)		(34,261	)		14,790			(163,860	)
Net unrealized gains on marketable securities		(5,457	)		13,513			(1,450	)		58,357
Net minimum pension liability		3,612			1,669			(946	)		7,120
Total other comprehensive income (loss), net of taxes (benefits):		(21,582	)		(19,079	)		12,394			(98,383	)
Total comprehensive loss, net	$	(5,228,875	)	$	(6,639,665	)	$	(9,575,344	)	$	(9,168,377	)

See accompanying notes to unaudited condensed consolidated financial statements.

5

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Six Months Ended
	June 30,
	2013			2012
Cash flows from operating activities:
Net loss	$	(9,587,738	)	$	(9,069,994	)
Adjustments to reconcile net loss to net cash from
operating activities:
Depreciation and amortization		1,369,782			1,702,187
Share-based payment compensation		1,131,530			2,508,448
Non-cash professional services expenses		-			29,930
Realized gain on marketable securities		(3,199	)		(546	)
Provision for returns and doubtful accounts		(378,923	)		(325,591	)
Deferred income tax provision		(7,772	)		7,928
Changes in operating assets and liabilities:
Accounts receivable		4,791,340			9,248,544
Prepaid expenses and other current assets		281,372			43,214
Inventory		(261,379	)		668,363
Other assets		(39,742	)		(20,718	)
Accounts payable		(712,032	)		(222,903	)
Accrued expenses and other liabilities		(2,168,298	)		(6,202,916	)
Deferred revenue		(1,237,922	)		(837,581	)
Net cash used in operating activities		(6,822,981	)		(2,471,635	)
Cash flows from investing activities:
Sales of marketable securities		7,480,733			11,818,443
Purchases of marketable securities		(4,789,832	)		(7,341,816	)
Purchases of property and equipment		(1,116,911	)		(1,612,104	)
Capitalized software development costs		(247,429	)		(461,555	)
Security deposits		(250,000	)		(41,746	)
Purchase of intangible assets		(61,781	)		(44,610	)
Net cash provided by investing activities		1,014,780			2,316,612
Cash flows from financing activities:
Proceeds from exercise of stock options		697,500			624,155
Net cash provided by financing activities		697,500			624,155
Effect of exchange rate changes on cash and cash equivalents		(246,987	)		(242,694	)
Net (decrease) increase in cash and cash equivalents		(5,357,688	)		226,438
Cash and cash equivalents, beginning of period		18,651,468			16,257,694
Cash and cash equivalents, end of period	$	13,293,780		$	16,484,132
Cash paid/(refund received) for income taxes, net	$	(132,217	)	$	528,714

The Company did not pay any interest for the six months ended June 30, 2013 and 2012.

See accompanying notes to unaudited condensed consolidated financial statements.

6

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

(1)   Summary of Significant Accounting Policies

(a)  The Company and Nature of Operations

FalconStor Software, Inc., a Delaware Corporation (the "Company"), develops, manufactures and sells data protection solutions and provides the related maintenance, implementation and engineering services.

(b)   Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.

(c)   Reclassifications

Certain prior year’s amounts have been reclassified to conform to the current year presentation. Certain costs previously recorded within “selling and marketing” are now presented within “research and development” to better align these costs with functions performed.

(d)  Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include those related to revenue recognition, accounts receivable allowances, share-based payment compensation, cost-based investments, marketable securities, software development costs, goodwill and other intangible assets and income taxes. Actual results could differ from those estimates.

The financial market volatility in many countries where the Company operates has impacted and may continue to impact the Company’s business. Such conditions could have a material impact to the Company’s significant accounting estimates discussed above.

(e)   Unaudited Interim Financial Information

The accompanying unaudited interim condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements.

In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company at June 30, 2013, and the results of its operations for the three and six months ended June 30, 2013 and 2012. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year.

7

(f)    Cash Equivalent, Restricted Cash and Marketable Securities

The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. The Company records its cash equivalents and marketable securities at fair value in accordancewith the authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) on fair value measurements and disclosures. As of June 30, 2013 and December 31, 2012, the Company’s cash equivalents consisted of money market funds.  At June 30, 2013 and December 31, 2012, the fair value of the Company’s cash equivalents amounted to approximately $5.5 million and $4.3 million, respectively.

As of June 30, 2013 and December 31, 2012, the Company had $0.8 million of restricted cash. The restricted cash serves as collateral related to deposit service indebtedness with the Company’s commercial bank. As of June 30, 2013 and December 31, 2012, the Company did not have any debt service indebtedness with the Company’s bank.

As of June 30, 2013 and December 31, 2012, the Company’s marketable securities consisted of corporate bond and government securities. As of June 30, 2013 and December 31, 2012, the fair value of the Company’s current marketable securities was approximately $7.8 million and $10.5 million, respectively. All of the Company’s marketable securities are classified as available-for-sale, and accordingly, unrealized gains and losses on marketable securities, net of tax, are reflected as a component of accumulated other comprehensive loss in stockholders’ equity. Any other-than-temporary impairments are recorded within interest and other loss, net in the condensed consolidated statement of operations. See Note (5) Marketable Securities for additional information.

(g)   Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability of fair value measurements, a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies, is as follows:

Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.

Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3—Valuations based on unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

As of June 30, 2013 and December 31, 2012, the fair value of the Company’s financial instruments including cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses, approximated carrying value due to the short maturity of these instruments. See Note (4) Fair Value Measurements for additional information.

(h)  Revenue Recognition

The Company derives its revenue from sales of its products, support and services. Product revenue consists of the Company’s software integrated with industry standard hardware and sold as complete turn-key integrated solutions. Product revenue also consists of stand-alone software applications. Support and services revenue consists of both maintenance revenues and professional services revenues. Revenue is recorded net of applicable sales taxes.

In accordance with the authoritative guidance issued by the FASB on revenue recognition, the Company recognizes revenue from product sales when persuasive evidence of an arrangement exists, the fee is fixed and determinable, the product is delivered, and collection of the resulting receivable is deemed probable. Products delivered to a customer on a trial basis are not recognized as revenue until a permanent key code is delivered to the customer. Reseller customers typically send the Company a purchase order when they have an end user identified. For bundled arrangements that include either maintenance or both maintenance and professional services, the Company uses the residual method to determine the amount of product revenue to be recognized. Under the residual method, consideration is allocated to the undelivered elements based upon vendor-specific objective evidence (“VSOE”) of the fair value of those elements, with the residual of the arrangement fee allocated to and recognized as product revenue. The long-term portion of deferred revenue relates to maintenance contracts with terms in excess of one year. The Company provides an allowance for product returns as a reduction of revenue, based upon historical experience and known or expected trends.

8

Revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract. Revenues associated with software implementation and software engineering services are recognized when the services are performed. Costs of providing these services are included in cost of support and services.

The Company has entered into various distribution, licensing and joint promotion agreements with OEMs, whereby the Company has provided to the OEM a non-exclusive software license to install the Company’s software on certain hardware or to resell the Company’s software in exchange for payments based on the products distributed by these OEMs. Such payments from these OEMs or distributors are recognized as revenue in the period reported by the OEM.

(i)   Property and Equipment

Property and equipment are recorded at cost. Depreciation is recognized using the straight-line method over the estimated useful lives of the assets (3 to 7 years). For the three months ended June 30, 2013 and 2012, depreciation expense was $561,448 and $709,241, respectively.  For the six months ended June 30, 2013 and 2012, depreciation expense was $1,148,428 and $1,506,800, respectively. Leasehold improvements are amortized on a straight-line basis over the term of the respective leases or over their estimated useful lives, whichever is shorter.

(j)    Goodwill and Other Intangible Assets

Goodwill represents the excess of the purchase price over the estimated fair value of net tangible and identifiable intangible assets acquired in business combinations. The Company has not amortized goodwill related to its acquisitions, but instead tests the balance for impairment. The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate that the carrying value may not be recoverable. The Company tests goodwill for impairment by first comparing the book value of net assets to the fair value of the reporting unit. If the fair value is determined to be less than the book value or qualitative factors indicate that it is more likely than not that goodwill is impaired, a second step is performed to compute the amount of impairment as the difference between the estimated fair value of goodwill and the carrying value.

The Company’s annual impairment assessment is performed during the fourth quarter of each year, and the Company has determined there to be no impairment for any of the periods presented. Identifiable intangible assets include (i) assets acquired through business combinations, which include customer contracts and intellectual property, and (ii) patents amortized over three years using the straight-line method.

9

For the three months ended June 30, 2013 and 2012, amortization expense was $27,687 and $29,862, respectively. For the six months ended June 30, 2013 and 2012, amortization expense was $57,229 and $58,249, respectively. The gross carrying amount and accumulated amortization of other intangible assets as of June 30, 2013 and December 31, 2012 are as follows:

	June 30,			December 31,
	2013			2012
Goodwill	$	4,150,339		$	4,150,339
Other intangible assets:
Gross carrying amount	$	3,190,369		$	3,128,588
Accumulated amortization		(3,011,391	)		(2,954,162	)
Net carrying amount	$	178,978		$	174,426

(k)   Software Development Costs

In accordance with the authoritative guidance issued by the FASB on costs of software to be sold, leased, or marketed, costs associated with the development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility of the product has been established. Based on the Company’s product development process, technological feasibility is established upon completion of a working model. Amortization of software development costs is recorded at the greater of the straight-line basis over the product’s estimated life, or the ratio of current revenue of the related products to total current and anticipated future revenue of these products.  During the three and six months ended June 30, 2013, the Company capitalized $247,429 of costs associated with software development projects. During the three and six months ended June 30, 2012, the Company capitalized $73,921 and $461,555, respectively, of costs associated with software development projects. During the three months ended June 30, 2013 and 2012, the Company recorded $82,063 and $78,983, respectively, of amortization expense related to capitalized software costs. During the six months ended June 30, 2013 and 2012, the Company recorded $164,125 and $137,138, respectively, of amortization expense related to capitalized software costs.

(l)    Income Taxes

The Company records income taxes under the liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In determining the period in which related tax benefits are realized for financial reporting purposes, excess share-based compensation deductions included in net operating losses are realized after regular net operating losses are exhausted.

The Company accounts for uncertain tax positions in accordance with the authoritative guidance issued by the FASB on income taxes, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return, should be recorded in the financial statements. Pursuant to the authoritative guidance, the Company may recognize the tax benefit from an uncertain tax position only if it meets the “more likely than not” threshold that the position will be sustained on examination by the taxing authority, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. In addition, the authoritative guidance addresses de-recognition, classification, interest and penalties on income taxes, accounting in interim periods, and also requires increased disclosures. The Company includes interest and penalties related to its uncertain tax positions as part of income tax expense within its consolidated statement of operations. See Note (3) Income Taxes for additional information.

10

(m)   Long-Lived Assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the sum of the expected future cash flows, undiscounted and without interest, is less than the carrying amount of the asset, an impairment loss is recognized as the amount by which the carrying amount of the asset exceeds its fair value.

(n)   Share-Based Payments

The Company accounts for share-based payments in accordance with the authoritative guidance issued by the FASB on share-based compensation, which establishes the accounting for transactions in which an entity exchanges its equity instruments for goods or services. Under the provisions of the authoritative guidance, share-based compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period), net of estimated forfeitures. The Company estimates the fair value of share-based payments using the Black-Scholes option-pricing model. The estimation of share-based awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from the Company’s current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. Additionally, share-based awards to non-employees are expensed over the period in which the related services are rendered at their fair value. All share-based awards are expected to be fulfilled with new shares of common stock. See Note (2) Share-Based Payment Arrangements for additional information.

(o)   Foreign Currency

Assets and liabilities of foreign operations are translated at rates of exchange at the end of the period, while results of operations are translated at average exchange rates in effect for the period. Gains and losses from the translation of foreign assets and liabilities from the functional currency of the Company’s subsidiaries into the U.S. dollar are classified as accumulated other comprehensive loss in stockholders’ equity. Gains and losses from foreign currency transactions are included in the condensed consolidated statements of operations within interest and other loss, net.

During the three months ended June 30, 2013 and 2012, foreign currency transactional losses totaled approximately $0.5 million and $0.1 million, respectively.  During the six months ended June 30, 2013 and 2012, foreign currency transactional losses totaled approximately $0.8 million and $0.3 million, respectively.

(p)   Earnings Per Share (EPS)

Basic EPS is computed based on the weighted average number of shares of common stock outstanding. Diluted EPS is computed based on the weighted average number of common shares outstanding increased by dilutive common stock equivalents, attributable to stock option awards, restricted stock awards and restricted stock unit awardsoutstanding. Due to the net loss for the three and six months ended June 30, 2013 and 2012, all common stock equivalents, totaling 11,323,575 and 12,377,225, respectively, were excluded from diluted net loss per share because they were anti-dilutive.

11

The following represents a reconciliation of the numerators and denominators of the basic and diluted EPS computation:

	Three Months Ended June 30, 2013								Three Months Ended June 30, 2012
	Net Loss			Shares		Per Share			Net Loss			Shares		Per Share
	(Numerator)			(Denominator)		Amount			(Numerator)			(Denominator)		Amount
Basic EPS	$	(5,207,293	)		47,996,027	$	(0.11	)	$	(6,620,586	)		47,472,909	$	(0.14	)
Effect of dilutive securities:
Stock options and restricted stock					-								-
Diluted EPS	$	(5,207,293	)		47,996,027	$	(0.11	)	$	(6,620,586	)		47,472,909	$	(0.14	)
	Six Months Ended June 30, 2013								Six Months Ended June 30, 2012
	Net Loss			Shares		Per Share			Net Loss			Shares		Per Share
	(Numerator)			(Denominator)		Amount			(Numerator)			(Denominator)		Amount
Basic EPS	$	(9,587,738	)		47,929,799	$	(0.20	)	$	(9,069,994	)		47,258,696	$	(0.19	)
Effect of dilutive securities:
Stock options and restricted stock					-								-
Diluted EPS	$	(9,587,738	)		47,929,799	$	(0.20	)	$	(9,069,994	)		47,258,696	$	(0.19	)

(q)  Investments

As of June 30, 2013 and December 31, 2012, the Company maintained certain cost-method investments aggregating approximately $0.9 million, which are included within “other assets, net” in the accompanying condensed consolidated balance sheets. During the three and six months ended June 30, 2013 and 2012, the Company did not recognize any impairment charges related to any of its cost-method investments. See Note 12 Subsequent Events for further information.

(r)   Treasury Stock

The Company accounts for treasury stock under the cost method and includes treasury stock as a component of stockholders’ equity.

 (s)  New Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (“FASB”) issued new guidance which requires companies to present information about reclassification adjustments from accumulated other comprehensive income in their financial statements or footnotes. The adoption of this new accounting guidance in the first quarter of 2013 did not have a material impact on our consolidated financial position, results of operations or cash flows. See Note (9) Accumulated Other Comprehensive Loss for the related disclosure.

 (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.

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The following table summarizes the plans under which the Company was able to grant equity compensation as of June 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	12,224,133	1,169,323	8,411,478	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 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, 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 June 30, 2013:

	Shares Available	Shares
Name of Plan	for Grant	Outstanding
FalconStor Software, Inc., 2000 Stock Option Plan	--	1,646,397
2004 Outside Directors Stock Option Plan	--	190,000
FalconStor Software, Inc., 2007 Outside Directors Equity Compensation Plan	--	170,000
Stand-Alone Stock Option Agreement between the Company and James P. McNiel	--	805,200
FalconStor Software, Inc., 2010 Outside Directors Equity Compensation Plan	--	50,500

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

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The following table summarizes stock option activity during the six months ended June 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
Options Exercisable at June 30, 2013		7,173,298		$	5.46		4.10	$	-

Stock option exercises are fulfilled with new shares of common stock. The total cash received from stock option exercises for the three months ended June 30, 2013 and 2012 was $0 and $421,290, respectively. The total cash received from stock option exercises for the six months ended June 30, 2013 and 2012 was $697,500 and $624,155, respectively. The total intrinsic value of stock options exercised during the three months ended June 30, 2013 and 2012 was $0 and $188,609, respectively.  The total intrinsic value of stock options exercised during the six months ended June 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 six months ended June 30, 2013 and 2012:

	Three months ended June 30,						Six months ended June 30,
	2013			2012			2013		2012
Cost of revenues - Product	$	50		$	49		$	99	$	99
Cost of revenues - Support and Service		53,936			(21,124	)		104,192		49,844
Research and development costs		87,028			125,231			221,938		444,188
Selling and marketing		(11,848	)		398,031			272,190		884,656
General and administrative		111,629			587,889			533,111		1,159,591
	$	240,795		$	1,090,076		$	1,131,530	$	2,538,378

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:

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	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Directors, officers and employees	$	32,551	$	130,164	$	95,748	$	407,580
Non-employee consultants		-		-		-		-
	$	32,551	$	130,164	$	95,748	$	407,580

As of June 30, 2013, an aggregate of 2,926,068 shares of restricted stock awards had been issued, of which, 2,325,817 had vested and 477,631 had been forfeited. As of June 30, 2012, an aggregate of 2,871,054 shares of restricted stock awards had been issued, of which, 2,193,552 had vested and 464,889 had been forfeited.

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

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 June 30, 2013 and 2012 was $64,361 and $178,592, respectively. The total intrinsic value of restricted stock for which the restrictions lapsed during the six months ended June 30, 2013 and 2012 was $185,497 and $1,038,739, 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.

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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 June 30,					Six months ended June 30,
	2013		2012			2013		2012
Non-qualified stock options	$	-	$	(25,262	)	$	-	$	29,930
Restricted stock awards		-		-			-		-
	$	-	$	(25,262	)	$	-	$	29,930

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 June 30, 2013, there was approximately $3,905,864 of total unrecognized compensation cost related to the Company’s unvested options and restricted shares granted under the Company’s equity plans.

(3)    Income Taxes

The Company’s provision for income taxes consists of state and local, and foreign taxes, as applicable, in amounts necessary to align the Company’s year-to-date tax provision with the effective rate that it expects to achieve for the full year.

For the six months ended June 30, 2013 and June 30, 2012, the Company recorded an income tax provision of $0.3 million on its pre-tax loss of $9.2 million and $0.4 million on its pre-tax loss of $8.7 million, respectively, consisting primarily of state and local and foreign taxes. The effective tax rate for the six months ended June 30, 2013 was (3.7%). As of June 30, 2013, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and, therefore, the Company has not recorded any benefit for its expected net domestic deferred tax assets for the full year 2013 estimated annual effective tax rate. As of June 30, 2013, the valuation allowance totaled approximately $40.3 million.

The Company’s total unrecognized tax benefits, excluding interest and penalties for June 30, 2013 and December 31, 2012 were approximately $5.1 million. At June 30, 2013, $2.5 million including interest, if recognized, would reduce the Company’s effective tax rate. As of June 30, 2013 and December 31, 2012, the Company recorded an aggregate of approximately $446,000 and $373,000, respectively, of accrued interest and penalties.

(4)   Fair Value Measurements

The Company measures its cash equivalents and marketable securities at fair value. Fair value is an exit price, representing the amount that would be received on the sale of an asset or that would be paid to transfer a liability in an orderly transaction between market participants. As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value.

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Fair Value Hierarchy

The methodology for measuring fair value specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs) or reflect the Company’s own assumptions of market participant valuation (unobservable inputs). As a result, observable and unobservable inputs have created the following fair value hierarchy:

· Level 1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities. The Level 1 category includes money market funds, which at June 30, 2013 and December 31, 2012 totaled $5.5 million and $4.3 million, respectively, which are included within cash and cash equivalents in the condensed consolidated balance sheets.

· Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly. The Level 2 category includes government securities and corporate debt securities, which at June 30, 2013 and December 31, 2012 totaled $7.8 million and $10.5 million, respectively, which are included within cash and cash equivalents and marketable securities in the condensed consolidated balance sheets.

· Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. The Company did not hold any cash, cash equivalents or marketable securities categorized as Level 3 as of June 30, 2013 or December 31, 2012.

Measurement of Fair Value

The Company measures its cash equivalents and marketable securities at fair value. Fair value is an exit price, representing the amount that would be received on the sale of an asset or that would be paid to transfer a liability in an orderly transaction between market participants. As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value.

Items Measured at Fair Value on a Recurring Basis

       The following table presents the Company’s assets that are measured at fair value on a recurring basis at June 30, 2013:

			Fair Value Measurements at Reporting Date Using
			Quoted Prices in				Significant
			Active Markets for		Significant other		Unobservable
			Identical Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Cash equivalents:
Money market funds	$	5,501,965	$	5,501,965	$	-	$	-
Total cash equivalents		5,501,965		5,501,965		-		-
Marketable securities:
Corporate debt and government securities		7,838,590		-		7,838,590		-
Total marketable securities		7,838,590		-		7,838,590		-
Total assets measured at fair value	$	13,340,555	$	5,501,965	$	7,838,590	$	-

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The following table presents the Company’s assets that are measured at fair value on a recurring basis at December 31, 2012:

			Fair Value Measurements at Reporting Date Using
			Quoted Prices in				Significant
			Active Markets for		Significant other		Unobservable
			Identical Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Cash equivalents:
Money market funds	$	4,285,309	$	4,285,309	$	-	$	-
Total cash equivalents		4,285,309		4,285,309		-		-
Marketable securities:
Corporate debt and government securities		10,530,942		-		10,530,942		-
Total marketable securities		10,530,942		-		10,530,942		-
Total assets measured at fair value	$	14,816,251	$	4,285,309	$	10,530,942	$	-

(5)   Marketable Securities

The Company’s marketable securities consist of available-for-sale securities, which are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity. Unrealized gains and losses are computed on the specific identification method. Realized gains, realized losses and declines in value judged to be other-than-temporary, are included in interest and other income, net. The cost of available-for-sale securities sold is based on the specific identification method and interest earned is included in interest and other income.

The cost and fair values of the Company’s available-for-sale marketable securities as of June 30, 2013, are as follows:

	Aggregate		Cost or Amortized		Net Unrealized
	Fair Value		Cost		Gains
Government securities	$	7,838,590	$	7,833,830	$	4,760
Corporate debt securities		-		-		-
	$	7,838,590	$	7,833,830	$	4,760

The cost and fair values of the Company’s available-for-sale marketable securities as of December 31, 2012, are as follows:

	Aggregate		Cost or Amortized		Net Unrealized
	Fair Value		Cost		Gains
Government securities	$	8,328,392	$	8,324,372	$	4,020
Corporate debt securities		2,202,550		2,200,360		2,190
	$	10,530,942	$	10,524,732	$	6,210

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(6)    Inventories

Inventories consist of component materials and finished systems. Inventories are stated at the lower of cost (first-in, first-out) or market, not in excess of net realizable value. Component material consists of certain key replacement parts for the finished systems. Inventories are as follows:

	June 30,		December 31,
	2013		2012
Component materials	$	15,365	$	18,989
Finished systems		888,833		623,830
Total Inventory	$	904,198	$	642,819

As of June 30, 2013 and December 31, 2012, the Company has not recorded any reserve for excess and/or obsolete inventories in arriving at estimated net realizable value of its inventory.

(7)    Stockholders’ Equity

Stock Repurchase Activity

At various times from October 2001 through February 2009, the Company’s Board of Directors authorized the repurchase of up to 14 million shares of the Company’s outstanding common stock in the aggregate.

During the six months ended June 30, 2013 and 2012, the Company did not repurchase any shares of its common stock. Since October 2001, the Company has repurchased a total of 8,005,235 shares of its common stock at an aggregate purchase price of $46,916,339.

Preferred Stock

The Company is authorized to issue two million shares of $0.001 par value preferred stock. No preferred stock has been issued or outstanding for any period presented. See Note 12 Subsequent Events for further information.

(8)    Commitments and Contingencies

During the second quarter of 2013 the Company signed a new operating lease covering its corporate office facility that expires in April 2021. The Company also has several operating leases related to offices in the United States and foreign countries. The expiration dates for these leases range from 2013 through 2017. The following is a schedule of future minimum lease payments for all operating leases as of June 30, 2013:

2013	$	1,397,075
2014		2,460,386
2015		1,687,643
2016		1,512,699
2017		1,462,447
Thereafter		5,036,525
	$	13,556,775

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The Company typically provides its customers a warranty on its software products for a period of no more than 90 days. Such warranties are accounted for in accordance with the authoritative guidance issued by the FASB on contingencies. To date, the Company has not incurred any costs related to warranty obligations.

Under the terms of substantially all of its software license agreements, the Company has agreed to indemnify its customers for all costs and damages arising from claims against such customers based on, among other things, allegations that the Company’s software infringes the intellectual property rights of a third party. In most cases, in the event of an infringement claim, the Company retains the right to (i) procure for the customer the right to continue using the software; (ii) replace or modify the software to eliminate the infringement while providing substantially equivalent functionality; or (iii) if neither (i) nor (ii) can be reasonably achieved, the Company may terminate the license agreement and refund to the customer a pro-rata portion of the license fee paid to the Company. Such indemnification provisions are accounted for in accordance with the authoritative guidance issued by the FASB on guarantees. As of June 30, 2013 and 2012, there were no claims outstanding under such indemnification provisions.

On July 23, 2013, the Company entered into an Employment Agreement (“Quinn Employment Agreement”) with Gary Quinn. Pursuant to the Quinn Employment Agreement, the Company agreed to employ Mr. Quinn as President and Chief Executive Officer of the Company effective July 23, 2013 through July 22, 2015, at an annual salary of $400,000 per annum. The Quinn Employment Agreement also provides for the grant of 500,000 restricted shares which will vest over a two-year period at 50% and 50% annually. The 500,000 restricted shares were granted to Mr. Quinn by the Company’s Compensation Committee on August 5, 2013.

On June 28, 2013, the President and Chief Executive Officer, and a Director, of FalconStor Software, Inc. (the “Company”), James P. McNiel, resigned from all of his positions with the Company, effective immediately. The Company also entered into a Severance Agreement and General Release (the “Agreement”), with Mr. McNiel.  Pursuant to the Agreement, among other things, the Company agreed to pay to Mr. McNiel $400,000 in severance pay and to purchase certain office furniture from Mr. McNiel for $20,000. These payments were made in July 2013.

On December 1, 2005, the Company adopted the 2005 FalconStor Software, Inc., Key Executive Severance Protection Plan, which was amended January 4, 2013 (“Severance Plan”). Pursuant to the Severance Plan, the Company’s Chief Executive Officer, Chief Financial Officer and certain other key personnel are entitled to receive certain contingent benefits, as set forth in the Severance Plan, including lump sum payments and acceleration of stock option vesting, each in certain circumstances.

As of June 30, 2013, the Company had a total of $1.7 million of payables outstanding relating to its settlement with the United States Attorney’s Office, which is to be paid in December 2013. In addition, on January 20, 2013, the Company announced that it had reached a proposed settlement of the Class Action lawsuit between the Company and class plaintiffs for $5.0 million. Court approval of the settlement is required. A joint stipulation of settlement and motion for preliminary approval of the settlement was filed with the Court on June 14, 2013, and as of the date of the filing of this quarterly report on Form 10-Q, no ruling has been made.

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(9)   Accumulated Other Comprehensive Loss

The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended June 30, 2013 are as follows:

				Net Unrealized
	Foreign Currency			Gains on Marketable			Net Minimum
	Translation			Securities			Pension Liability			Total
Accumulated other comprehensive (loss) income at March 31, 2013	$	(1,566,611	)	$	10,217		$	(59,680	)	$	(1,616,074	)
Other comprehensive (loss) income
Other comprehensive (loss) income before reclassifications		(19,737	)		(2,258	)		1,471			(20,524	)
Amounts reclassified from accumulated other comprehensive (loss) income		-			(3,199	)		2,141			(1,058	)
Total other comprehensive (loss) income		(19,737	)		(5,457	)		3,612			(21,582	)
Accumulated other comprehensive (loss) income at June 30, 2013	$	(1,586,348	)	$	4,760		$	(56,068	)	$	(1,637,656	)

The changes in Accumulated Other Comprehensive Loss, net of tax, for the six months ended June 30, 2013 are as follows:

				Net Unrealized
	Foreign Currency			Gains on Marketable			Net Minimum
	Translation			Securities			Pension Liability			Total
Accumulated other comprehensive (loss) income at January 1, 2013	$	(1,601,138	)	$	6,210		$	(55,122	)	$	(1,650,050	)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications		14,790			1,749			(5,229	)		11,310
Amounts reclassified from accumulated other comprehensive income		-			(3,199	)		4,283			1,084
Total other comprehensive income (loss)		14,790			(1,450	)		(946	)		12,394
Accumulated other comprehensive (loss) income at June 30, 2013	$	(1,586,348	)	$	4,760		$	(56,068	)	$	(1,637,656	)

For the three and six months ended June 30, 2013, the amounts reclassified to net loss related to the Company’s defined benefit plan. These amounts are included within “Operating loss” within the condensed consolidated statements of operations.

(10) Litigation

In view of the inherent difficulty of predicting the outcome of litigation, particularly where the claimants seek very large or indeterminate damages, the Company generally cannot predict what the eventual outcome of the pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties related to each pending matter may be.

In accordance with the authoritative guidance issued by the FASB on contingencies, the Company accrues anticipated costs of settlement, damages and losses for claims to the extent specific losses are probable and estimable. The Company records a receivable for insurance recoveries when such amounts are probable and collectable.  In such cases, there may be an exposure to loss in excess of any amounts accrued.  If, at the time of evaluation, the loss contingency related to a litigation is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable and, the Company will expense these costs as incurred. If the estimate of a probable loss is a range and no amount within the range is more likely, the Company will accrue the minimum amount of the range.

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The Internal and Government Investigations

As previously disclosed, both the United States Attorney’s Office for the Eastern District of New York (“USAO”) and the Securities and Exchange Commission (“SEC”) commenced investigations of the Company in October, 2010, in response to the Company’s announcement that it had accepted the resignation of ReiJane Huai, its President and Chief Executive Officer, and the Chairman of its Board of Directors, following his disclosure to the Company that certain improper payments allegedly were made in connection with the Company’s licensing of software to one customer.

The Company conducted its own investigation into the matter and cooperated with the USAO and SEC investigations.

On June 27, 2012, the Company announced that it had entered into settlements with the USAO and the SEC.

The Company entered into a Deferred Prosecution Agreement (DPA) with the USAO.  Under the DPA, the USAO agreed that it will defer prosecution of the Company in connection with the matter, and ultimately not prosecute the Company if the Company satisfies its obligations during the 18 month term of the DPA.  The DPA acknowledges the remedial actions taken by the Company in response to its discovery of the improper payments and does not require the Company to make any additional control or compliance changes.  Under the DPA, the Company will forfeit $2.9 million over eighteen months.

The Company agreed with the SEC to the entry of a Consent Judgment (CJ) to settle a civil action filed by the SEC.  Pursuant to the CJ, the Company agreed not to violate the anti-fraud and registration provisions of Sections 17(a)(2), 5(a) and 5(c) of the Securities Act of 1933, and the books and records provisions of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934.  The Company further agreed to pay a civil penalty of $2.9 million to the SEC.

As of June 30, 2013, the Company has paid a total of $4.1 million of the total $5.8 million, for which the Company had previously accrued. The balance of $1.7 million is payable in December 2013.

Stockholder Litigation

The Company is a defendant in a class action lawsuit brought in United Stated District Court for the Eastern District of New York, by Company shareholders (the “Class Action”).  The other defendants are James Weber, our former CFO and Vice President for Operations, and the estate of ReiJane Huai. Mr. Huai was the Company’s former Chairman, President and CEO.

The Class Action complaint alleges that the defendants defrauded shareholders by falsely certifying in the Company’s SEC filings that they had disclosed any fraud, whether or not material, that involved management or other employees who had a significant role in the registrant’s internal control over financial reporting.  The Class Action complaint alleges that the defendants were in fact aware of fraud.

In January, 2013, the parties to the Class Action reached an agreement in principle to settle the Class Action.  Pursuant to a Memorandum of Understanding signed by counsel for the class plaintiffs and by counsel for all defendants, the Company will pay $5.0 million to settle the Class Action. This amount includes damages, plaintiffs’ attorneys’ fees, and costs of administration of the settlement. The Company expects to pay this settlement with a combination of cash on hand and insurance proceeds. A stipulation of settlement and a joint motion for preliminary approval of the settlement were submitted to the court for its approval on June 14, 2013.  Final settlement of the Class Action is subject to certain conditions and to approval by the court.  We cannot predict if or when the court might approve the settlement. Certain of the defendants may be entitled to indemnification by the Company under the laws of Delaware and/or our by-laws.

Company stockholders filed actions in the Suffolk County Division of the Supreme Court of the State of New York, putatively derivatively on behalf of the Company, against the Company, each of the Company’s Directors, Mr. Weber, Wayne Lam, a former Vice president of the Company, the estate of Mr. Huai, and Jason Lin, a former employee of the Company (the “Derivative Action”). The consolidated amended Derivative Action complaint alleged that the defendants breached their duties to the Company by: (1) causing or allowing the dissemination of false and misleading information; (2) failing to maintain internal controls; (3) failing to manage the Company properly; (4) unjustly enriching themselves; (5) abusing their control of the Company; and (6) wasting Company assets.

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On March 5, 2013, the Suffolk County Division of the Supreme Court of the State of New York granted a motion made by all of the defendants in the Derivative Action, except Mr. Lin, and dismissed the Derivative Action as to all defendants other than Mr. Lin. The stockholders have filed a notice of appeal of the dismissal of the Derivative Action. The Company cannot predict when the  appeal will be resolved or the ultimate  outcome of the matter.  Certain of the defendants may be entitled to indemnification by the Company under the laws of Delaware and/or the Company’s by-laws.

The Company has insurance policies that were purchased to cover, among other things, lawsuits like the Class Action and the Derivative Action. The Company’s Directors and Officers (“D&O”) Insurance, is composed of more than one layer, each layer written by a different insurance company.  However, the events that gave rise to the claims in the Class Action and the Derivative Action caused the Company’s insurers to reserve their rights to disclaim, rescind, or otherwise not be obligated to provide coverage to the Company and certain other insureds under the policies.  In light of these uncertainties, the Company has entered into settlements with two of its insurers.  Pursuant to these settlements, the Company will not receive repayment of all amounts it might otherwise have received.

In October, 2012, the Company entered into an agreement with the carrier of the first $5.0 million layer of the Company’s D&O insurance.  Pursuant to this agreement, the Company accepted a payment of $3.9 million from the first layer insurance carrier in satisfaction of the carrier’s obligations to the Company under the first layer D&O insurance policy.  In addition, as part of the October 2012 agreement with the carrier, the Company agreed to indemnify the carrier of the first layer of D&O insurance against potential claims by certain named insured persons under the first layer D&O insurance policy. The Company cannot predict the likelihood or the outcome of any such claims by the named insureds.

Because the carrier of the next layer of insurance would not be obligated to make payment to the Company until the full $5.0 million first layer limit had been exhausted, this means that the Company is responsible for $1.1 million out of pocket before it can again seek reimbursement from its insurers.

On July 31, 2013, after the close the second quarter, the Company entered into an agreement with the carrier of the second $5.0 million layer of the Company’s D&O insurance.  Pursuant to the agreement, the insurer agreed to pay seventy five percent (75%) of the Company’s losses attributable to the Class Action and the Derivative Action above the first $5.25 million of such losses. In addition, as part of the July 31, 2013 agreement with the carrier, the Company agreed to indemnify the carrier of the second layer of D&O insurance against potential claims by certain named insured persons under the second layer D&O insurance.  The agreement with the carrier is contingent on final approval of the Class Action settlement. The Company cannot predict the likelihood or the outcome of any such claims by the named insureds.

While, at present, the Company does not believe that the amounts it will pay in connection with the Class Action and the Derivative Action will exceed the limits of the first two layers of its coverage, there can be no assurance that if the Company seeks recovery from the additional layers, the recovery the Company makes on the remainder of its insurance will be adequate to cover the costs of its defense or settlement of the Class Action, or any damages that might ultimately be awarded against the Company or anyone to whom the Company might owe indemnification if the settlement is not approved by the court.  The Company’s insurers may deny coverage under the policies. If the Company’s insurance recovery is not adequate to cover the costs of defense, settlement, damages and/or indemnification, or its insurers deny coverage, the amounts to be paid by the Company could have a significant negative impact on its financial results, its cash flows and its cash balances.

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The Company’s remaining insurers may deny coverage under the policies. If the plaintiffs are awarded damages and the Company’s insurance is not adequate to cover the amounts, or its insurers deny coverage, the amounts to be paid by the Company could have a significant negative impact on our financial results, our cash flow and our cash reserves.

To date, the Company has recorded $7.0 million of total costs associated with the Class Action and the Derivative Actions. The Company has recorded a liability in the amount of $5.2 million in “accrued expenses” in the condensed consolidated balance sheets as of June 30, 2013 which includes estimated costs of resolutions and legal fees for both the Class Action and the Derivative Action to date. As a result of the agreement reached with the insurance carrier for the first layer of the Company’s D&O insurance carrier in the prior year, the Company has recorded an insurance recovery in 2012 of approximately $3.9 million of legal expenses previously incurred related to the class action and derivative lawsuits as well as the potential settlement of the class action lawsuit. The $3.9 million insurance recovery was reimbursed by the Company’s insurance carrier during 2012. As a result of the agreement reached with the insurer of the Company’s next layer of D&O insurance regarding that insurer’s obligations to the Company, the Company has recorded a $1.3 million receivable in “prepaid expenses and other current assets” in the condensed consolidated balance sheet as of June 30, 2013 as collection is deemed probable.

During the three and six months ended June 30, 2013, our total investigation, litigation, and settlement related costs consisted of $0.1 million and $0.2 million, respectively, of net legal expenses related to the class action and derivative lawsuits that are not recoverable through insurance.

Avazpour Litigation

The Company is the defendant in an action brought by Avazpour Networking Services, Inc., and its former principals (collectively, “Avazpour”), pending in the United States District Court for the Eastern District of New York. Avazpour alleged that the Company gave grossly negligent advice in connection with an upgrade of Avazpour’s storage system resulting in damages to Avazpour and breached its contract with Avazpour.   On March 13, 2013, the Court granted the Company’s motion to dismiss all of the claims except for the claim of breach of contract.  In June, 2013, the Company and the Avazpour reached an agreement in principle to settle the claim for $250,000.  This amount will be paid by the Company’s insurers.

Other Claims

The Company is subject to various legal proceedings and claims, asserted or unasserted, which arise in the ordinary course of business. While the outcome of any such matters cannot be predicted with certainty, such matters are not expected to have a material adverse effect on the Company’s financial condition or operating results.

The Company continues to assess certain litigation and claims to determine the amounts, if any, that the Company believes may be paid as a result of such claims and litigation and, therefore, additional losses may be accrued and paid in the future, which could materially adversely impact the Company’s financial results, its cash flows and its cash reserves.

(11) Segment Reporting

The Company is organized in a single operating segment for purposes of making operating decisions and assessing performance. Revenues from the United States to customers in the following geographical areas for the three and six months ended June 30, 2013 and 2012, and the location of long-lived assets as of June 30, 2013 and December 31, 2012, are summarized as follows:

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	Three Months Ended June 30,				Six Months Ended June 30,
Revenues:	2013		2012		2013		2012
Americas	$	5,195,655	$	7,085,505	$	11,631,581	$	15,201,737
Asia Pacific		4,715,039		4,833,526		9,111,042		10,744,801
Europe, Middle East, Africa and Other		4,063,445		4,547,170		8,516,333		9,887,735
Total Revenues	$	13,974,139	$	16,466,201	$	29,258,956	$	35,834,273
	June 30,		December 31,
Long-lived assets:	2013		2012
Americas	$	10,541,103	$	10,263,056
Asia Pacific		918,148		1,041,470
Europe, Middle East, Africa and Other		564,310		434,353
Total long-lived assets	$	12,023,561	$	11,738,879

For the three months ended June 30, 2013 and 2012, the Company had two customers that accounted for 10% or more of total revenues. As of June 30, 2013, the Company had two customers that accounted for 14% and 10% of the accounts receivable balance. As of December 31, 2012, the Company had one customer that accounted for 20% of the accounts receivable balance.

The Company recorded provisions for returns of less than $0.1 million and approximately $0.3 million during the three months ended June 30, 2013 and 2012, respectively. Due to cash collections of previously reserved accounts receivable balances, the Company recorded benefits of $0.1 million and $0.3 million during the six months ended June 30, 2013 and 2012, respectively. These amounts are included within revenues in the accompanying condensed consolidated statement of operations.

(12) Subsequent Events

On August 5, 2013, the Company reached an agreement in principle, and signed a term sheet, for an investment of between $7.5 million and $15.0 million from a private equity group.  The investment will be in the form of redeemable convertible preferred stock.  Closing of the investment is subject to the negotiation of definitive documents and certain other conditions. The purchase price of the redeemable convertible preferred stock will be the lesser of the volume weighted average price of the Company’s common stock for the twenty trading days immediately prior to the closing of the transaction and the closing price of the Company’s common tock on August 5, 2013, the date on which the term sheet for the transaction was signed.

On August 7, 2013, the Company signed an Equity Transfer Agreement, to sell its interest in Tianjin Zhongke Blue Whale Information Technologies Co., Ltd. (“Blue Whale”), a Chinese joint venture, for $3.0 million.  Closing of the sale is subject to certain conditions, including the approval of the appropriate government entities in China.

Both the private equity investment and the sale of the Company’s Blue Whale investment are subject to various closing conditions, including, with regard to the Blue Whale investment sale, government approvals, and there can be no guarantee that either transaction will close.

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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  These forward-looking statements can be identified by the use of predictive, future-tense or forward-looking terminology, such as “believes,” “anticipates,” “expects,” “estimates,” “plans,” “may,” “intends,” “will,” or similar terms.  Investors are cautioned that any forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties, and that actual results may differ materially from those projected in the forward-looking statements. The following discussion should be read together with the consolidated financial statements and notes to those financial statements included elsewhere in this report.

OVERVIEW

Our recent performance has fallen short of our expectations. During the second quarter, and continuing to the date of this filing, the markets for our products remained vey competitive.

The actions we have taken to date to address our performance have failed to facilitate our growth or to enable us to achieve profitability.

Therefore, after the close of the quarter, we began to take steps to revive the Company and to put us on a path for positive cash flow.  We intend to strengthen our capital structure to give comfort to our current and future customers, and so that we will be able to take advantage of future opportunities.

First, we intend to raise cash to bolster our balance sheet.  We have reached an agreement in principle, and we have signed a term sheet, for an investment of between $7.5 million and $15.0 million from a private equity group.  The investment will be in the form of redeemable convertible preferred stock.  The purchase price of the redeemable convertible preferred stock will be the lesser of the volume weighted average price of the Company’s common stock for the twenty trading days immediately prior to the closing of the transaction and the closing price of the Company’s common stock on August 5, 2013, the day on which the term sheet for the transaction was signed. Such preferred stock will not be and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements.  Consummation of the transaction is contingent upon the execution of definitive documentation and  satisfaction of certain closing conditions, of which there can be no assurance.

We have also signed an Equity Transfer Agreement, to sell our interest in Tianjin Zhongke Blue Whale Information Technologies Co., Ltd. (“Blue Whale”) for $3.0 million.  We invested $1.0 million in Blue Whale, a joint venture company in China, in 2008.   We believe that the time is right to sell this investment because it will provide us with $3.0 million in cash, which represents a 200% return on our investment, and because Blue Whale’s product development and our product roadmap have begun to diverge.  Closing of the sale is subject to certain conditions, including the approval of the appropriate government entities in China, and, accordingly, there can be no assurance that the investment will be consummated.

This additional cash infusion is intended to provide further assurance to our current and potential customers, our partners and our employees that we have the resources necessary to continue to be a leader in the field and to continue as a viable business.

Second, after careful evaluation, we believe that our resources will be best used on new generations of our existing products, with new features and functionality, rather than on new business segments.  To that end, we have partnered with Violin Memory, Inc. (“Violin”), for joint development of a next generation product. Violin will be paying us up to $12.0 million over the course of the development process in addition to providing their expertise in solid state drives (SSD) (also known as “Flash memory”). At the end of the development process, which is expected to take approximately twelve months, we believe we will have a next generation of products optimized for SSD which will make us a leader in the markets for Flash memory and traditional hard disk drives, cloud storage, and data protection services.  Violin will receive a license to use these products.

Third, we intend to restructure our business with the goal of aligning expenses and revenue so that we are cash flow positive in the near future.  We will be looking at all aspects of our business to find areas where we can be more efficient.  We will be addressing the parts of our business that have been underperforming and we intend to make the necessary adjustments in our cost structure including among other things, product portfolio evaluation, customer-addressable markets, geographic coverage and routes to market, to properly align all of our resources with our current and long-term outlooks.

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Combined, these initiatives should put us on the path to positive cash flow and should position us for future growth and profitability.

RESULTS OF OPERATIONS – FOR THE THREE MONTHS ENDED JUNE 30, 2013 COMPARED WITH THE THREE MONTHS ENDED JUNE 30, 2012.

Our primary sales focus is on selling turn-key solutions, whereby our software is integrated with industry standard hardware and sold as one complete integrated solution. As a result, our revenue is classified as either: (i) product revenue, or (ii) support and services revenue. Product revenue consists of both integrated solutions and stand-alone software revenues. Support and services revenues consists of both maintenance revenues and professional services revenues.

Total revenues for the three months ended June 30, 2013 decreased 15% to $14.0 million, compared with $16.5 million for the three months ended June 30, 2012. Our cost of revenues decreased 22% to $3.8 million for the three months ended June 30, 2013, compared with $4.9 million for the three months ended June 30, 2012. Included in our cost of revenues was $0.1 million of share-based compensation expense for the three months ended June 30, 2013 and a benefit of less than $0.1 million for the three months ended June 30, 2012. Our operating expenses decreased 18% from $17.9 million for the three months ended June 30, 2012 to $14.7 million for the three months ended June 30, 2013. Included in the operating results for the three months ended June 30, 2013 was $0.1 million of investigation, litigation and settlement related costs compared with $0.9 million for the three months ended June 30, 2012. Also included in our operating expenses for the three months ended June 30, 2013 and June 30, 2012 was $0.2 million and $1.1 million, respectively, of share-based compensation expense. Net loss for the three months ended June 30, 2013 was $5.2 million, compared with a net loss of $6.6 million for the three months ended June 30, 2012. Included in our net loss for the three months ended June 30, 2013 was an income tax provision of $0.2 million, compared with an income tax provision of $0.2 million for the three months ended June 30, 2012. The income tax provision of $0.2 million was primarily attributable to the impact of our estimated full year effective tax rate on our pre-tax losses for both the three months ended June 30, 2013 and June 30, 2012. No tax benefits were recognized for expected net domestic deferred tax assets for each of the full years 2013 and 2012, respectively, due to the full valuation allowance over these deferred tax assets.

The decrease in total revenues was due to a decrease in product revenues and support and services revenues for the three months ended June 30, 2013, compared with the same period in 2012. In total, our product revenues decreased 17%. Product revenues from our OEM partners decreased 76%, while product revenues from our non-OEM partners decreased 14% for the three months ended June 30, 2013, compared with the same period in 2012. During the quarter, we continued our focus and emphasis on the FalconStor-branded business. However, the decrease in product revenue from our non-OEM partners was primarily attributable to (i) the continued overall macroeconomic conditions which have resulted in significant competitive pricing practices from our competitors, customers subjecting IT spending to stricter ROI returns and overall deal review, and more consideration of traditional storage needs as compared to cloud based alternatives which has all led to elongated sales cycles, and (ii) the impact of questions raised by the Company’s declining cash balances  and concerns about the Company’s performance over the past twelve months. The decline in OEM product revenues was primarily the result of continued disruption with one of our largest OEM partners in China, which was part of a significant corporate reorganization which commenced during 2012, and which has led to continued unpredictability in sales volume from this OEM during the first half of 2013.

In total, support and services revenue decreased 14% from $8.6 million for the three months ended June 30, 2012 to $7.4 million for the three months ended June 30, 2013. The decrease in support and services revenue was attributable to a decrease in both maintenance and technical support services revenue and professional services revenues. Maintenance and technical support services revenue decreased from $7.7 million for the three months ended June 30, 2012 to $7.1 million for the three months ended June 30, 2013. Our maintenance and technical support service revenue is expected to result primarily from (i) the purchase of maintenance and support contracts by our customers, and (ii) the renewal of maintenance and support contracts by our existing and new customers after their initial contracts expire. During the three months ended June 30, 2013 the decline in maintenance was primarily attributable to (i) a decline in maintenance revenue from certain legacy OEM customers due to the wind down in our OEM business which commenced in 2009, (ii) a decrease from the previous year in revenue from sales of products that are generally sold with maintenance, and (iii) deeper discounts provided on products in the current economic and competitive environments. Professional services revenue varies from period to period based upon (i) the number of solutions sold during the existing and previous periods, (ii) the number of our customers who elect to purchase professional services, (iii) the number of professional services contracts that are performed during the period, and (iv) the number of customers who elect to purchase engineering services. We expect professional services revenues to continue to vary from period to period based upon the number of customers who elect to utilize our professional services upon purchasing any of our solutions.

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Overall, our total operating expenses decreased $3.2 million, or 18%, to $14.7 million for the three months ended June 30, 2013, compared with $17.9 million for the same period in 2012. The decrease in total operating expenses was primarily attributable to (i) a decrease in salary and personnel costs including share-based compensation expense due to lower headcount, (ii) a decrease in commissions due to the decrease in revenues during the three months ended June 30, 2013 as compared with the three months ended June 30, 2012, and (iii) a $0.8 million decrease in investigation, litigation, and settlement related costs compared with the same period in 2012. We will continue to evaluate the appropriate headcount levels to properly align our resources with our current and long-term outlook and to take actions in areas of the Company that are not performing. Our worldwide headcount was 418 employees as of June 30, 2013, compared with 481 employees as of June 30, 2012.

Revenues

	Three months ended June 30,
	2013		2012
Revenues:
Product revenue	$	6,542,429	$	7,835,568
Support and services revenue		7,431,710		8,630,633
Total Revenues	$	13,974,139	$	16,466,201

Year-over-year percentage change
Product revenue	-17	%	-33	%
Support and services revenue	-14	%	8	%
Total percentage change	-15	%	-16	%

Product revenue

Product revenue is comprised of sales of licenses for our software integrated on industry standard hardware creating a turn-key solution or integrated solution, and our stand-alone software applications. The products are sold through our OEMs, and through (i) value-added resellers, (ii) distributors, and/or (iii) directly to end-users (collectively “non-OEMs”). These revenues are recognized when, among other requirements, we receive a customer purchase order or a royalty report summarizing stand-alone software applications sold, integrated solutions sold and/or permanent key codes are delivered to the customer.

Product revenue decreased 17% from $7.8 million for the three months ended June 30, 2012, to $6.5 million for the three months ended June 30, 2013. These amounts are net of a return provision of less than $0.1 million recognized during the three months ended June 30, 2013, compared with a provision of $0.3 million in the same period in 2012.  Product revenue represented 47% and 48% of our total revenues for the three months ended June 30, 2013 and 2012, respectively. Product revenues from our OEM partners decreased 76%, while product revenues from our non-OEM partners decreased 14% for the three months ended June 30, 2013, compared with the same period in 2012. During the quarter, we continued our focus and emphasis on the FalconStor-branded business. However, the decrease in product revenue from our non-OEM partners was primarily attributable to (i) the continued overall macroeconomic conditions which have resulted in significant competitive pricing practices from our competitors, customers subjecting IT spending to stricter ROI returns and overall deal review, and more consideration of traditional storage needs as compared to cloud based alternatives which has all led to elongated sales cycles, and (ii) the impact of questions raised by the Company’s declining cash balances  and concerns about the Company’s performance over the past twelve months.  The decline in OEM product revenues was primarily the result of continued disruption with one of our largest OEM partners in China, which was part of a significant corporate reorganization which commenced during 2012, and which has led to continued unpredictability in sales volume from this OEM during the first half of 2013. Product revenue from our non-OEM partners represented 99% and 96% of our total product revenue for the three months ended June 30, 2013 and 2012, respectively. Product revenue from our OEM partners represented 1% and 4% of our total product revenue for the three months ended June 30, 2013 and 2012, respectively.

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We continue to focus our investments on the FalconStor-branded non-OEM channel business as we feel this is in line with our long-term outlook.

Support and services revenue

Support and services revenue is comprised of revenue from (i) maintenance and technical support services, (ii) professional services primarily related to the implementation of our software, and (iii) engineering services. Revenues derived from maintenance and technical support contracts are deferred and recognized ratably over the contractual maintenance term. Professional services revenue is recognized in the period that the related services are performed. Support and services revenue decreased 14% from $8.6 million for the three months ended June 30, 2012 to $7.4 million for the three months ended June 30, 2013. The decrease in support and services revenue was attributable to decreases in both maintenance and technical support services revenue and professional services revenues.

Maintenance and technical support services revenue decreased from $7.7 million for the three months ended June 30, 2012 to $7.1 million for the three months ended June 30, 2013. Our maintenance and technical support service revenue is expected to result primarily from (i) the purchase of maintenance and support contracts by our customers, and (ii) the renewal of maintenance and support contracts by our existing and new customers after their initial contracts expire. During the three months ended June 30, 2013, the decline in maintenance and technical support services revenue was primarily attributable to (i) a $0.5 million decline in maintenance revenue from our OEM partners, primarily certain legacy OEM customers due to the wind down in our OEM business which commenced in 2009, (ii) a decrease from the previous year in revenue from sales of products that are generally sold with maintenance, and (iii) deeper discounts provided on products in the current economic and competitive environments.

Professional services revenues decreased from $0.9 million for the three months ended June 30, 2012 to $0.4 million for the same period in 2013. Professional services revenue varies from period to period based upon (i) the number of solutions sold during the existing and previous periods, (ii) the number of our customers who elect to purchase professional services, (iii) the number of professional services contracts that are performed during the period, and (iv) the number of customers who elect to purchase engineering services. We expect professional services revenues to continue to vary from period to period based upon the number of customers who elect to utilize our professional services upon purchasing any of our solutions.

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Cost of Revenues

	Three months ended June 30,
	2013		2012
Cost of revenues:
Product	$	963,102	$	1,787,186
Support and service		2,861,992		3,091,055
Total cost of revenues	$	3,825,094	$	4,878,241
Total Gross Profit	$	10,149,045	$	11,587,960

Gross Margin:
Product	85	%	77	%
Support and service	61	%	64	%
Total gross margin	73	%	70	%

Cost of revenues, gross profit and gross margin

Cost of product revenue consists primarily of industry standard hardware we purchase and integrate with our software for turn-key integrated solutions, personnel costs, amortization of capitalized software, shipping and logistics costs, and share-based compensation expense. Cost of support and service consists primarily of personnel and other costs associated with providing software implementations, technical support under maintenance contracts, training, and share-based compensation expense. Cost of product revenue for the three months ended June 30, 2013 decreased $0.8 million, or 46%, to $1.0 million, compared with $1.8 million for the same period in 2012. The decrease in cost of product revenue was primarily attributable to the decline in the number of fully integrated solutions which included hardware appliances as a percentage of all product revenues as compared with the same period in 2012. Our cost of support and service revenues for the three months ended June 30, 2013 decreased $0.2 million, or 7%, to $2.9 million, compared with $3.1 million for the same period in 2012. This decrease was primarily attributable to a decrease in personnel costs as a result of lower headcount during the second quarter of 2013 compared with the same period in 2012.

Total gross profit decreased $1.4 million, or 12%, to $10.1 million for the three months ended June 30, 2013 from $11.6 million for the same period in 2012. Total gross margin increased to 73% for the three months ended June 30, 2013, from 70% for the same period in 2012. The decrease in our total gross profit for the three months ended June 30, 2013, compared with the same period in 2012, was primarily due to a 15% decrease in our total revenues. Generally, our total gross profits and total gross margins may fluctuate based on several factors, including (i) revenue growth levels, (ii) changes in personnel headcount and related costs, and (iii) our product offerings and mix of sales.

Share-based compensation expense included in the cost of product revenue was less than 1% of total revenue for the three months ended June 30, 2013 and June 30, 2012. Share-based compensation expense included in the cost of support and service revenue was less than $0.1 million for both the three months ended June 30, 2013 and the three months ended June 30, 2012. Share-based compensation expense included in cost of support and service revenue was less than 1% of total revenue for the three months ended June 30, 2013 and June 30, 2012.

Operating Expenses

Research and Development Costs

Research and development costs consist primarily of personnel costs for product development, share-based compensation expense, and other related costs associated with the development of new products, enhancements to existing products, quality assurance and testing. Research and development costs decreased $0.5 million, or 9%, to $4.4 million for the three months ended June 30, 2013, from $4.8 million in the same period in 2012. The decrease in research and development costs was primarily the result of a decline in personnel related costs including share-based compensation expense. This decline was also attributable to an increase in capitalized software development costs which increased to $0.2 million for the three months ended June 30, 2013 as compared to $0.1 million for the three months ended June 30, 2012. We believe we continue to provide adequate levels of resources in support of our research and development activities to continue to enhance and to test our core products and in the development of new innovative products, features and options. Share-based compensation expense included in research and development costs was $0.1 million for the three months ended June 30, 2013 and June 30, 2012. Share-based compensation expense included in research and development costs was less than 1% of total revenue for the three months ended June 30, 2013 and 1% of total revenue for the three months ended June 30, 2012.

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Selling and Marketing

Selling and marketing expenses consist primarily of sales and marketing personnel and related costs, share-based compensation expense, travel, public relations expense, marketing literature and promotions, commissions, trade show expenses, and the costs associated with our foreign sales offices. Selling and marketing expenses decreased $2.3 million, or 25%, to $6.9 million for the three months ended June 30, 2013, from $9.2 million for the same period in 2012. The decrease in selling and marketing expenses was primarily attributable to (i) a decrease in commissions due to the 17% decline in product revenue compared with the same period in 2012, and (ii) a decrease in salary and personnel costs as a result of lower sales and marketing headcount as well as a decrease in share-based compensation expenses.  Share-based compensation expense included in selling and marketing decreased to $0.0 million from $0.4 million for the three months ended June 30, 2013 and 2012, respectively due to the reversal of previously accrued share-based compensation related to the resignations of certain former sales and marketing professionals. Share-based compensation expense included in selling and marketing expenses was equal to 0% of total revenue for the three months ended June 30, 2013 and 2% for the three months ended June 30, 2012.

General and Administrative

General and administrative expenses consist primarily of personnel costs of general and administrative functions, share-based compensation expense, public company related costs, directors and officers’ insurance, legal and professional fees, bad debt expense, and other general corporate overhead costs. General and administrative expenses increased $0.3 million, or 11%, to $3.4 million for the three months ended June 30, 2013, compared with $3.0 million for the same period in 2012. The overall increase within general and administrative expenses was primarily related to an increase in professional fees, severance costs, and other administrative costs which were partially offset by a decrease in share-based compensation. Share-based compensation expense included in general and administrative expenses was $0.1 million for the three months ended June 30, 2013, compared with $0.6 million for the three months ended June 30, 2012 due to the reversal of previously accrued share-based compensation related to the resignation of the Company’s former CEO. Share-based compensation expense included in general and administrative expenses was equal to 1% and 4% of total revenue for the three months ended June 30, 2013 and June 30, 2012, respectively.

Investigation, Litigation and Settlement Related Costs

During the three months ended June 30, 2013, our total investigation, litigation, and settlement related costs totaled $0.1 million, which was comprised of $0.2 million of legal expenses related to the class action and derivative lawsuits and legal fees associated with other settlement related activities, which were partially offset by $0.1 million that are expected to be recoverable through insurance. During the three months ended June 30, 2012, our total investigation, litigation, and settlement related costs of $0.9 million were comprised of (i) $0.5 million of legal fees, and (ii) a $0.4 million accrual associated with the possible resolution of the class action lawsuit. For further information, refer to Note (10) Litigation, to our unaudited condensed consolidated financial statements.

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We expect that our operating expenses will continue to be adversely impacted during 2013 due to professional and service provider fees and other costs, resulting from the ongoing stockholder lawsuits and other settlement related activities.

Interest and Other Loss

We invest our cash primarily in money market funds, government securities, and corporate bonds. As of June 30, 2013, our cash, cash equivalents, and marketable securities totaled $21.9 million, compared with $33.6 million as of June 30, 2012. Interest and other loss increased $0.4 million to a loss of $0.5 million for the three months ended June 30, 2013 compared with a loss of $0.1 million for the same period in 2012. The increase in interest and other loss was primarily due to a foreign currency loss of $0.5 million during the three months ended June 30, 2013 compared with a foreign currency loss of $0.1 million for the same period in 2012.

Income Taxes

Our provision for income taxes consists of state, local, and foreign taxes. For both the three months ended June 30, 2013 and June 30, 2012, we recorded an income tax provision of $0.2 million on our pre-tax loss of $5.0 million and $6.4 million, respectively, consisting primarily of state and local and foreign taxes. Our domestic deferred tax assets are realizable on a more-likely-than-not basis and, therefore, we have recorded a full valuation allowance against our domestic deferred tax assets. During the three months ended June 30, 2013, our conclusion did not change with respect to our domestic deferred tax assets and therefore, we have not recorded any benefit for our expected net domestic deferred tax assets for the full year 2013 estimated annual effective tax rate. As of June 30, 2013, the valuation allowance totaled approximately $40.3 million.

RESULTS OF OPERATIONS – FOR THE SIX MONTHS ENDED JUNE 30, 2013 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2012.

Total revenues for the six months ended June 30, 2013 decreased 18% to $29.3 million, compared with $35.8 million for the six months ended June 30, 2012. Our cost of revenues decreased 19% to $8.1 million for the six months ended June 30, 2013, compared with $10.1 million for the six months ended June 30, 2012. Included in our cost of revenues was $0.1 million of share-based compensation expense for the six months ended June 30, 2013 and less than $0.1 million for the six months ended June 30, 2012. Our operating expenses decreased 14% from $34.2 million for the six months ended June 30, 2012 to $29.5 million for the six months ended June 30, 2013. Included in the operating results for the six months ended June 30, 2013 was $0.2 million of investigation, litigation and settlement related costs compared with a benefit of $0.4 million for the six months ended June 30, 2012. Also included in our operating expenses for the six months ended June 30, 2013 and June 30, 2012 was $1.0 million and $2.5 million, respectively, of share-based compensation expense. Net loss for the six months ended June 30, 2013 was $9.6 million, compared with a net loss of $9.1 million for the six months ended June 30, 2012. Included in our net loss for the six months ended June 30, 2013 was an income tax provision of $0.3 million, compared with an income tax provision of $0.4 million for the six months ended June 30, 2012. The income tax provision of $0.3 million was primarily attributable to the impact of our estimated full year effective tax rate on our pre-tax losses for both the six months ended June 30, 2013 and June 30, 2012. No tax benefits were recognized for expected net domestic deferred tax assets for each of the full years 2013 and 2012, respectively, due to the full valuation allowance over these deferred tax assets.

The decrease in total revenues was due to a decrease in product revenues and support and services revenues for the six months ended June 30, 2013, compared with the same period in 2012. In total, our product revenues decreased 23%. Product revenues from our OEM partners decreased 79%, while product revenues from our non-OEM partners decreased 19% for the six months ended June 30, 2013, compared with the same period in 2012. During the first six months of 2013, we continued our focus and emphasis on the FalconStor-branded business. However, the decrease in product revenue from our non-OEM partners was primarily attributable to (i) the continued overall macroeconomic conditions which have resulted in significant competitive pricing practices from our competitors, customers subjecting IT spending to stricter ROI returns and overall deal review, and more consideration of traditional storage needs as compared to cloud based alternatives which has all led to elongated sales cycles, and (ii) the impact of questions raised by the Company’s declining cash balances  and concerns about the Company’s roadmap over the past twelve months.  The decline in OEM product revenues was primarily the result of continued disruption with one of our largest OEM partners in China, which was part of a significant corporate reorganization which commenced during 2012, and which has led to continued unpredictability in sales volume from this OEM during the first half of 2013.

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In total, support and services revenue decreased 14% from $17.3 million for the six months ended June 30, 2012 to $15.0 million for the six months ended June 30, 2013. The decrease in support and services revenue was attributable to a decrease in both maintenance and technical support services revenue and professional services revenues. Maintenance and technical support services revenue decreased from $15.4 million for the six months ended June 30, 2012 to $14.1 million for the six months ended June 30, 2013. Our maintenance and technical support service revenue is expected to result primarily from (i) the purchase of maintenance and support contracts by our customers, and (ii) the renewal of maintenance and support contracts by our existing and new customers after their initial contracts expire. During the six months ended June 30, 2013 the decline in maintenance and technical support services revenue was primarily attributable to (i) a decline in maintenance revenue from certain legacy OEM customers due to the wind down in our OEM business which commenced in 2009, (ii) a decrease from the previous year in revenue from sales of products that are generally sold with maintenance, and (iii) deeper discounts provided on products in the current economic and competitive environments. Professional services revenue varies from period to period based upon (i) the number of solutions sold during the existing and previous periods, (ii) the number of our customers who elect to purchase professional services, (iii) the number of professional services contracts that are performed during the period, and (iv) the number of customers who elect to purchase engineering services. We expect professional services revenues to continue to vary from period to period based upon the number of customers who elect to utilize our professional services upon purchasing any of our solutions.

Overall, our total operating expenses decreased $4.6 million, or 14%, to $29.5 million for the six months ended June 30, 2013, compared with $34.2 million for the same period in 2012. The decrease in total operating expenses was primarily attributable to (i) a decrease in salary and personnel costs including share-based compensation expense due to lower headcount and (ii) a decrease in commissions due to the decrease in revenues during the six months ended June 30, 2013 as compared with the six months ended June 30, 2012. These decreases were partially offset by a $0.6 million increase in investigation, litigation, and settlement related costs compared with the same period in 2012 primarily due to the $0.4 million net recovery recorded in the six month period ended June 30, 2012. We will continue to evaluate the appropriate headcount levels to properly align our resources with our current and long-term outlook and to take actions in areas of the Company that are not performing.

Revenues

	Six months ended June 30,
	2013		2012
Revenues:
Product revenue	$	14,301,885	$	18,498,521
Support and services revenue		14,957,071		17,335,752
Total Revenues	$	29,258,956	$	35,834,273

Year-over-year percentage growth
Product revenue	-23	%	-19	%
Support and services revenue	-14	%	10	%
Total percentage growth	-18	%	-7	%

Product revenue

Product revenue decreased 23% from $18.5 million for the six months ended June 30, 2012, to $14.3 million for the six months ended June 30, 2013. These amounts are net of a benefit of $0.1 million recognized during the six months ended June 30, 2013, compared with a benefit of $0.3 million in the same period in 2012, resulting from the impact of our collection efforts of previously reserved accounts receivable. Product revenue represented 49% and 52% of our total revenues for the six months ended June 30, 2013 and 2012, respectively. Product revenues from our OEM partners decreased 79%, while product revenues from our non-OEM partners decreased 19% for the six months ended June 30, 2013, compared with the same period in 2012. During the first six months of 2013, we continued our focus and emphasis on the FalconStor-branded business However, the decrease in product revenue from our non-OEM partners was primarily attributable to (i) the continued overall macroeconomic conditions which have resulted in significant competitive pricing practices from our competitors, customers subjecting IT spending to stricter ROI returns and overall deal review, and more consideration of traditional storage needs as compared to cloud based alternatives which has all led to elongated sales cycles, and (ii) the impact of questions raised by the Company’s declining cash balances  and concerns about the Company’s performance over the past twelve months. The decline in OEM product revenues was primarily the result of continued disruption with one of our largest OEM partners in China, which was part of a significant corporate reorganization which commenced during 2012, and which has led to continued unpredictability in sales volume from this OEM during the first half of 2013. Product revenue from our non-OEM partners represented 98% and 94% of our total product revenue for the six months ended June 30, 2013 and 2012, respectively. Product revenue from our OEM partners represented 2% and 6% of our total product revenue for the six months ended June 30, 2013 and 2012, respectively.

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We continue to focus our investments on the FalconStor-branded non-OEM channel business as we feel this is in line with our long-term outlook.

Support and services revenue

Support and services revenue decreased 14% from $17.3 million for the six months ended June 30, 2012 to $15.0 million for the six months ended June 30, 2013. The decrease in support and services revenue was attributable to decreases in both maintenance and technical support services revenue and professional services revenues.

Maintenance and technical support services revenue decreased from $15.4 million for the six months ended June 30, 2012 to $14.1 million for the six months ended June 30, 2013. Our maintenance and technical support service revenue is expected to result primarily from (i) the purchase of maintenance and support contracts by our customers, and (ii) the renewal of maintenance and support contracts by our existing and new customers after their initial contracts expire. During the six months ended June 30, 2013, the decline in maintenance was primarily attributable to (i) a $0.9 million decline in maintenance revenue from our OEM partners, particularly certain legacy OEM customers due to the wind down in our OEM business which commenced in 2009, (ii) a decrease from the previous year in revenue from sales of products that are generally sold with maintenance, and (iii) deeper discounts provided on products in the current economic and competitive environments.

Professional services revenues decreased from $2.0 million for the six months ended June 30, 2012 to $0.9 million for the same period in 2013. Professional services revenue varies from period to period based upon (i) the number of solutions sold during the existing and previous periods, (ii) the number of our customers who elect to purchase professional services, (iii) the number of professional services contracts that are performed during the period, and (iv) the number of customers who elect to purchase engineering services. We expect professional services revenues to continue to vary from period to period based upon the number of customers who elect to utilize our professional services upon purchasing any of our solutions.

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Cost of Revenues

	Six months ended June 30,
	2013		2012
Cost of revenues:
Product	$	2,262,756	$	3,807,672
Support and service		5,870,395		6,252,411
Total cost of revenues	$	8,133,151	$	10,060,083
Total Gross Profit	$	21,125,805	$	25,774,190

Gross Margin:
Product	84	%	79	%
Support and service	61	%	64	%
Total gross margin	72	%	72	%

Cost of revenues, gross profit and gross margin

Cost of product revenue for the six months ended June 30, 2013 decreased $1.5 million, or 41%, to $2.3 million, compared with $3.8 million for the same period in 2012. The decrease in cost of product revenue was primarily attributable to the decline in the number of fully integrated solutions which included hardware appliances as a percentage of all product revenues as compared with the same period in 2012. Our cost of support and service revenues for the six months ended June 30, 2013 decreased $0.4 million, or 6%, to $5.9 million, compared with $6.3 million for the same period in 2012. This decrease was primarily attributable to a decrease in personnel costs as a result of lower headcount during the first six months of 2013 compared with the same period in 2012.

Total gross profit decreased $4.6 million, or 18%, to $21.1 million for the six months ended June 30, 2013 from $25.8 million for the same period in 2012. Total gross margin was 72% for each of the six months ended June 30, 2013 and 2012. The decrease in our total gross profit for the six months ended June 30, 2013, compared with the same period in 2012, was primarily due to an 18% decrease in our total revenues. Generally, our total gross profits and total gross margins may fluctuate based on several factors, including (i) revenue growth levels, (ii) changes in personnel headcount and related costs, and (iii) our product offerings and mix of sales.

Share-based compensation expense included in the cost of product revenue was less than 1% of total revenue for the six months ended June 30, 2013 and June 30, 2012. Share-based compensation expense included in the cost of support and service revenue was $0.1 million for both the six months ended June 30, 2013 and less than $0.1 million for the six months ended June 30, 2012. Share-based compensation expense included in cost of support and service revenue was less than 1% of total revenue for the six months ended June 30, 2013 and June 30, 2012.

Operating Expenses

Research and Development Costs

Research and development costs decreased $0.6 million, or 6%, to $9.0 million for the six months ended June 30, 2013, from $9.6 million in the same period in 2012. The decrease in research and development costs was primarily the result of a decline in personnel related costs including share-based compensation expense. These decreases were partially offset by higher capitalization of software development costs in the six months ended June 30, 2012 of $0.5 million as compared to $0.2 million during the six months ended June 30, 2013. We believe we continue to provide adequate levels of resources in support of our research and development activities to continue to enhance and to test our core products and in the development of new innovative products, features and options. Share-based compensation expense included in research and development costs decreased to $0.2 million from $0.4 million for the six months ended June 30, 2013 and June 30, 2012, respectively. Share-based compensation expense included in research and development costs was 1% of total revenue for the six months ended June 30, 2013 and June 30, 2012.

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Selling and Marketing

Selling and marketing expenses decreased $5.2 million, or 27%, to $13.7 million for the six months ended June 30, 2013, from $18.9 million for the same period in 2012. The decrease in selling and marketing expenses was primarily attributable to (i) a decrease in commissions due to the 23% decline in product revenue compared with the same period in 2012, and (ii) a decrease in salary and personnel costs as a result of lower sales and marketing headcount as well as a decrease in share-based compensation expenses.  Share-based compensation expense included in selling and marketing decreased to $0.3 million from $0.9 million for the six months ended June 30, 2013 and 2012, respectively due to the reversal of previously accrued share-based compensation related to the resignations of certain former sales and marketing professionals . Share-based compensation expense included in selling and marketing expenses was equal to 1% of total revenue for the six months ended June 30, 2013 and 2% of total revenue for the six months ended June 30, 2012.

General and Administrative

General and administrative expenses increased $0.5 million, or 8%, to $6.6 million for the six months ended June 30, 2013, compared with $6.1 million for the same period in 2012. The overall increase within general and administrative expenses was primarily related to an increase in professional fees, severance costs, and other administrative costs which were partially offset by a decrease in bad debt expense and share-based compensation. Share-based compensation expense included in general and administrative expenses was $0.5 million for the six months ended June 30, 2013, compared with $1.2 million for the six months ended June 30, 2012 due to the reversal of previously accrued share-based compensation related to the resignation of the Company’s former CEO. Share-based compensation expense included in general and administrative expenses was equal to 2% and 3% of total revenue for the six months ended June 30, 2013 and June 30, 2012, respectively.

Investigation, Litigation and Settlement Related Costs

During the six months ended June 30, 2013, our total investigation, litigation, and settlement related costs totaled $0.2 million, which was comprised of $0.5 million of legal expenses related to the class action and derivative lawsuits and legal fees associated with other settlement related activities, which were partially offset by $0.3 million that are expected to be recoverable through insurance. For the six months ended June 30, 2012, our total investigation, litigation, and settlement related costs resulted in a net reduction of $0.4 million, which was comprised of (i) $0.9 million of legal fees, (ii) a $0.4 million accrual related to possible resolution of class action lawsuits, and (iii) a $1.7 million accrual reduction. For further information, refer to Note (10) Litigation, to our unaudited condensed consolidated financial statements.

We expect that our operating expenses will continue to be adversely impacted during 2013 due to professional and service provider fees and other costs, resulting from the ongoing stockholder lawsuits and settlement related activities.

Interest and Other Loss

Interest and other loss increased $0.6 million to a loss of $0.8 million for the six months ended June 30, 2013 compared with a loss of $0.2 million for the same period in 2012. The increase in interest and other loss was primarily due to a foreign currency loss of $0.8 million during the six months ended June 30, 2013 related primarily to declines in foreign exchange for both the Japanese Yen and the Euro compared with a foreign currency loss of $0.3 million for the same period in 2012, partially offset by $0.1 million of interest income.

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Income Taxes

Our provision for income taxes consists of state, local, and foreign taxes. For the six months ended June 30, 2013, we recorded an income tax provision of $0.3 million as compared with a provision of $0.4 million for the same period in 2012, consisting primarily of state and local and foreign taxes. Our domestic deferred tax assets are realizable on a more-likely-than-not basis and, therefore, we have recorded a full valuation allowance against our domestic deferred tax assets. During the six months ended June 30, 2013, our conclusion did not change with respect to our domestic deferred tax assets and therefore, we have not recorded any benefit for our expected net domestic deferred tax assets for the full year 2013 estimated annual effective tax rate. As of June 30, 2013, the valuation allowance totaled approximately $40.3 million.

Critical Accounting Policies and Estimates

Our critical accounting policies and estimates are those related to revenue recognition, accounts receivable allowances, deferred income taxes, accounting for share-based payments, goodwill and other intangible assets, software development costs, fair value measurements and litigation.

Revenue Recognition. As discussed further in Note (1) Summary of Significant Accounting Policies, to our unaudited condensed consolidated financial statements, we recognize revenue in accordance with the authoritative guidance issued by the FASB on revenue recognition. Product revenue is recognized only when pervasive evidence of an arrangement exists and the fee is fixed and determinable, among other criteria. An arrangement is evidenced by a signed customer contract, a customer purchase order, and/or a royalty report summarizing software licenses sold for each software license resold by an OEM, distributor or reseller to an end user. Product fees are fixed and determinable as our standard payment terms range from 30 to 90 days, depending on regional billing practices, and we have not provided any of our customers with extended payment terms during the three and six months ended June 30, 2013. When a customer purchases our integrated solutions and/or licenses software together with the purchase of maintenance, we allocate a portion of the fee to maintenance based upon vendor-specific objective evidence (“VSOE”) of the fair value of the contractual optional maintenance renewal rate. If professional services are included in our multi-element software arrangements, we allocate a portion of the fee to these services based on its VSOE of fair value which is established using rates charged when sold on a stand-alone basis.

Accounts Receivable. We review accounts receivable to determine which receivables are doubtful of collection. In making the determination of the appropriate allowance for uncollectible accounts and returns, we consider (i) historical return rates, (ii) specific past due accounts, (iii) analysis of our accounts receivable aging, (iv) customer payment terms, (v) historical collections, write-offs and returns, (vi) changes in customer demand and relationships, (vii) actual cash collections on our accounts receivables and (viii) concentrations of credit risk and customer credit worthiness. When determining the appropriate allowance for uncollectable accounts and returns each period, the actual customer collections of outstanding account receivable balances impact the required allowance for returns. Due to cash collections of previously reserved accounts receivable balances, we recorded benefits of approximately $0.4 million and $0.3 million for the six months ended June 30, 2013 and June 30, 2012, respectively. These amounts are included within our unaudited condensed consolidated statement of operations in each respective year. Changes in the product return rates, credit worthiness of customers, general economic conditions and other factors may impact the level of future write-offs, revenues and our general and administrative expenses.

Income Taxes. As discussed further in Note (1) Summary of Significant Accounting Policies, to our unaudited condensed consolidated financial statements, in accordance with the authoritative guidance issued by the FASB on income taxes, we regularly evaluate our ability to recover deferred tax assets, and report such deferred tax assets at the amount that is determined to be more-likely-than-not recoverable. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In determining the period in which related tax benefits are realized for financial reporting purposes, excess share-based compensation deductions included in net operating losses are realized after regular net operating losses are exhausted.

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We account for uncertain tax positions in accordance with the authoritative guidance issued by the FASB on income taxes, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return, should be recorded in the financial statements. Pursuant to the authoritative guidance, we may recognize the tax benefit from an uncertain tax position only if it meets the “more likely than not” threshold that the position will be sustained on examination by the taxing authority, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. In addition, the authoritative guidance addresses de-recognition, classification, interest and penalties on income taxes, accounting in interim periods, and also requires increased disclosures.

Accounting for Share-Based Payments. As discussed further in Note (1) Summary of Significant Accounting Policies andNote (2) Share-Based Payment Arrangements, to our unaudited condensed consolidated financial statements, we account for share-based awards in accordance with the authoritative guidance issued by the FASB on stock compensation.

We have used and expect to continue to use the Black-Scholes option-pricing model to compute the estimated fair value of share-based compensation expense for our stock option grants. The Black-Scholes option-pricing model includes assumptions regarding dividend yields, expected volatility, expected option term and risk-free interest rates. The assumptions used in computing the fair value of share-based compensation expense reflect our best estimates, but involve uncertainties relating to market and other conditions, many of which are outside of our control. We estimate expected volatility based primarily on historical daily price changes of our stock and other factors. The expected option term is the number of years that we estimate that the stock options will be outstanding prior to exercise. The estimated expected term of the stock awards issued has been determined pursuant to SEC Staff Accounting Bulletin SAB No. 110. Additionally, we estimate forfeiture rates based primarily upon historical experience, adjusted when appropriate for known events or expected trends. We may adjust share-based compensation expense on a quarterly basis for changes to our estimate of expected equity award forfeitures based on our review of these events and trends and recognize the effect of adjusting the forfeiture rate for all expense amortization in the period in which we revised the forfeiture estimate. If other assumptions or estimates had been used, the share-based compensation expense that was recorded for the three and six months ended June 30, 2013 and 2012 could have been materially different. Furthermore, if different assumptions or estimates are used in future periods, share-based compensation expense could be materially impacted in the future.

Goodwill and Other Intangible Assets. As discussed further in Note (1) Summary of Significant Accounting Policies, to our unaudited condensed consolidated financial statements, we account for goodwill and other intangible assets in accordance with the authoritative guidance issued by the FASB on goodwill and other intangibles. The authoritative guidance requires an impairment-only approach to accounting for goodwill and other intangibles with an indefinite life. Absent any prior indicators of impairment, we perform an annual impairment analysis during the fourth quarter of each of our fiscal years.

As of each of June 30, 2013 and December 31, 2012, we had $4.2 million of goodwill. As of each of June 30, 2013 and December 31, 2012, we had $0.2 million (net of amortization), of other identifiable intangible assets. We do not amortize goodwill, but we assess for impairment at least annually and more often if a trigger event occurs. We amortize identifiable intangible assets over their estimated useful lives. We evaluate the recoverability of goodwill using a two-step process based on an evaluation of the reporting unit. The first step involves a comparison of a reporting unit’s fair value to its carrying value. In the second step, if the reporting unit’s carrying value exceeds its fair value, we compare the goodwill’s implied fair value and its carrying value. If the goodwill’s carrying value exceeds its implied fair value, we recognize an impairment loss in an amount equal to such excess. We evaluate the recoverability of other identifiable intangible assets whenever events or changes in circumstances indicate that its carrying value may not be recoverable. Such events include significant adverse changes in business climate, several periods of operating or cash flow losses, forecasted continuing losses or a current expectation that an asset or asset a group will be disposed of before the end of its useful life. As of June 30, 2013 and December 31, 2012, we did not record any impairment charges on either our goodwill or other identifiable intangible assets.

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Software Development Costs. As discussed further in Note (1) Summary of Significant Accounting Policies, to our unaudited condensed consolidated financial statements, we account for software development costs in accordance with the authoritative guidance issued by the FASB on costs of software to be sold, leased or marketed.

As of June 30, 2013 and December 31, 2012, we had $1.2 million of software development costs, net of amortization. The authoritative guidance requires that the costs associated with the development of new software products and enhancements to existing software products be expensed as incurred until technological feasibility of the product has been established. Once technological feasibility is established, all software costs are capitalized until the product is available for general release to customers. Judgment is required in determining when technological feasibility of a product is established and assumptions are used that reflect our best estimates. If other assumptions had been used in the current period to estimate technological feasibility, the reported product development and enhancement expense could have been affected. Annual amortization of capitalized software costs is the greater of the amount computed using the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues for that product or the straight-line method over the remaining estimated economic life of the software product, generally estimated to be five years from the date the product became available for general release to customers. Software development costs are reported at the lower of amortized cost or net realizable value. Net realizable value is computed as the estimated gross future revenues from each software solution less the amount of estimated future costs of completing and disposing of that product. Because the development of projected net future revenues related to our software solutions used in our net realizable value computation is based on estimates, a significant reduction in our future revenues could impact the recovery of our capitalized software development costs. We amortize software development costs using the straight-line method.

Fair Value Measurement. As discussed further in Note (1) Summary of Significant Accounting Policies and Note (4) Fair Value Measurements, to our unaudited condensed consolidated financial statements, we determine fair value measurements of both financial and nonfinancial assets and liabilities in accordance with the authoritative guidance issued by the FASB on fair value measurements and disclosures.

The FASB authoritative guidance establishes three levels of inputs that may be used to measure fair value. Each level of input has different levels of subjectivity and difficulty involved in determining fair value.

Level 1 - instruments represent quoted prices in active markets. Therefore, determining fair value for Level 1 instruments does not require significant management judgment, and the estimation is not difficult.

Level 2 - instruments include observable inputs other than Level 1 prices, such as quoted prices for identical instruments in markets with insufficient volume or infrequent transactions (less active markets), issuer credit ratings, non-binding market consensus prices that can be corroborated with observable market data, model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated with observable market data for substantially the full term of the assets or liabilities, or quoted prices for similar assets or liabilities. These Level 2 instruments require more management judgment and subjectivity compared to Level 1 instruments.

Level 3 - instruments include unobservable inputs to the valuation methodology that are significant to the measurement of fair value of assets or liabilities. The determination of fair value for Level 3 instruments requires the most management judgment and subjectivity. All of our marketable debt instruments classified as Level 3 are valued using an undiscounted cash flow analysis, a non-binding market consensus price and/or a non-binding broker quote, all of which we corroborate with unobservable data. Non-binding market consensus prices are based on the proprietary valuation models of pricing providers or brokers. These valuation models incorporate a number of inputs, including non-binding and binding broker quotes; observable market prices for identical and/or similar securities; and the internal assumptions of pricing providers or brokers that use observable market inputs, and to a lesser degree non-observable market inputs. There were no instruments classified as Level 3 as of June 30, 2013 or December 31, 2012.

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Other-Than-Temporary Impairment

After determining the fair value of our available-for-sale debt instruments, gains or losses on these investments are recorded to other comprehensive income, until either the investment is sold or we determine that the decline in value is other-than-temporary. Determining whether the decline in fair value is other-than-temporary requires management judgment based on the specific facts and circumstances of each investment. For investments in debt instruments, these judgments primarily consider the financial condition and liquidity of the issuer, the issuer’s credit rating, and any specific events that may cause us to believe that the debt instrument will not mature and be paid in full; and our ability and intent to hold the investment to maturity.

Litigation. As discussed further in Note (10) Litigation, to our unaudited condensed consolidated financial statements, in accordance with the authoritative guidance issued by the FASB on contingencies, the Company accrues anticipated costs of settlement, damages and losses for claims to the extent specific losses are probable and estimable. The Company records a receivable for insurance recoveries when such amounts are probable and collectable.  In such cases, there may be an exposure to loss in excess of any amounts accrued.  If, at the time of evaluation, the loss contingency related to a litigation  is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable and, the Company will expense these costs as incurred. If the estimate of a probable loss is a range and no amount within the range is more likely, the Company will accrue the minimum amount of the range.

Impact of Recently Issued Accounting Pronouncements

See Item 1 of Part 1, Condensed Consolidated Financial Statements – Note (1) Summary of Significant Accounting Policies – New Accounting Pronouncements.

LIQUIDITY AND CAPITAL RESOURCES

	Six months ended June 30,
	2013			2012
Cash provided by (used in):
Operating activities	$	(6,822,981	)	$	(2,471,635	)
Investing activities		1,014,780			2,316,612
Financing activities		697,500			624,155
Effect of exchange rate changes		(246,987	)		(242,694	)
Net (decrease) increase in cash and cash equivalents	$	(5,357,688	)	$	226,438

Our principal sources of liquidity are cash flows generated from operations and our cash, cash equivalents, and marketable securities balances. Our cash and cash equivalents and marketable securities balance as of June 30, 2013 totaled $21.9 million, compared with $29.9 million as of December 31, 2012. Cash and cash equivalents totaled $13.3 million, restricted cash totaled $0.8 million and marketable securities totaled $7.8 million at June 30, 2013. As of December 31, 2012, we had $18.7 million in cash and cash equivalents, $0.8 million in restricted cash and $10.5 million in marketable securities.

As of June 30, 2013 and December 31, 2012, the Company had $0.8 million of restricted cash. The restricted cash serves as collateral related to deposit service indebtedness with the Company’s commercial bank. As of June 30, 2013 and December 31, 2012, the Company did not have any debt service indebtedness with the Company’s bank.

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Over the past several years, we have been through multiple transitions, which included various senior management changes, new sales leadership in all of our regions, changes within our North American sales force structure, and restructurings. We continually evaluate our cost structure to ensure our resources are aligned to effectively execute our long-term growth strategy, drive operational efficiencies and support the anticipated revenue level we expect to achieve on a go forward basis. As we enter the second half of 2013, we will be addressing the parts of our business that have been underperforming and we intend to make the necessary adjustments in our cost structure including among other things, evaluating appropriate headcount levels to properly align all of our resources with our current and long-term outlook. We will continue to evaluate potential software license purchases and acquisitions, and if the right opportunity presents itself, we may use our cash for these purposes. As of the date of this filing, we have no agreements, commitments or understandings with respect to any such license purchases or acquisitions.

After the close of the second quarter, we reached an agreement in principle, and we signed a term sheet, for an investment of between $7.5 million and $15.0 million from a private equity group.  The investment will be in the form of redeemable convertible preferred stock.  Closing of the investment is subject to the negotiation of definitive documents and certain other conditions.

After the close of the second quarter, we also signed an Equity Transfer Agreement, to sell our interest in Tianjin Zhongke Blue Whale Information Technologies Co., Ltd. (“Blue Whale”) for $3.0 million.  Closing of the sale is subject to certain conditions, including the approval of the appropriate government entities in China.

As discussed further in Part II, Item 1 – Legal Proceedings of this quarterly report on Form 10-Q, in June 2012, we settled charges arising from investigations conducted by the United States Attorney’s Office and the Securities and Exchange Commission for a total of $5.8 million. During 2012, we paid $4.1 million of the $5.8 million investigation settlement, with the balance of $1.7 million due in December 2013.

 In addition, we are among the defendants named in class action and derivative lawsuits. In accordance with our by-laws and Delaware law, we have been paying for the costs of defense of these actions for the other named defendants. If liability is ultimately assessed some of the other named defendants may be entitled to claim indemnification from us. We have incurred, and continue to incur significant expenses, primarily for legal counsel, due to the class action and derivative lawsuits. In January, 2013, the parties to the Class Action reached an agreement in principle to settle the Class Action.  Pursuant to a Memorandum of Understanding signed by counsel for the class plaintiffs and by counsel for all defendants, the Company will pay $5.0 million to settle the Class Action. This amount includes damages, plaintiffs’ attorneys’ fees, and costs of administration of the settlement. We expect to pay this settlement with a combination of cash on hand and insurance proceeds. A stipulation of settlement and a joint motion for preliminary approval of the settlement were submitted to the court for its approval on June 14, 2013.  Final settlement of the Class Action is subject to certain conditions and to approval by the court.  We cannot predict if or when the court might approve the settlement. Certain of the defendants may be entitled to indemnification by the Company under the laws of Delaware and/or our by-laws. In addition, we may be entitled to seek the recovery of certain costs and payments from certain former Company employees. On March 5, 2013, the Suffolk County Division of the Supreme Court of the State of New York granted a motion made by all of the defendants in the Derivative Action, except Mr. Lin, and dismissed the Derivative Action as to all defendants other than Mr. Lin. The stockholders have filed a notice of appeal of the dismissal of the Derivative Action.

At various times from October 2001 through February 2009 our Board of Directors authorized the repurchase of up to 14 million shares of our outstanding common stock in the aggregate. We did not repurchase any of our outstanding common stock during each of the three and six months ended June 30, 2013 and 2012. Since October 2001, we have repurchased a total of 8,005,235 shares at an aggregate purchase price of $46.9 million. See Note (7) Stockholders’ Equity to our unaudited condensed consolidated financial statements for further information.

Net cash used in operating activities totaled $6.8 million and $2.5 million for the six months ended June 30, 2013 and June 30, 2012, respectively. The decrease in net cash provided by operating activities during the six months ended June 30, 2013, compared with the same period in 2012, was partially the result of our net loss of $9.6 million compared with a net loss of $9.1 million, respectively, adjusted for: (i) the impact of non-cash charges, particularly relating to stock-based compensation, depreciation, amortization, and provisions for returns and doubtful accounts; and (ii) adjustments for net changes in operating assets and liabilities, primarily changes in our accounts receivable, prepaid expenses, inventory, accounts payable, accrued expenses and deferred revenues.

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Net cash provided by investing activities was $1.0 million and $2.3 million for the six months ended June 30, 2013 and June 30, 2012, respectively. Included in investing activities for the six months ended June 30, 2013 and June 30, 2012, are the sales and purchases of our marketable securities, which include the sales, maturities and reinvestment of our marketable securities. The net cash provided by investing activities from the net sales of securities was $2.7 million for the six months ended June 30, 2013, and $4.5 million for the same period in 2012. These amounts will fluctuate from period to period depending on the maturity dates of our marketable securities. The cash used to purchase property and equipment was $1.1 million for the six months ended June 30, 2013 and $1.6 million for the same period in 2012. The cash used in the capitalization of software development costs was $0.2 million for the six months ended June 30, 2013 and $0.5 million for the same period in 2012. We continually evaluate potential software license purchases and acquisitions, and we may continue to make such investments if we find opportunities that would benefit our business. The cash used for security deposits was $0.3 million for the six months ended June 30, 2013 and less than $0.1 million for the same period in 2012. We anticipate continued capital expenditures, including capitalized software costs, as we continue to invest in our infrastructure and expand and enhance our product offerings.

Net cash provided by financing activities was $0.7 million and $0.6 million for the six months ended June 30, 2013 and June 30, 2012, respectively. Cash inflows from financing activities represent proceeds received from the exercise of stock options.

We currently do not have any debt and our only significant commitments are related to our employment agreement with Gary Quinn, our President and Chief Executive Officer, the $1.7 million remaining settlement payment to the United States Attorney’s Office, which is due in December 2013 and our office leases. In addition, on January 20, 2013, we announced we had reached a proposed settlement of the Class Action lawsuit between the Company and class plaintiffs for $5.0 million which is pending approval by the court. We cannot predict if or when the court might approve the settlement.

On June 28, 2013, the President and Chief Executive Officer, and a Director, of FalconStor Software, Inc. (the “Company”), James P. McNiel, resigned from all of his positions with the Company, effective immediately. The Company also entered into a Severance Agreement and General Release (the “Agreement”), with Mr. McNiel.  Pursuant to the Agreement, among other things, the Company agreed to pay to Mr. McNiel $400,000 in severance pay and to purchase certain office furniture from Mr. McNiel for $20,000. These payments were made in July 2013.

We have an operating lease covering our corporate office facility that expires in April 2021. We also have several operating leases related to offices in the United States and foreign countries. The expiration dates for these leases range from 2013 through 2017. Refer to Note (8) Commitments and Contingencies to our unaudited condensed consolidated financial statements.

In addition, as of June 30, 2013 and December 31, 2012, our liability for uncertain tax positions totaled $2.5 million.

With the cash infusions mentioned above, we believe that our balance of cash, cash equivalents and marketable securities, and expected cash flows from operations, will be sufficient to meet our cash requirements for at least the next twelve months.  However, both the private equity investment and the sale of our Blue Whale investment are subject to various closing conditions, including, with regard to the Blue Whale investment sale, government approvals, and there can be no guarantee that either transaction will close.  If the private equity investment does not close and the Company continues to incur losses, there can be no guarantee that we will have cash, cash equivalents and marketable securities, and expected cash flows from operations, sufficient to meet our needs for the next twelve months.

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Off-Balance Sheet Arrangements

As of June 30, 2013 and December 31, 2012, we had no off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risks. Our cash, cash equivalents and marketable securities aggregated $21.9 million as of June 30, 2013. Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. All of our cash equivalent and marketable securities are designated as available-for-sale and, accordingly, are presented at fair value on our consolidated balance sheets. We regularly assess these risks and have established policies and business practices to manage the market risk of our marketable securities. We generally invest our excess cash in investment grade short- to intermediate-term fixed income securities and AAA-rated money market funds. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, and we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. Due to the short-term nature of the majority of our investments, the already severely suppressed interest rates we currently earn, and the fact that over 60% of our total cash, cash equivalents and marketable securities are comprised of money market funds and cash, we do not believe we are subject to any material interest rate risks on our investment balances levels at June 30, 2013.

Foreign Currency Risk. We have several offices outside the United States. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. For the six months ended June 30, 2013 and 2012, approximately 60% and 58% of our sales were from outside North America. Not all of these transactions were made in foreign currencies. Our primary exposure is to fluctuations in exchange rates for the U.S. Dollar versus the Euro and Japanese Yen, and to a lesser extent the Canadian Dollar, the Korean Won, the New Taiwanese Dollar and the Australian dollar. Changes in exchange rates in the functional currency for each geographic area’s revenues are primarily offset by the related expenses associated with such revenues. However, changes in exchange rates of a particular currency could impact the re-measurement of such balances on our balance sheets.

If foreign currency exchange rates were to change adversely by 10% from the levels at June 30, 2013, the effect on our results before taxes from foreign currency fluctuations on our balance sheet would be approximately $1.2 million. The above analysis disregards the possibility that rates for different foreign currencies can move in opposite directions and that losses from one currency may be offset by gains from another currency.

Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report, and, based on their evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective. No changes in the Company's internal control over financial reporting occurred during the quarter ended June 30, 2013, that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

Disclosure controls and procedures are procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

See the discussion of the Company’s material litigation in Note (10) – Litigation to the unaudited condensed consolidated financial statements, which is incorporated by reference in the Item 1.

Item 1A. Risk Factors

We are affected by risks specific to us as well as factors that affect all businesses operating in a global market. The significant factors known to us that could materially adversely affect our business, financial condition, or operating results are set forth in Item 1A to our Annual Report on Form 10-K for the year ended December 31, 2012 (the “2012 10-K”). The information below sets forth additional risk factors or risk factors that have had material changes since the 2012 10-K, and should be read in conjunction with Item 1A of the 2012 10-K.

We have had sixteen consecutive quarters of losses and there is no guarantee that we will return to profitability.

We have incurred losses in each of the last sixteen quarters. While we have taken steps to try reduce or eliminate the losses – such as reducing headcount and other expenses and trying to replace lost OEM sales with sales of FalconStor-branded products – there is no guarantee that we will be successful and return to profitability. As of June 30, 2013, we had approximately $21.9 million in cash, cash equivalents and marketable securities. If our losses continue we will deplete our available cash and we may not be able to continue to fund effective sales and marketing or research and development activities on which we are dependent.

If we are not able to cut spending and/or increase revenues and/or raise additional capital, we might run out of operating capital.  Raising additional capital could result in the dilution of the percentage ownership of our current stockholders.

At the end of the second quarter of 2013, we had $21.9 million in cash and cash equivalents and marketable securities.  At our current cash burn rate, the amount of cash and cash equivalents and marketable securities will only support our business through part of 2014.  To avoid running out of cash, we are planning on reducing spending and we are attempting to increase our revenues.  In addition, we signed a term sheet for an investment of up to $15 million from a new investor.  We also entered into an agreement to sell of certain cost-based investments that are not part of our strategy going forward.  If we are unsuccessful in any or all of these attempts to reduce spending, to increase revenues, to raise additional investment, or to sell off the cost-based investments, we could run out of operating capital.  In addition, raising capital from new investors will likely result in the dilution of the percentage ownership of our current stockholders and depending on the terms could result in a decrease in the market price of our common stock.

We have terminated Wells Fargo Securities LLC’s engagement as our advisor with regard to potential strategic alternatives to enhance stockholder value.  

We have terminated our retainer of the investment banking firm Wells Fargo Securities, LLC as our exclusive financial advisor to assist us in exploring and evaluating strategic alternatives to maximize stockholder value.  This termination does not mean that we will not continue to explore additional strategic alternatives.  However, there can be no guarantee that we will be able to identify or to enter into any strategic alternative to enhance stockholder value.

We continue to have turnover in our senior management.

On June 28, 2013, James P. McNiel voluntarily resigned his positions as President and Chief Executive Officer of the Company.  Gary Quinn has been named President and Chief Executive Officer.

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In addition to Mr. McNiel’s resignation, since September 29, 2010, we have accepted the resignations of our prior CEO; two CFO’s; our CTO; two VP’s of Sales for North America; our VP of Sales and General Manager for Europe, the Middle East and Africa; our VP of Sales and General Manager of Asia-Pacific; our VP of Global Support; and our VP of Marketing.

We have filled these positions with highly qualified individuals with extensive storage and software company experience. However, there can be no guarantee that the new senior management will be able to get up to speed and successfully manage the Company. In addition, with the exception of Gary Quinn, we have no employment agreements with any of our senior management and there can be no assurance that we will be able to retain any or all of the members of the senior management team.

We have a significant number of outstanding options, the exercise of which would dilute the then-existing stockholders’ percentage ownership of our common stock, and a smaller number of restricted shares of stock, the vesting of which will also dilute the then-existing stockholders’ percentage ownership of our common stock.

As of June 30, 2013, we had outstanding options to purchase 11,200,955 shares of our common stock, and we had an aggregate of 122,620 outstanding restricted shares. If all of these outstanding options were exercised, and all of the outstanding restricted stock vested, the proceeds to the Company would average $4.25 per share. We also had 1,519,323 shares of our common stock reserved for issuance under our stock plans with respect to options (or restricted stock or restricted stock units) that have not been granted. In addition, if, on July 1st of any calendar year in which our 2006 Incentive Stock Plan, as amended (the “2006 Plan”), is in effect, the number of shares of stock to which options, restricted shares and restricted stock units may be granted 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 shall be 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. See Note (2) Share-Based Payment Arrangements to our unaudited condensed consolidated financial statements.

The exercise of all of the outstanding options and/or the vesting of all outstanding restricted shares and restricted stock units and/or the grant and exercise of additional options and/or the grant and vesting of restricted stock and restricted stock units would dilute the then-existing stockholders’ percentage ownership of common stock, and any sales in the public market of the common stock issuable upon such exercise could adversely affect prevailing market prices for the common stock.  Moreover, the terms upon which we would be able to obtain additional equity capital could be adversely affected because the holders of such securities can be expected to exercise or convert them at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable than those provided by such securities.

Our stock price may be volatile.

The market price of our common stock has been volatile in the past and may be volatile in the future. For example, during the past twelve months ended June 30, 2013, the closing market price of our common stock as quoted on the NASDAQ Global Market fluctuated between $1.24 and $2.82. Subsequently to June 30, 2013, the closing market price of our common stock has been as low as $0.95. To the extent the market price of our common stock consistently closes below $1.00 per share, we may be subject to delisting from the NASDAQ Global Market. If our common stock is delisted from the NASDAQ Global Market, it could materially impact the liquidity of our stock or our ability to raise more capital. The market price of our common stock may be significantly affected by the following factors:

· actual or anticipated fluctuations in our operating results;

· the impact of the Deferred Prosecution Agreement and whether we comply with the Deferred Prosecution Agreement;

· the status of the class action and derivative lawsuits;

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· failure to meet financial estimates;

· changes in market valuations of other technology companies, particularly those in the network storage software market;

· announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, strategic alternatives,  joint ventures, licensing arrangements or capital commitments;

· loss of one or more key customers; and

· departures of key personnel.

The stock market has experienced extreme volatility that often has been unrelated to the performance of particular companies. These market fluctuations may cause our stock price to fall regardless of our performance.

Unknown Factors

Additional risks and uncertainties of which we are unaware or which currently we deem immaterial also may become important factors that affect us.

Item 5. Other Information

On August 8, 2013, the Company terminated its retainer of the investment banking firm Wells Fargo Securities, LLC as its exclusive financial advisor to assist the Company in exploring and evaluating strategic alternatives to maximize stockholder value.

On July 23, 2013, the Company’s Board of Directors appointed Gary Quinn the Company’s Chief Executive Officer and President. On July 23, 2013, the Company entered into an employment agreement with Mr. Quinn (the “Employment Agreement”).  Pursuant to the Employment Agreement, Mr. Quinn is employed as the Company’s Chief Executive Officer and President for a term of two years.  Mr. Quinn will receive an annual salary of $400,000 and standard Company benefits.  On August 5, 2013, as called for by the Employment Agreement, Mr. Quinn was granted 500,000 shares of restricted Company common stock.   The restrictions on 250,000 shares of the restricted stock lapse on each of the first two anniversaries of the date of the Employment Agreement.

On August 5, 2013, the Company reached an agreement in principle, and signed a term sheet, for an investment of between $7.5 million and $15.0 million from a private equity group.  The investment will be in the form of redeemable convertible preferred stock. The purchase price of the redeemable convertible preferred stock will be the lesser of the volume weighted average price of the Company’s common stock for the twenty trading days immediately prior to the closing of the transaction and the closing price of the Company’s common tock on August 5, 2013, the date on which the term sheet for the transaction was signed.

On August 7, 2013, the Company signed an Equity Transfer Agreement, to sell its interest in Tianjin Zhongke Blue Whale Information Technologies Co., Ltd. (“Blue Whale”), a Chinese joint venture company, for $3.0 million.  Closing of the sale is subject to the negotiation of definitive documents and certain other conditions, including the approval of the appropriate government entities in China.

On August 8, 2013, the Board of Directors voted to increase the number of Directors of the Company from five to six.

On August 8, 2013, Gary Quinn was elected a Director of the Company.  Mr. Quinn is the Company’s President and Chief Executive Officer.  Additional biographical information regarding Mr. Quinn may be found in the Form 8-K filed by the Company on July 24, 2013.

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Item 6. Exhibits

31.1 Certification of the Chief Executive Officer

31.2 Certification of the Chief Financial Officer

32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350)

32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350)

99.1 Agreement of Lease dated May 30, 2013 by and between Huntington Quadrangle 2, LLC, and FalconStor Software, Inc.

101.1 The following financial statements from FalconStor Software, Inc’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2013, formatted in XBRL (eXtensible Business Reporting Language):

(i) unaudited Condensed Consolidated Balance Sheets – June 30, 2013 and December 31, 2012.

(ii) unaudited Condensed Consolidated Statement of Operations – Three and Six Months Ended June 30, 2013 and 2012.

(iii) unaudited Condensed Consolidated Statement of Comprehensive Loss – Three and Six Months Ended June 30, 2013 and 2012

(iv) unaudited Condensed Consolidated Statement of Cash Flows – Six Months Ended June 30, 2013 and 2012.

(v) Notes to unaudited Condensed Consolidated Financial Statements –June 30, 2013.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	FALCONSTOR SOFTWARE, INC.
	(Registrant)
	/s/ Louis J. Petrucelly
	Louis J. Petrucelly
	Executive Vice President, Chief Financial Officer and Treasurer
	(principal financial and accounting officer)
	/s/ Gary Quinn
	Gary Quinn
	President & Chief Executive Officer
August 9, 2013	(principal executive officer)

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EX-31.1

Exhibit 31.1

I, Gary Quinn, certify that:

1. I have reviewed this quarterly report on Form 10-Q of FalconStor Software, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:   August 9, 2013	/s/ Gary Quinn
	Gary Quinn
	President and Chief Executive Officer
	(principal executive officer)

EX-31.2

Exhibit 31.2

I, Louis J. Petrucelly, certify that:

1. I have reviewed this quarterly report on Form 10-Q of FalconStor Software, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  August 9, 2013	/s/ Louis J. Petrucelly
	Louis J. Petrucelly
	Executive Vice President, Chief Financial Officer and Treasurer
	(principal financial and accounting officer)

EX-32.1

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of FalconStor Software, Inc., a Delaware Corporation (the Company) on Form 10-Q for the period ended June 30, 2013, as filed with the Securities and Exchange Commission on the date hereof (the Form 10-Q), I, Gary Quinn, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant section 906 of the Sarbanes-Oxley Act of 2002, that to the best of our knowledge:

(i)           the Form 10-Q fully complies, in all material respects, with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934; and

(ii)           the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and result of operations of the Company.

/s/ Gary Quinn

Gary Quinn

President and Chief Executive Officer

August 9, 2013

EX-32.2

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of FalconStor Software, Inc., a Delaware Corporation (the Company) on Form 10-Q for the period ended June 30, 2013, as filed with the Securities and Exchange Commission on the date hereof (the Form 10-Q), I, Louis J. Petrucelly, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant section 906 of the Sarbanes-Oxley Act of 2002, that to the best of our knowledge:

(i)           the Form 10-Q fully complies, in all material respects, with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934; and

(ii)           the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and result of operations of the Company.

.

/s/ Louis J. Petrucelly

Louis J. Petrucelly

Executive Vice President, Chief Financial Officer and Treasurer

August 9, 2013

EX-99.1

Exhibit 99.1

AGREEMENT OF LEASE

Made as of this day of May, 2013, by and between HUNTINGTON QUADRANGLE 2, LLC, a New York general partnership having its principal office at 100 Jericho Quadrangle, Jericho, New York 11753, hereinafter referred to as “Landlord” and FALCONSTOR SOFTWARE INC., a Delaware corporation with offices located at 2 Huntington Quadrangle, Suite 2S01, Melville, New York 11747, hereinafter referred to as “Tenant”.

WITNESSETH:                                          Landlord and Tenant hereby covenant and agree as follows:

SPACE

1.         Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord the two spaces consisting of the entire rentable area, including bathrooms, of the second floor south wing known as Suite 2S01, and Suite 1S20, both substantially as shown on the rental plan initialed by the parties and made part hereof as Exhibit 1 in the building known as Two Huntington Quadrangle, Melville, New York 11747 (the “Building”), hereinafter referred to as the “Demised Premises”. The parties agree that for all purposes of this lease the Demised Premises consist of 59,218 rentable square feetirrespective of any disparity between the (i) such figure and any actual measurement of such area, or (ii) the usable area thereof.  Tenant shall also be permitted to use, on a non-exclusive basis, in common with other tenants at the Building, the common facilities of the Building. Such use of such facilities shall be subject to such reasonable rules, regulations and procedures governing the use thereof as Landlord shall from time to time promulgate.

Additionally, Tenant shall be permitted to use portions of the Building as are required in order to interconnect the equipment located in the two suites of the Demised Premises, including cabling, wire and conduit now existing or hereafter installed in order to make such connections and that portion of the common area located on the second (2nd) floor and shown as the crosshatched portion of Exhibit 1 attached hereto and made a part hereof, including the use of the easternmost mechanical room on the 2nd floor (denoted “MR” on attached Exhibit 1) as it is currently being utilized.

Tenant shall also be permitted to use, on a non-exclusive basis, in common with other tenants at the Building, the common facilities of the Building. Such use of such facilities shall be subject to such reasonable rules, regulations and procedures governing the use thereof as Landlord shall from time to time promulgate.

TERM

2.         The term of this lease shall commence on March 1, 2014, hereinafter referred to as the “Term Commencement Date”, and shall terminate on April  30, 2021, hereinafter referred to as the “Expiration Date”, unless earlier terminated or extended as provided herein.

RENT

3.         A.         The base annual rental rate payable by Tenant is as follows:

Lease period			Base Annual Rent
3/1/2014	-	2/28/2015	$1,302,796.00
3/1/2015	-	2/29/2016	$1,341,879.88
3/1/2016	-	2/28/2017	$1,382,136.28
3/1/2017	-	2/28/2018	$1,423,600.36
3/1/2018	-	2/28/2019	$1,466,308.38
3/1/2019	-	2/29/2020	$1,510,297.63
3/1/2020	-	2/28/2021	$1,555,606.56
3/1/2021	-	4/30/2021	$1,602,274.75

In addition to the Base Annual Rent, Tenant shall pay to Landlord the base annual common area electric charge, which, shall be $74,022.50, subject to escalations pursuant to Schedule C-2, (together the “Rent”). Tenant agrees to pay the Rent equal monthly installments in advance, on the first day of each calendar month during the Demised Term at the office of Landlord. Tenant shall pay the rent as above and as hereinafter provided, without any set off or deduction whatsoever.  As used herein, the term “Lease Year” shall mean each consecutive twelve (12) calendar month period, the first such period commencing on the Term Commencement Date and ending on the day immediately preceding the first anniversary of the Term Commencement Date.Provided that Tenant is not in monetary or other material default with the terms of this Lease, beyond any applicable grace, notice, or cure period, no monthly payments of base annual rental shall be due during the second (2nd),thirteenth (13th), and twenty-fifth (25th) calendar months of the Demised Term. Additionally, provided that Tenant is not in monetary or other material default with the terms of this Lease, beyond any applicable grace, notice, or cure period, Tenant will receive a credit against the payment of rent during the twenty- sixth (26th) calendar month, equal to two-thirds (2/3) of the rent payable in said 26th calendar month of the Demised Term.

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B.         (intentionally omitted)

C.         If Tenant shall fail to pay when due any installment of Base Annual Rent, common area electric charge or any payment of additional rent for a period of five (5) days after such installment or payment shall have become due, Tenant shall pay interest on the amount of such installment outstanding at the lesser rate (the “Default Rate”) of (i) four percent (4%) per annum in excess of the prime interest rate of Citibank, N.A., as publicly announced from time to time or, if Citibank, N.A. shall cease to exist or announce such rate, any similar rate designated by Landlord which is publicly announced from time to time by any other bank in the City of New York having combined capital and surplus in excess of One Hundred Million and 00/100 Dollars ($100,000,000) ("Prime Rate"), or (ii) the maximum rate of interest, if any, which Tenant may legally contract to pay, from the date when such installment or payment shall have become due to the date of the payment thereof, and such interest shall be deemed additional rent. In addition, Tenant shall pay to Landlord a late fee in the amount of five percent (5%) of such overdue amount (“Late Fee”) to compensate Landlord for its administrative costs associated with such failure to timely pay. Such fee shall be deemed additional rent and shall be payable immediately upon demand .This provision is in addition to all other rights or remedies available to Landlord for nonpayment of fixed annual rent or additional rent under this lease and at law and in equity.  Notwithstanding the foregoing, Tenant shall be permitted one late payment (not exceeding 10 days after written notice from Landlord) in each 12 month period without obligation to pay the Late Fee.

USE

4.         The Tenant shall use and occupy the Demised Premises for executive and administrative offices, sales, marketing, training, research and development (normally and customarily performed in similarly situated office buildings), for the operation of a data center, and for any other use consistent with the foregoing and permitted by the certificate of occupancy and by law.  In no event shall any research and development include any hazardous activity or affect any other tenants in the Building.  Neither Tenant, its successors, subtenants or assigns shall utilize the Demised Premises to conduct a “boiler room” operation as such term is understood in the securities business or a financial services business that is not a member of the New York Stock Exchange.  The first floor UPS space shall be used exclusively by Tenant and shall be maintained by Tenant at its sole cost and expense.

LANDLORD’S ALTERATIONS FOR TENANT

5.         Landlord, at its expense, will perform the work and make the installations as set forth in Schedule A annexed hereto, which is sometimes herein referred to as the "Landlord's Initial Construction".  Tenant shall not alter, demolish or remove Landlord's Initial Construction, or any part thereof, unless Tenant shall, prior to the commencement thereof, obtain Landlord's written consent thereto, and pay to Landlord a sum, fixed by Landlord, for the restoration thereof. Landlord shall commence, and thereafter diligently pursue, Landlord’s Initial Construction within thirty (30) days after the execution and delivery of this Lease by Landlord and Tenant, and Tenant’s delivery of all information, plans, and specifications necessary for Landlord to perform Landlord’s Initial Construction. Landlord and Tenant will use commercially reasonable efforts to co-operate with each other to facilitate Landlord’s Initial Construction while Tenant occupies the Demised Premises.

Landlord, at its expense, will provide up to $275,000.00, of “Extra Work” as such term is defined in Schedule A. Anything contained in the Schedule A notwithstanding, such $275,000.00 of Extra Work shall be provided by Landlord on the basis of cost plus 8% of such cost and expense for overhead and an additional 5% of the resulting total as a supervisory fee.

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UTILITIES

6.         Landlord, during the hours of 8:00 A.M. to 6:00 P.M. on weekdays and on Saturdays from 9:00 A.M. to 1:00 P.M. (Working Hours), excluding public holidays (as recognized under the New York State General Construction Law), shall furnish the Demised Premises with heat and air-conditioning(excluding supplemental air conditioning) in the respective seasons, furnish elevator service to the Demised Premises and provide the Demised Premises with electricity for lighting and usual office equipment pursuant to Article 8.

During periods other than Working Hours, Landlord will provide and Tenant shall pay for, in addition to electricity used within its Demised Premises, the electricity required by the supplemental roof chiller to provide chilled water for after- hours HVAC purposes.  Said rooftop chiller currently provides water to one fan on the first floor of the Demised Premises and two fans on the second floor of the Demised Premises. The rate to provide chilled water to the first of these fans in order to provide air conditioning is $60 per hour. The rate to provide chilled water to each of the other two fans in order to provide air conditioning is $15 per hour. The rate to provide tepid water to the first of these fans in order to provide heating is $45 per hour. The rate to provide tepid water to each of the other two fans in order to provide heat is $10 per hour.

Tenant shall be solely responsible for the installation, maintenance and operation of any air-conditioning systems to service Tenant’s computer room.  Landlord has installed a submeter in the Demised Premises for the purpose of monitoring and measuring Tenant’s electrical consumption for lighting, convenience outlets, heating, ventilating and air conditioning, and other electrical use within the Demised Premises.  Tenant shall pay to Landlord within thirty (30) days after written notice therefor by Landlord, as additional rent, all charges for such electrical consumption.  Such charges shall be equal to the electricity consumed by Tenant multiplied by 105% of the rates actually charged to Landlord by the applicable utility company for such usage as determined in accordance with paragraph 8 C. below.

LANDLORD'S REPAIRS AND MAINTENANCE

7.         Landlord, at its expense, will make all repairs to and provide the maintenance for the common areas and base systems, sidewalks, parking areas and structure (including the roof and foundation) of the Building as set forth in Schedule B, except such repairs (whether structural or otherwise) and maintenance as may be necessitated by the negligence, improper care or use of such premises and facilities by Tenant, its agents, employees, licensees or invitees, which will be made by Tenant at Tenant's expense as provided in Article 12 hereof. Tenant acknowledges that Landlord shall have no obligation to perform its repair and maintenance obligations hereunder, except during Landlord’s regular working hours, except in the event of an emergency and except for cleaning services, snow removal and other maintenance obligations which are normally performed outside normal business hours.  If Tenant desires Landlord to perform any such repair and maintenance obligations at any hours other than Landlord’s regular working hours, Landlord shall use its reasonable efforts to accommodate Tenant’s request, provided, however, that Tenant shall pay to Landlord, as additional rent, any reasonable overtime charges incurred by Landlord as a result thereof.

Landlord shall maintain the base building fire suppression system serving the Building and the Demised Premises and will complete and pay for any base building fire suppression improvements as may be required by law.   Tenant shall be solely responsible for maintenance, repair and replacement of any supplemental system(s) installed by Tenant or prior tenants including SPHERION.   Tenant shall also be responsible for maintenance and replacement of fire extinguishers required by Tenant’s operations.

SERVICES

8.         A.         Landlord, at its expense, shall furnish hot and cold water for lavatory purposes and chilled potable water for drinking purposes, and tepid water for pantry purposes.

B.         Tenant shall pay for all electricity which is separately metered including lighting, air conditioning, electrical outlets, fan coils, and air handlers serving the Demised Premises in accordance with Article 6.  The building water and hot water for the fan coil units and air handlers are provided by a central plant and the cost to operate this equipment is included in the base rent.  Landlord shall furnish an electrical panel for the Demised Premises, together with a submeter therefore at its sole cost and expense.

C.         Except as expressly otherwise provided herein, Landlord shall not be obligated to furnish to Tenant or the Demised Premises any services or utilities of any kind or nature whatsoever.  Tenant shall make arrangements with, and pay directly to, the public utilities servicing the building for the installation and furnishing of any telephone or other services, which Tenant deems necessary or desirable in connection with its use and occupancy of the Demised Premises.  Tenant agrees that electric current will be supplied by Landlord, and Tenant will pay Landlord, as additional rent for the supplying of electric current to the Demised Premises, the amount as calculated pursuant to the last sentence of Article 6 above. The rates actually charged during any billing period pursuant to which Landlord purchases electricity for the Building shall be determined by dividing the total kw-hrs consumed in the Building during such period into the total amount of Landlord’s electric bill for the Building (including sales tax) for such period.

Page 3

Bills therefor shall be rendered monthly, in arrears, and shall be deemed to be, and shall be paid as, additional rent.  Landlord shall not in any way be liable or responsible to Tenant for any loss or damage or expense which Tenant may sustain or incur if either the quantity or character of electric service is changed or is no longer available for suitable for Tenant’s requirements.  Upon request, Landlord shall provide Tenant with reasonable back-up documentation supporting the charges.

If any tax is imposed upon Landlord’s receipt from the sale or resale of electrical energy to Tenant by any Federal, State or Municipal Authority, Tenant agrees that, where permitted by law, such taxes shall be passed on to, and including in the bill of, and paid by, Tenant to Landlord.  In no event however shall the cost to Tenant for the supply of electric energy be less than the cost to Landlord to supply electric energy to Tenant at the Demised Premises (including any meter, company and other charges to which Landlord is subject).

D.         Landlord, at its expense, shall furnish cleaning services as detailed in Schedule B attached hereto and made a part hereof, to the Demised Premises after business hours.

E.         Landlord shall use commercially reasonable efforts to continue to lease the cafeteria space in the Building.  If the cafeteria ceases to operate, Landlord shall use reasonable efforts to relet the space for similar use.

F.         Landlord represents that there is a back-up electrical generator for the Demised Premises and agrees to provide supplemental air-conditioning to the Demised Premises twenty-four (24) hours a day, seven days a week.  Landlord, at Landlord’s cost, shall maintain, repair, replace and operate the heating and air-conditioning systems and the back- up generator.

PARKING FIELD

9.         Tenant shall have the right to use 237 parking spaces, for the parking of automobiles of the Tenant, its employees and invitees, in the parking area reserved for tenants of the Building (hereinafter sometimes referred to as “Building Parking Area”) subject to the Rules and Regulations now or hereafter adopted by Landlord.  Landlord shall mark an additional five (5) parking spaces in the Building Parking Area as reserved for Tenant as shown on the attached Parking Plan.Tenant shall not use nor permit any of its officers, agents or employees to use any parking area other than the Building Parking Area, nor use in excess of Tenant’s allotted number of spaces therein. Tenant further acknowledges that a violation of the provisions of this Article 9 shall constitute a material breach of the lease, except a violation of the parking rules shall not constitute a material breach of this lease except where such recurrent excessive use exceeds permissible use by 10% or more and adversely affects other tenants at “HQ1” or the Building.

DIRECTORY

10.         Landlord will furnish in the lobby of the Building an electronic directory which will contain listing(s) reasonably requested by Tenant.  There will be a charge of $35.00 for the replacement of listing(s).  Tenant shall have the right to maintain at its own cost and expense its corporate logo in the elevator lobby of the Demised Premises subject to the prior written consent of Landlord not to be unreasonably withheld conditioned or delayed.  Tenant may install and maintain up to four (4) parking banners in the parking area at Tenant’s sole cost and expense.

TAXES

11.       A.         Taxes.  If the Taxes which would be assessable to the Landlord in any escalation year (without taking into consideration any reductions or abatements granted to the Landlord by the taxing authorities by reason of vacancies or other hardships or provisions of law) shall be increased above the Tax Base, then Tenant shall pay to Landlord as additional rent for such escalation year a sum equal to 16.748% (the “Percentage”) of such increases in Taxes. (“Tenant’s Tax Payment” or “Tax Payment”) The Percentage has been computed on the basis of a fraction, the numerator of which is the rentable square foot area of the Demised Premises, and the denominator of which is the total rentable square foot area of the Building. The parties acknowledge and agree that the total rentable square foot area of the building shall be deemed to be 353,590 square feet.  The tax base shall be total Taxes due for the tax year beginning on December 1, 2013 and ending November 30, 2014. (“Base Year Taxes”).  Any refund due to Tenant shall be debited by Tenant’s proportionate share of all legal, experts, administrative and other reasonable costs, fees or expenses incurred in connection with obtaining such reduction.

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The Tax Base does not presently include any abatements and shall not be deemed reduced by virtue of any future abatements for purposes of this Article 11.

B.         Definitions: As used in and for the purposes of this Article 11, the following definition shall apply:

i.         The term “Taxes” shall be deemed to include all real estate taxes and assessments, special or otherwise and sewer rents, upon or with respect to the Building and the land allocated to it including all parking areas (hereinafter called the “Real Property”).  If, due to any change in the method of taxation, any franchise, income, profit, sales, rental use and occupancy, or other tax shall be substituted for, or levied against Landlord or any owner of the Building or the Real Property in lieu of, any real estate taxes, assessments or sewer rents upon or with respect to the Real Property, such tax shall be included in the term Taxes for the purposes of this Article.

ii.          “Taxes” shall not include (i) any succession, transfer, inheritance, capital stock, excise, excess profits, occupancy or rent, gift, estate, foreign ownership or control, payroll or stamp tax of Landlord (unless to the extent that there shall be a governmental substitution of method of taxation), (ii) taxes which are paid by individual tenants (including, by way of example only, occupancy taxes), which shall be the obligation of such tenants as applicable (other than taxes payable under escalation clauses similar to this Article), (iii) any penalties or late charges or interest resulting from a late payment imposed against Landlord with respect to real estate taxes, assessments and the like or taxes of general application as opposed to those applicable only to owners or lessees of real property (provided Tenant is current in its payment of additional rent), or (iv) realty transfer taxes or real property transfer gains taxes (if any) imposed in connection with the sale of or the lease of all or substantially all of the Land or the Building. (v) Any income or franchise tax, unless such income or franchise tax has been substituted for, or levied against Landlord or any owner of the Building or the Real Property in lieu of, any real estate taxes, assessments or sewer rents upon or with respect to the Real Property.

In the event that a tax is instituted which is an income based or similar tax, Tenant’s proportionate share of taxes shall be computed on the basis of the income of the Landlord as if the Building and assets related thereto were the Landlord’s sole asset.

C.         Procedure For Invoicing And Payment Of Additional Rent.

i.         Landlord shall render to Tenant a statement containing a computation of additional rent due under this Article (“Landlord's Statement”) at any time and from time to time as such becomes due.  Within ten (10) days after the rendition of the Landlord's Statement which shows additional rent to be payable, Tenant shall pay to Landlord the amount of such additional rent.  On the first day of each month following rendition of each Landlord's Statement, Tenant shall pay to Landlord, on account of the prospective additional rent, a sum equal to one-twelfth (1/12th) of the annualized additional rent last paid by Tenant.
 

ii.         Following each Landlord's Statement, Tenant shall be debited with any additional rent shown on such Landlord's Statement to be payable, and credited with the aggregate amount paid by Tenant in accordance with the provisions of subsection 11.C.i above on account of the potential additional rent. If there is a credit in Landlord’s Statements at the expiration of the Lease, and Tenant has fully a faithfully complied with all of the terms, conditions, covenants, and provisions of the Lease, then Landlord will refund to Tenant such the amount of such credit.

iii.         The obligations of Landlord and Tenant under the provisions of this Article 11 with respect to any additional rent for any Lease Year shall survive the expiration or any sooner termination of the Demised Term.

iv.         In the event that Tenant challenges the amount of additional rent payable pursuant to this Article 11, then, as a condition precedent to the submission of a dispute as to such amount to judicial review, and pending the determination of any dispute, Tenant shall promptly pay the additional rent as billed by Landlord. After such determination, any adjustment in the disputed amount shall be made within thirty (30) days.

TENANT'S REPAIRS

12.       A.         Except for replacements and repairs to the base Building systems, Tenant shall be responsible for all non-structural replacements and repairs within the Demised Premises.  In furtherance thereof, Tenant shall, throughout the Demised Term, take good care of the Demised Premises and the fixtures and appurtenances therein and, at Tenant's sole cost and expense, make all non-structural repairs thereto, and, as required, non-structural replacements thereof, as and when needed to preserve the same in good working order and condition, reasonable wear and tear, obsolescence and damage from the elements, fire or other casualty, excepted.  Notwith­standing the foregoing, all damage or injury to any part of the Building, or to the fixtures, equipment and appurtenances thereof, whether requiring structural or non-structural repairs, caused by or resulting from carelessness, omission, neglect or improper conduct of Tenant, Tenant's servants, employees, invitees or licensees, shall be repaired promptly by Tenant at its sole cost and expense.  Tenant shall also repair all damage to the Building caused by the moving of Tenant's fixtures, furniture or equipment.  Any repairs or replacements to be made by Tenant shall be made with commercially reasonable diligence, in a commercially good and workmanlike manner and so as not to unreasonably interfere with other tenants’ use and occupancy of the Building. Tenant, at its expense, shall maintain service contracts on its supplemental and computer room HVAC, fire alarm and suppression systems, and UPS system.

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B.         Except as provided in Article 25 hereof, there shall be no allowance to Tenant for a diminution of rental value and no liability on the part of Landlord by reason of inconvenience, annoyance or injury to business arising from Landlord, Tenant or others making any repairs, alterations, additions or improvements in or to any portion of the Building or the Demised Premises, or in or to fixtures, appurtenances, or equipment thereof, and no liability upon Landlord for failure of Landlord or others to make any repairs, alterations, additions or improvements in or to any portion of the Building or of the Demised Premises, or in or to the fixtures, appurtenances or equipment thereof.Any repairs which Tenant is required to carry out pursuant to the terms hereof may, upon prior written notice and reasonable opportunity to cure (except in the case of an emergency or a situation that is affecting other tenants in the Building) at Landlord's option, be made by Landlord at the expense of Tenant, on the basis of cost plus ten (10%) percent of such cost and expense for overhead and an additional eight (8%) percent of the resulting total as a supervisory fee, which shall be collectible as additional rent after the rendition of a bill or statement therefor.  Landlord shall make reasonable efforts, under the circumstances presented, to make any required repairs so as not to unreasonably interfere with Tenant’s business.

FLOOR LOADING

13.         The emplacement of any equipment which will impose an evenly distributed floor load in excess of 50 pounds per square foot shall be done only after written permission is received from the Landlord which shall not be unreasonably withheld, conditioned or delayed.  Such permission will be granted only after adequate proof is furnished by a professional engineer that such floor loading will not endanger the structure.  Landlord agrees  that the installations, fixtures, furniture and computer and office equipment currently operated and existing in the Demised Premises do not presently exceed Landlord’s maximum permitted floor load.

FIXTURES AND INSTALLATIONS

14.         All appurtenances, fixtures, improvements, additions and other property attached to or built into the Demised Premises, whether by Landlord or Tenant or others, and whether at Landlord's expense, or Tenant's expense, or the joint expense of Landlord and Tenant, shall become and remain the property of Landlord, and shall remain upon and be surrendered with the Demised Premises unless Landlord, by notice to Tenant prior to the installation of same notifies Tenant that it requires Tenant, at Tenant’s expense, to remove same at the termination of this lease.  Tenant shall not be required to remove any appurtenances, fixtures, improvements or additions existing in the Demised Premises prior to the Term Commencement Date.  Nothing in this Article shall be construed to prevent Tenant's removal of trade fixtures, furniture or any other personal property of Tenant, but upon removal of any such trade fixtures,furniture or any other personal property from the Demised Premises or upon removal of other installations as may be required by Landlord, Tenant shall immediately and at its expense, repair and restore the Demised Premises to the condition existing prior to installation and repair any damage to the Demised Premises or the Building due to such removal.  All property permitted or required to be removed by Tenant at the end of the Demised Term remaining in the Demised Premises after Tenant's removal shall be deemed abandoned and may, at the election of Landlord, either be retained as Landlord's property or may be removed from the Demised Premises at Tenant's expense.  All the outside walls of the Demised Premises including corridor walls and the outside entrance doors to the Demised Premises, any balconies, terraces or roofs adjacent to the Demised Premises, and any space in the Demised Premises used for shafts, stacks, pipes, conduits, ducts or other building facilities, and the use thereof, as well as access thereto in and through the Demised Premises for the purpose of operation, maintenance, decoration and repair, are expressly reserved to Landlord, and Landlord does not convey any rights to Tenant therein.  Notwithstanding the foregoing, Tenant shall enjoy full right of access to the Demised Premises through the public entrances, public corridors and public areas within the Building and the loading dock area, twenty-four hours a day, seven days a week (except in the event of an emergency required maintenance work or other condition not directly within control of Landlord).

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ALTERATIONS

15.       A.         Tenant shall make no alterations, decorations, installations, additions or improvements in or to the Demised Premises which would require the filing of a building permit or otherwise require approval of a municipal agency without Landlord's prior written consent (which consent shall not be unreasonably withheld, conditioned or delayed), and then only by contractors or mechanics approved by Landlord and at such times and in such manner as Landlord may from time to time designate which approval shall not be unreasonably withheld, conditioned or delayed.  Tenant may make alterations during normal business hours unless to do so would interfere with the quiet enjoyment of other tenants in the Building.   Tenant shall notify Landlord as to when such work will commence, such notice to be given at least five (5) business days prior to the commencement thereof.  Landlord shall have the right to make inspections of any such work being carried out by Tenant or on Tenant's behalf at reasonable times during business hours, upon reasonable notice (except in the case of an emergency) during the progress of such work.  Tenant shall be entitled to have a representative present (except in the case of an emergency).  Anything herein contained to the contrary notwithstanding, the consent requirements and payment of Landlord’s Supervisory Fee set forth in this Article 15A shall not apply to non-structural alterations or other alteration, decorative alterations costing less than $35,000 in the aggregate per project, or painting and carpeting.

B.         All installations or work done by Tenant shall be done in a commercially good and workmanlike manner and shall at all times comply with:

i.         Laws, rules, orders and regulations of governmental authorities having jurisdiction thereof.

ii.         Rules and regulations of Landlord, as promulgated from time to time.

iii.           Plans and specifications prepared by and at the expense of Tenant theretofore submitted to Landlord for its prior written approval which shall not be unreasonably withheld, conditioned or delayed; no installations or work shall be undertaken, started or begun by Tenant, its agents, servants or employees, until Landlord has approved (which shall not be unreasonably withheld, conditioned or delayed) such plans and specifications and shall be subject to Landlord’s supervisory fee charge of five (5%) percent of the total value of the work to be performed; and no amendments or additions to such plans and specifications shall be made without the prior written consent of Landlord (which shall not be unreasonably withheld, conditioned or delayed) and shall be subject to Landlord's supervisory fee charge of five (5%) percent of the total value of work to be performed .  If Landlord performs the alterations for Tenant, Tenant shall not be subject to any supervisory fee.  Standard painting and/or carpeting shall not be subject to the supervisory fee charge. For the purposes hereof, the “total value of the work to be performed” shall not include the material cost of business equipment installed by Tenant.

Tenant agrees that it will not, either directly or indirectly, use, suffer or permit any contractors, sub-contractors and/or labor and/or materials if the use of such contractors and/or labor and/or materials would or will create any difficulty with other contractors and/or labor engaged by Tenant or Landlord or others in the construction, maintenance and/or operation of the Building or any part thereof.  Tenant shall, before making any alterations, additions, installations or improvements, at its expense, obtain all permits, approvals and certificates required by any governmental or quasi-governmental bodies and (upon completion) certificates of final approval thereof and shall deliver promptly duplicates of all such permits, approvals and certificates to Landlord and Tenant agrees to carry and will cause Tenant's contractors and sub-contractors material persons to carry such workmen's compensation, general liability, personal and property damage insurance as Landlord may require.  Tenant agrees to obtain and deliver to Landlord, after the construction and/or alterations have been completed, written and unconditional waivers of mechanic's liens upon the real property in which the Demised Premises are located, for all property in which the Demised Premises are located, for all work, labor and services performed and materials furnished in connection with such work after payment therefor, signed by all contractors, sub-contractors, materialmen and laborers involved in such work.  Notwithstanding the foregoing, if any mechanic's lien is filed against the Demised Premises, or the Building, for work claimed to have been done for, or materials furnished to, Tenant, whether or not done pursuant to this Article the same shall be discharged or bonded (and removed as a lien) by Tenant within thirty (30) days after notice thereof, at Tenant's expense, by filing the bond required by law.  Failure to so discharge or bond any mechanic’s lien shall be a material default under this lease.

C.         Anything contained herein to the contrary notwithstanding, Tenant shall make no alterations, decorations, installations, additions or improvements in or to the Demised Premises which shall in any way affect utility services or plumbing and electrical lines.  Moreover, Landlord shall not be deemed to have acted unreasonably for withholding consent to any alterations, decorations, installations, additions or improvements which: (i) involve or might affect any structural or exterior element of the Building outside the Demised Premises or the Building, or (ii) will require unusual expense to readapt the Demised Premises to normal office use on the expiration of the Demised Term or increase the cost of construction or of insurance or taxes on the Building or of the services called for hereunder unless Tenant first gives assurances acceptable to Landlord for payment of such increased cost and that such re-adaptation will be made prior to the Expiration Date without expense to Landlord.

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REQUIREMENTS OF LAW

16.       A.         Tenant, at Tenant's cost, shall comply with all laws and governmental rules and regulations arising out of or relating to Tenant’s manner of use and occupancy of the interior of Demised Premises.  Notwithstanding the foregoing, as it may relate to the base building only and the existing fire suppression system servicing the Demised Premises, Tenant shall not be liable with respect to the fire suppression system and the repair, replacement and maintenance of such systems shall be performed by Landlord at its sole cost and expense.

B.         (i) Tenant shall not permit any “Hazardous Materials” (as defined below) in the Demised Premises.  The term Hazardous Materials shall mean any biologically or chemically active or other toxic or hazardous wastes, pollutants or substances, including, without limitation, asbestos, PCBs, petroleum products and by-products, and substances defined or listed as “hazardous substances” or “toxic substances” or similarly identified in or pursuant to laws or governmental rules and regulations including, but not limited to the Comprehensive Environmental Response Compensation and Liability Act of 1980 as amended, 42 U.S.C. §9601, et sec., the Hazardous Materials Transportation Act, 49 U.S.C. § 1802, et sec., the Resource Conservation and Recovery Act, 42 U.S.C. §6901, et sec., the Toxic Substance Control Act of 1976, as amended, 15 U.S.C. §2601, et sec., and the Clean Water Act, 33 U.S.C § 446 et sec., as amended.  Landlord represents that it has no knowledge of any Hazardous Materials at the Demised Premises or the Building which are in violation of applicable law. (ii) The foregoing shall not prohibit Tenant’s s use of Hazardous Materials which are contained with cleaning solutions or other office products, or contained within or incorporated into any of Tenant’s business equipment, provided that such use is in compliance with all applicable laws relating to Hazardous Materials.

C.         Tenant shall indemnify, defend and hold harmless Landlord from or against any and all claims, actions or proceedings arising from Tenant’s failure to comply with Article 16.A and/or 16.B and from use of Hazardous Materials in accordance with Article 16.B. (ii), and all costs, expenses and liabilities incurred in connection with any such claim or action or proceeding brought thereon.  Tenant, upon notice from Landlord, agrees that Tenant, at Tenant's expense, will resist or defend such action or proceeding and will employ counsel therefor reasonably satisfactory to Landlord.  Tenant's liability under this lease extends to the acts and omissions of any subtenant, and any agent, contractor, employee, invitee or licensee of Tenant or any subtenant.

D.         Landlord shall indemnify, defend and hold Tenant harmless from or against any and all claims, actions or proceedings arising from Landlord’s breach of its representation contained in the penultimate sentence of Article 16.B and all costs, expenses and liabilities incurred in connection with any such claim or action or proceeding brought thereon.  Landlord, upon notice from Tenant, agrees that Landlord, at Landlord’s expense, will resist or defend such action or proceeding.

END OF TERM

17.       A.         Upon the expiration or other sooner termination of the Demised Term, Tenant shall quit and surrender to Landlord the Demised Premises, broom clean, in good order and condition, ordinary wear and tear excepted, and Tenant shall remove all of its property (excluding such property stated to remain the property of Landlord pursuant to Article 14), and shall repair all damage to the Demised Premises or the Building occasioned by such removal. Any property not removed from the Demised Premises shall be deemed abandoned by Tenant and may be disposed of in any manner deemed appropriate by the Landlord at Tenant’s expense.  Tenant expressly waives, for itself and for any person claiming through or under Tenant, any rights which Tenant or any such person may have under the provisions of Section 2201 of the New York Civil Practice Law and Rules and of any successor law of like import then in force, in connection with any holdover summary proceedings which Landlord may institute to enforce the foregoing provisions of this Article.  Tenant's obligation to observe or perform this covenant shall survive the expiration or other sooner termination of the Demised Term.  If the last day of the Demised Term or any renewal hereof falls on Sunday or a legal holiday, this lease shall expire on the business day immediately preceding.

B.         Tenant acknowledges that possession of the Demised Premises, unless otherwise agreed, must be surrendered to Landlord at the expiration or sooner termination of the Demised Term.  Tenant hereby agrees to indemnify and save Landlord harmless against any and all costs, damages, claims, loss or liability resulting from delay of greater than thirty (30) days by Tenant in so surrendering the Demised Premises, including, without limitation, any claims made by any succeeding tenant, founded on such delay.  The parties recognize and agree that the damage to Landlord resulting from any failure by Tenant timely to surrender possession of the Demised Premises as aforesaid will be extremely substantial, will exceed the amount of monthly rent theretofore payable hereunder, and will be impossible of accurate measurement.  Tenant therefore agrees that if possession of the Demised Premises is not surrendered to Landlord on or before the date of the expiration or other sooner termination of the Demised Term, time being of the essence with respect thereto, then, in addition to any other remedies and/or damages otherwise available to Landlord hereunder or at law, Tenant agrees to pay Landlord, for each month and for each portion of any month during which Tenant holds over in the Demised Premisesa sum equal to two (2) times the rent and additional rent (inclusive of escalations) that was payable per month under this lease during the last month of the term thereof. Tenant shall be responsible for the rent and additional rent payable under this Lease during the first month Tenant holds over after the expiration or sooner termination of this Lease.  Nothing contained herein shall be construed to constitute Landlord's consent to Tenant remaining in possession of the Demised Premises after the expiration or other termination of the Demised Term.  Landlord shall be entitled to pursue any action necessary to recover immediate possession of the Demised Premises notwithstanding Tenant's payment of the aforementioned sum.  The aforesaid provisions of this paragraph shall survive the expiration or sooner termination of the Demised Term.

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QUIET ENJOYMENT

18.       Landlord covenants and agrees with Tenant that upon Tenant paying the rent and additional rent and observing and performing all the terms, covenants and conditions on Tenant's part to be observed and performed, Tenant may peaceably and quietly enjoy the Demised Premises during the Demised Term without hindrance or molestation by anyone claiming by or through Landlord, subject, nevertheless, to the terms, covenants and conditions of this lease including, but not limited to, Article 23.  Tenant acknowledges that Landlord is granting similar quiet enjoyment to other tenants in the Building.  Tenant covenants and agrees not to do, suffer or permit anything that would breach any such similar covenant.

SIGNS

19.       No signs may be put on or in any window nor on the exterior of the Building.  Any signs or lettering in the public corridors or on the doors must be submitted to Landlord for approval before installation, which approval shall not be unreasonably withheld, conditioned or delayed. Tenant shall be permitted to maintain its existing monument sign (and revise the same to reflect and changes in its name or logo).

RULES AND REGULATIONS

20.       Tenant and Tenant's agents, employees, visitors, and licensees shall faithfully comply with the Rules and Regulations set forth on Schedule D annexed hereto and made part hereof, and with such further reasonable Rules and Regulations as Landlord at any time may make and communicate in writing to Tenant which, in the Landlord's judgment, shall be reasonably necessary for the reputation, safety, care or appearance of the Building and land allocated to it or the preservation of good order therein, or the operation or maintenance of the Building, its equipment and such land, or the more useful occupancy or the comfort of the tenants or others in the Building. Landlord shall not be liable to Tenant for the violation of any of said Rules and Regulations, or the breach of any covenant or condition of any lease by any other tenant (including their agents, guests, employees and invitees) in the Building.  Rules and Regulations shall be uniformly applied to the tenants of the Building where possible.

Tenant’s provisions for meals for its employees at times when the cafeteria is closed will not violate the “no catering” provision of the Rules and Regulations.  Tenant shall pay for any incremental extermination costs or other costs directly resulting from such provisions.

The provisions of this Lease shall supersede and control over any contrary or inconsistent rule or regulation promulgated by Landlord after the execution of this Lease. No rule or regulation promulgated after the execution of this Lease shall result in a mandatory payment by Tenant.

ASSIGNMENT AND SUBLETTING

21.       A.         Tenant, for itself, its successors, under-tenants and assigns (all of the foregoing hereinafter referred to as the “Tenant”), expressly covenants that it shall not assign, mortgage or encumber this lease, nor underlet the Demised Premises or any part thereof, or license or permit the Demised Premises or any part thereof to be used by others, without the prior written consent of the Landlord in each instance and upon due compliance with the provisions of this Article 21.  Landlord shall not, unreasonably withhold, condition or delay consent to a sublet request consistent with the terms hereof.   Landlord shall have 30 days after receipt of a written complete application to accept or reject such application.  If the application is not accepted or rejected within said 30 day period, it shall be deemed accepted.

B.         Intentionally deleted.

C.         At the time Tenant requests the approval of Landlord to an assignment or a subletting as hereinafter provided, Tenant shall, by notice as provided in Article 35, advise the Landlord of all the terms, covenants and conditions of the Tenant's proposed sublease or assignment, including providing Landlord with a true, accurate and complete copy of the agreement with the proposed assignee/subtenant.  In the event of a subleasing of 75% or more of the Demised Premises, Tenant shall offer to the Landlord the option: (i) to terminate the lease as of the last day of any calendar month of the term hereof, which day shall be prior to the effective date of such proposed sublease or assignment, and after Landlord’s Acceptance Period (as such phrase is hereinafter defined), and to vacate and surrender the Demised Premises to Landlord; or (ii) to execute a sublease for the said space with the Landlord on the same terms and conditions as are contained in the proposed sublease.  Landlord shall have thirty (30) days after the receipt of such offer, and all the terms, covenants and conditions of the Tenant's proposed sublease or assignment, a true, accurate and complete copy of the agreement with the proposed assignee/subtenant, to accept in writing either or neither of such offers ("Landlord’s Acceptance Period").

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D.         Upon Tenant's due compliance with the aforesaid provisions of this Article 21, and if Landlord shall not accept either of Tenant’s aforesaid offers, Landlord agrees not to unreasonably withhold, condition or delay its consent to an assignment or subletting, provided that the Tenant is not then in default beyond any applicable notice and cure period under this lease and that the proposed assignee or under-tenant is financially responsible, of good reputation and engaged in a business compatible with the business generally carried on in the Building and that the proposed assignment or sublease would not be inconsistent with any agreement previously made with any other tenant or mortgagee, and further provided that such assignee or under-tenant shall execute and deliver to Landlord an assumption agreement wherein it agrees to perform all the obligations of the Tenant under this lease in form appropriate for recording.

E.         No assignment of this lease or underletting of the Demised Premises shall release or discharge the Tenant hereunder from any of its obligations to be performed under this lease.  The consent by Landlord to an assignment or underletting shall not in any way be construed to relieve Tenant from obtaining the express consent in writing of Landlord to any further assignment or underletting.

F.          If Tenant is a corporation, Tenant may assign this lease without Landlord’s consent, to any successor by merger or consolidation, provided (i) that a copy of said assignment, in recordable form, is delivered to the Landlord containing a full assumption by the assignee of all the Tenant’s obligations hereunder and (ii) that such successor shall have had, for each of its prior two (2) fiscal years, a net worth equal to or greater than Tenant’s net worth.  In the event that such successor shall be unable to satisfy the provisions of sub-clause (ii) above, as a condition to such assignment, such successor shall post additional security equal to four (4) months of the then current total base annual rent and additional rent.

G.         Except as expressly otherwise provided in Section 21.F hereof, the following shall be deemed an "assignment" of this lease for the purposes of Article 21:

i.         an assignment of a part interest in this lease;

ii.         one or more sales or transfers, by operation of law or otherwise, or creation of new stock or issuance of additional shares of stock, resulting in a transfer of at least fifty-one (51%) percent of the outstanding stock of Tenant, if Tenant is a corporation, or of any corporate subtenant, except that the transfer of the outstanding capital stock of any corporate tenant, or subtenant, shall be deemed not to include the sale of such stock by persons or parties, through the “over-the-counter market” or through any recognized stock exchange;

For the purposes of this Article 21, a modification, amendment or extension of a sublease shall be deemed a sublease.

H.         If Tenant assigns, sells, conveys, transfers, mortgages, pledges or sublets this lease, the Demised Premises, or any portion thereof in violation of this Article 21, or if the Demised Premises are occupied by anybody other than Tenant, Landlord may collect rent from any assignee, sublessee or anyone who claims a right to this Agreement or letting or who occupies the Demised Premises, and Landlord shall apply the net amount collected to the annual rental herein reserved; and no such collection shall be deemed a waiver by Landlord of the covenants contained in this Article nor an acceptance by Landlord of any such assignee, sublessee, claimant or occupant as Tenant, nor a release of Tenant from the further performance by Tenant of the covenants contained herein.

I.         Tenant shall pay to Landlord, as additional rent, the sum of $2,500 to cover cost of Landlord's attorneys' fees and administration costs in connection with any consent to subletting or assignment pursuant to this Article 21.

ACCESS TO PREMISES

22.       A.         (i) Landlord or Landlord's agents shall have the right to enter and/or pass through the Demised Premises at all times to examine the same, to show them to mortgagees, ground lessors, prospective purchasers or lessees or mortgagees of the Building, adjusters or any other persons, and to make such repairs, improvements or additions as Landlord may deem necessary or desirable and Landlord shall be allowed to take all material into and upon and/or through said Demised Premises that may be required therefor.  (ii) During the one (1) year prior to the expiration of the Demised Term, or any renewal term, Landlord may exhibit the Demised Premises to prospective tenants or purchasers.. Landlord’s access to the Demised Premises, pursuant to Articles 22.A. i. and 22.A.ii. above, shall be at reasonable times and upon reasonable notice, and without unreasonably interfering with Tenant's business except in cases of emergency or necessary repairs.  If Tenant shall not be personally present to open and permit an entry into said premises, at any time, when for any reason an entry therein shall be necessary or permissible, Landlord or Landlord's agents may enter the same by a master key, without rendering Landlord or such agent liable therefor (if during such entry Landlord or Landlord's agents shall accord reasonable care to Tenant's property).  Landlord shall use reasonable efforts to comply with Tenant’s security procedures (except in the case of an emergency).

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If during the last month of the Demised Term, Tenant shall have removed all or substantially all of Tenant's property there from, Landlord may immediately enter, alter, renovate or redecorate the Demised Premises without limitation or abatement of rent, or incurring liability to Tenant for any compensation and such act shall have no effect on this lease or Tenant's obligations hereunder, except that Landlord will indemnify Tenant from any loss, damage or liability arising out of Landlord’s entry, alterations, renovations, or redecorations.

Landlord has provided Tenant with building access cards.  Landlord shall provide Tenant with additional building access cards at a charge of $25.00 per card.

B.         Landlord shall also have the right at any reasonable time to use, maintain and replace pipes and conduits in and through the Demised Premises and to erect new pipes and conduits therein provided they are placed within the walls or above the ceilings, to change the arrangement and/or location of entrances or passageways, doors and doorways, and corridors, elevators, stairs, toilets or other public parts of the Building, provided, however, that Landlord shall make no change in the arrangement and/or location of entrances or passageways or other public parts of the Building which will adversely affect in any material manner Tenant's use and enjoyment of the Demised Premises unless required by law or governmental authority.  Landlord shall also have the right, at any time, to name the Building, to display appropriate signs and/or lettering on any or all entrances to the Building, and to change the name, number or designation by which the Building is commonly known, provided it is not the name of any of Tenant’s competitors.

 C.         Neither this lease nor any use by Tenant shall give Tenant any right or easement to the use of any door or passage or concourse connecting with any other building or to any public conveniences, and the use of such doors and passages and concourse and of such conveniences may be regulated and/or discontinued at any time and from time to time by Landlord without notice to Tenant.

D.         The exercise by Landlord or its agents of any right reserved to Landlord in this Article shall not constitute an actual or constructive eviction, in whole or in part, or entitle Tenant to any abatement or diminution of rent, or relieve Tenant from any of its obligations under this lease, or impose any liability upon Landlord, or its agents, or upon any lessor under any ground or underlying lease, by reason of inconvenience or annoyance to Tenant, or injury to or interruption of Tenant's business, or otherwise.

E.         Tenant shall have the right of access to the Demised Premises at all times except in the case of an emergency or other circumstances beyond the control of Landlord.

F.         With the Landlord’s prior written consent which shall not be unreasonably withheld, conditioned or delayed, Tenant shall have the right to utilize the 8 foot “pop-out” window for moving equipment in and out of the Demised Premises provided that all such work is performed by Landlord’s contractors at Tenant’s cost and expense.

SUBORDINATION

23.       A.         This lease is subject and subordinate in all respects to all ground leases and/or underlying leases and to all mortgages which may now or hereafter be placed on or affect such leases and/or the real property of which the Demised Premises form a part, or any part or parts of such real property, and/or Landlord's interest or estate therein, and to each advance made and/or hereafter to be made under any such mortgages, and to all renewals, modifications, consolidations, replacements and extensions thereof and all substitutions therefor.  This subsection a. shall be self-operative and no further instrument of subordination shall be required.  In confirmation of such subordination, Tenant shall execute and deliver promptly any certificate reasonably satisfactory to Landlord’s lender from time to time that Landlord and/or any mortgagee and/or the lessor under any ground or underlying lease and/or their respective successors in interest may request.

B.         Without limitation of any of the provisions of this lease, in the event that any mortgagee or its assigns shall succeed to the interest of Landlord or of any successor-Landlord and/or shall have become lessee under a new ground or underlying lease, then, at the option of such mortgagee, this lease shall nevertheless continue in full force and effect and Tenant shall and does hereby agree to attorn to such mortgagee or its assigns and to recognize such mortgagee or its respective assigns as its Landlord.

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C.         Tenant shall, at any time and from time to time upon not less than ten (10) days' prior notice by Landlord, execute, acknowledge and deliver to Landlord a statement in writing certifying that this lease is unmodified and in full force and effect (or if there have been modifications, that the same is in full force and effect as modified and stating the modifications), and the dates to which the rent, additional rent and other charges have been paid in advance, if any, and stating whether or not to the best knowledge of the signer of such certificate Landlord is in default in performance of any covenant, agreement, term, provision or condition contained in this lease and, if so, specifying each such default of which the signer may have knowledge, it being intended that any such statement delivered pursuant hereto may be relied upon by any prospective purchaser or lessee of said real property or any interest or estate therein, any mortgagee or prospective mortgagee thereof or any prospective assignee of any mortgage thereof.  If, in connection with obtaining financing or refinancing for the Building and the land allocated to it, a banking, insurance or other recognized institutional lender shall request reasonable modifications in this lease as a condition to such financing, Tenant will not unreasonably withhold, delay or defer its consent thereto, provided that such modifications do not increase the obligations of Tenant hereunder or materially adversely affect the leasehold interest hereby created.  Failure by Tenant to comply with this Article 23.C shall be a material default under this lease.

D.         Landlord shall use commercially-reasonable efforts to obtain an agreement (a “Non-Disturbance Agreement”) from the holder of any mortgage now encumbering the Building, in the usual form of such holder, in favor of Tenant, providing in substance that so long as Tenant is not in default under the terms of this lease beyond any applicable notice and cure periods, the right of possession of Tenant to the demised premises shall not be affected or disturbed by such holder in the exercise of any of its rights under the mortgage or any note secured thereby, and any sale of the Building pursuant to the exercise of any rights and remedies under the mortgage or otherwise shall be made subject to Tenant’s right of possession under this lease; and Landlord shall use commercially-reasonable efforts to obtain a Non-Disturbance Agreement in such usual form from the holder of any mortgage hereafter encumbering the Building.  Such efforts hereunder shall be limited to making a written request to each such holder for such Non-Disturbance Agreement.  Landlord shall incur no liability, nor shall this lease or the obligations of Tenant hereunder be affected in any manner, in the event Landlord shall be unable to obtain a Non-Disturbance Agreement from the holder of any mortgage in favor of Tenant.  Furthermore, Landlord shall not be required to incur any expense or to pay any consideration or to commence any action or proceeding in order to obtain any Non-Disturbance Agreement in favor of Tenant.

E.         Landlord represents that as of the date of this Lease, there is no ground leases affecting the Building, and the only mortgage in effect with respect to the Building is held by the Variable Life Insurance Company.

PROPERTY LOSS, DAMAGE, REIMBURSEMENT

24.       A.         Loss or Damage.  Landlord or its agents shall not be liable for any damage to property of Tenant or of others entrusted to employees of the Building, nor for the loss of or damage to any property of Tenant by theft or otherwise. Landlord or its agents shall not be liable for any injury or damage to persons or property resulting from fire, explosion, falling plaster, steam, gas, electricity, electrical disturbance, water, rain or snow or leaks from any part of the Building or from the pipes, appliances or plumbing works or from the roof, street or subsurface or from any other place or by dampness or by any other cause of whatsoever nature, unless caused by or due to the negligence of Landlord, its agents, servants or employees; nor shall Landlord or its agents be liable for any such damage caused by other tenants or persons in the Building or caused by operations in construction of any private, public or quasi public work; nor shall Landlord be liable for any latent defect in the Demised Premises or in the Building.  If at any time any windows of the Demised Premises are temporarily closed or darkened incident to or for the purpose of repairs, replacements, maintenance and/or cleaning in, on, to or about the Building or any part or parts thereof, Landlord shall not be liable for any damage Tenant may sustain thereby and Tenant shall not be entitled to any compensation therefor nor abatement of rent nor shall the same release Tenant from its obligations hereunder nor constitute an eviction.  Tenant shall reimburse and compensate Landlord as additional rent for all expenditures made by, or damages or fines sustained or incurred by Landlord due to non-performance or non-compliance with or breach or failure to observe any term, covenant or condition of this lease upon Tenant's part to be kept, observed, performed or complied with provided notice such breach or failure is beyond any applicable notice and cure period.  Tenant shall give immediate notice to Landlord in case of fire or accidents in the Demised Premises or in the Building or of defects therein or in any fixtures or equipment.

         In the event that Tenant requests permission to self-insure pursuant to Article 39.E hereof, and Landlord consents thereto, then, in such an event, to the fullest extent permitted by law, Tenant shall have the responsibility for any and all losses or damages resulting therefrom. Tenant hereby expressly agrees to indemnify, defend, and hold Landlord, its principals, directors, officers, employees, agents, subsidiaries and other affiliated entities, free and harmless from and against any loss, liability, expense, claim, cost, suit and damage, directly or indirectly arising out of or relating to Tenant's obligations or performance hereunder.

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B.         Tenant’s Indemnity.  Tenant shall indemnify and save harmless Landlord against and from any and all claims by and on behalf of any person or persons, firm or firms, corporation or corporations arising from the conduct or management of or from any work or thing whatsoever done (other than by Landlord or its contractors or the agents or employees of either) in and on the Demised Premises during the Demised Term and during the period of time, if any,  prior to the Term Commencement Date that Tenant may have been given access to the Demised Premises for the purpose of making installations, and will further indemnify and save harmless Landlord against and from any and all claims arising from any condition of the Demised Premises due to or arising from any act or omission or negligence of Tenant or any of its agents, contractors, servants, employees, licensees or invitees, and against and from all reasonable costs, expenses and liabilities incurred in connection with any such claim or claims or action or proceeding brought thereon; and in case any action or proceeding be brought against Landlord by reason of any such claim, Tenant, upon reasonable notice from Landlord, agrees that Tenant, at Tenant's expense, will resist or defend such action or proceeding and will employ counsel therefor reasonably satisfactory to Landlord.  Tenant's liability under this lease extends to the acts and omissions of any subtenant, and any agent, contractor, employee, invitee or licensee of any subtenant.

C.         Landlord’s Indemnity.  Landlord shall indemnify and save harmless Tenant against and from any and all claims by and on behalf of any person or persons, firm or firms, corporation or corporations arising from the conduct or management of or from any work or thing whatsoever done (other than by Tenant or its contractors or the agents or employees of either) in and on the common areas of the Building during the Demised Term due to or arising from any act or omission or negligence of Landlord and against and from all costs, expenses and liabilities incurred in connection with any such claim or claims or action or proceeding brought thereon; and in case any action or proceeding be brought against Tenant by reason of any such claim, Landlord, upon notice from Tenant, agrees that Landlord, at Landlord's expense, will resist or defend such action or proceeding and will employ counsel therefore.

DESTRUCTION-FIRE OR OTHER CASUALTY

25.       A.         If the Demised Premises shall be damaged by fire or other casualty and if Tenant shall give prompt notice to Landlord of such damage, Landlord, at Landlord's expense, shall repair such damage.  However, Landlord shall have no obligation to repair any damage to, or to replace, Tenant's personal property or any other property or effects of Tenant, including (without limitation) furnishings and equipment of Tenant or its employees, agents and clients.  If the Demised Premises shall be rendered untenantable, not due to Tenant’s acts or omissions, and by reason of any such damage, and Tenant no longer occupies the Demised Premises, the rent shall abate for the period from the date of such damage to the date when the restoration of such damage shall have been substantially completed; and if only a portion of the Demised Premises (less than 50%) shall be so rendered untenantable (“Insubstantial Casualty”) and Tenant no longer occupies such untenantable portion, the rent shall abate for such period in the proportion which the area of the part of the Demised Premises so rendered untenantable bears to the total area of the Demised Premises.  With respect to such Insubstantial Casualty in the event that Landlord shall not substantially complete the restoration of the Demised Premises required on account of such casualty within 12 months from the casualty, Tenant shall have the right to terminate the Leaase upon 30 days written notice to Landlord.  Notwithstanding the foregoing, if the raised floor area-server room or the telecommunication room are damaged by fire or other casualty, Tenant shall have same rights as if  there was a Substantial Casualty to the Demised Premises were rendered substantially untenantable. Within sixty (60) days of the date of such fire or other casualty, Landlord shall furnish Tenant with the opinion of a reputable independent architect or contractor reasonably satisfactory to Landlord and Tenant specifying the time necessary to substantially restore the building and/or the Demised Premises to its condition existing prior to the fire or other casualty.  If (i) (a) fifty (50%) percent or more of the Demised Premises are damaged or rendered untenantable by fire or other casualty (“Substantial Casualty”), and (b) in the opinion of the architect or contractor the building and/or the Demised Premises cannot be restored to its condition existing prior to the fire or other casualty within one hundred eighty (180) days of the fire or other casualty (whether or not any specified percentage of the Demised Premises are damaged or rendered untenantable) or (ii) the Demised Premises are damaged or rendered untenantable by fire or other casualty at any time during the last twelve (12) months of the term (whether or not any specified percentage of the Demised Premises are damaged or rendered untenantable), then, provided Tenant was not responsible for the casualty, Tenant shall have the right to terminate this lease by notice given within sixty (60) days of the date of such fire or other casualty or within thirty (30) days of the date the architect's opinion was given or was required to have been given pursuant to the above, as the case may be, such termination having the same force and effect as if the date of such termination were the date set forth above for the expiration of the term of this lease.  In addition, if Tenant does not so elect to terminate this lease and if the Demised Premises, the common areas of the building and the systems serving the Demised Premises shall not be restored to their condition existing prior to the fire or other casualty within one hundred eighty (180) days of the date of the fire or other casualty, then Tenant may at any time thereafter, until such restoration is completed, terminate this lease by written notice to Landlord with the same force and effect as if the date of termination were the date set forth above for the expiration of the term of this lease.

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B.         If the entire Demised Premises shall be rendered untenantable by reason of any such damage, and Tenant shall have ceased to occupy the Demised Premises, the rent shall abate for the period from the date of such damage to the date which is five (5) days following the date upon which Landlord shall give notice to Tenant stating that such damage shall have been repaired, and if only a part of the Demised Premises shall be so rendered untenantable, and Tenant shall have ceased to occupy the Demised Premises, the rent shall abate for such period in the proportion which the area of the part of the Demised Premises so rendered untenantable bears to the total area of the Demised Premises.  However, if prior to the date when all of such damage shall have been repaired any part of the Demised Premises so damaged shall be rendered tenantable and shall be used or occupied by Tenant or any person or persons claiming through or under Tenant, then the amount by which the rent shall abate shall be equitably apportioned for the period from the date of any such use or occupancy to the date when all such damage shall have been repaired.  Tenant hereby expressly waives the provisions of Section 227 of the New York Real Property Law, and of any successor law of like import then in force, and Tenant agrees that the provisions of this Article shall govern and control in lieu thereof.  Notwithstanding the foregoing provisions of this Article, if, prior to or during the Demised Term, (i) the Demised Premises shall be totally damaged or rendered wholly untenantable by fire or other casualty, and if Landlord shall decide not to restore the Demised Premises, or (ii) the Building shall be so damaged by fire or other casualty that, in Landlord's opinion, substantial alteration, demolition, or reconstruction of  the Building shall be required (whether or not the Demised Premises shall be damaged or rendered untenantable), then, in any of such events, Landlord at Landlord's option, may give to Tenant, within sixty (60) days after such fire or other casualty, a thirty (30) days' notice of termination of this lease and, in the event such notice is given, this lease and the Demised Term shall come to an end and expire (whether or not said term shall have commenced) upon the expiration of said thirty (30) days with the same effect as if the date of expiration of said thirty (30) days were the Expiration Date, the rent shall be apportioned as of such date and any prepaid portion of rent for any period after such date shall be refunded by Landlord to Tenant.

SUBROGATION

26.       Each of the parties hereto and their successors or assigns hereby waives any and all rights of action for negligence against the other party hereto which may hereafter arise for damage to the Demised Premises or to property therein resulting from any fire or other casualty of the kind covered by standard fire insurance policies with extended coverage, regardless of whether or not, or in what amounts, such insurance is now or hereafter carried by the parties hereto, or either of them.  The foregoing release and waiver shall be in force only if both releasors' insurance policies contain a clause providing that such a release or waiver shall not invalidate the insurance and also provided that such a policy can be obtained without additional premiums. Both parties agree to use their best efforts to obtain and maintain a waiver of subrogation from their respective carriers if they are insured.

EMINENT DOMAIN

27.       A.         In the event that the whole or a substantial portion of the Demised Premises or more than 25% of the parking area of the Building shall be lawfully condemned or taken in any manner for any public or quasi-public use, this lease and the Demised Term and estate hereby granted shall forthwith cease and terminate as of the date of vesting of title.  In the event that only one part of the Demised Premises shall be so condemned or taken, then, effective as of the date of vesting of title, the rent hereunder shall be abated in an amount thereof apportioned according to the area of the Demised Premises so condemned or taken.  In the event that only a part of the Building shall be so condemned or taken, then (i) Landlord (whether or not the Demised Premises be affected) may, at its option, terminate this lease and the term and estate hereby granted as of the date of such vesting of title by notifying Tenant in writing of such termination within 60 days following the date on which Landlord shall have received notice of vesting of title, and (ii) if such condemnation or taking shall be of a substantial part of the Demised Premises or of a substantial part of the means of access thereto, Tenant shall have the right, by delivery of notice in writing to Landlord within 60 days following the date on which Tenant shall have received notice of vesting of title, to terminate this lease and the term and estate hereby granted as of the date of vesting of title or (iii) if neither Landlord nor Tenant elects to terminate this lease, as aforesaid, this lease shall be and remain unaffected by such condemnation or taking, except that the rent shall be abated to the extent, if any, hereinabove provided in this Article 27.  In the event that only a part of the Demised Premises shall be so condemned or taken and this lease and the term and estate hereby granted are not terminated as hereinbefore provided, Landlord will, at its expense, restore the remaining portion of the Demised Premises as nearly as practicable to the same condition as it was in prior to such condemnation or taking.

B.         In the event of a termination in any of the cases hereinabove provided, this lease and the term and estate granted shall expire as of the date of such termination with the same effect as if that were the date hereinbefore set for the expiration of the Demised Term, and the rent hereunder shall be apportioned as of such date.

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C.         In the event of any condemnation or taking hereinabove mentioned of all or a part of the Building, Landlord shall be entitled to receive the entire award in the condemnation proceeding, including any award made for the value of the estate vested by this lease in Tenant, and Tenant hereby expressly assigns to Landlord any and all right, title and interest of Tenant now or hereafter arising in or to any such award or any part thereof, and Tenant shall be entitled to receive no part of such award, except that the Tenant may file a claim for any taking of removable fixtures owned by Tenant and for moving expenses incurred by Tenant.

It is expressly understood and agreed that the provisions of this Article 27 shall not be applicable to any condemnation or taking for governmental occupancy for a limited period.

CERTIFICATE OF OCCUPANCY

28.       Tenant will not at any time use or occupy the Demised Premises in violation of the certificate of occupancy (temporary or permanent) issued for the Building or portion thereof of which the Demised Premises form a part.  Landlord represents that the Tenant’s use of the Demised Premises, pursuant to Article 4, is not in violation of the certificate of occupancy.  A copy of the certificate of occupancy is attached hereto as Exhibit 5 and made a part hereof.

DEFAULT

29.       A.         Upon the occurrence at any time prior to or during the Demised Term, of any one or more of the following events (referred to as “Events of Default”):

i.         if Tenant shall default in the payment when due of any installment of rent or in the payment when due of any additional rent, and such default shall continue for a period of ten (10) days after notice by Landlord to Tenant of such default; or

ii.        if Tenant shall default in the observance or performance of any term, covenant or condition of this lease on Tenant's part to be observed or performed (other than the covenants for the payment of rent and additional rent) and Tenant shall fail to remedy such default within ten (10) days after notice by Landlord to Tenant of such default, or if such default is of such a nature that it cannot be completely remedied within said period of ten (10) days and Tenant shall not commence within said period of ten (10) days, or shall not thereafter diligently prosecute to completion, all steps necessary to remedy such default; or

iii.       if Tenant or Tenant's guarantor hereunder (if any) shall file a voluntary petition in bankruptcy or insolvency, or shall be adjudicated a bankrupt or become insolvent, or shall file any petition or answer seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under the present or any future federal bankruptcy act or any other present or future applicable federal, state or other statute or law, or shall make an assignment for the benefit of creditors or shall seek or consent to or acquiesce in the appointment of any trustee, receiver or liquidator of Tenant or of all or any part of Tenant's property; or

iv.      if, within thirty (30) days after the commencement of any proceeding against Tenant, whether by the filing of a petition or otherwise, seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under the present or any future federal bankruptcy act or other present or future applicable federal, state or other statute or law, such proceeding shall not have been dismissed, or if, within thirty (30) days after the appointment of any trustee, receiver or liquidator of Tenant, or of all or any part of Tenant's property, without the consent or acquiescence of Tenant, such appointment shall not have been vacated or otherwise discharged, or if any execution or attachment shall be issued against Tenant or any of Tenant's property pursuant to which the Demised Premises shall be taken or occupied or attempted to be taken or occupied; or

v.        if Tenant shall default in the observance or performance of any term, covenant or condition on Tenant's part to be observed or performed under any other lease with Landlord of space in the Building and such default shall continue beyond any applicable notice and grace period set forth in such other lease for the remedying of such default; or

vi.       Intentionally Deleted; or

vii.      if Tenant's interest in this lease shall devolve upon or pass to any person, whether by operation of law or otherwise, except as expressly permitted under Article 21; then, upon the occurrence, at any time prior to or during the Demised Term, of any one or more of such Events of Default, Landlord, at any time thereafter, at Landlord's option, may give to Tenant a ten (10) days' notice of termination of this lease and, in the event such notice is given, this lease and the Demised Term shall come to an end and expire (whether or not said term shall have commenced) upon the expiration of said ten (10) days with the same effect as if the date of expiration of said ten (10) days were the Expiration Date, but Tenant shall remain liable for damages as provided in Article 30.

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B.         If, at any time, (i) Tenant shall be comprised of two (2) or more persons, or (ii) Tenant's obligations under this lease shall have been guaranteed by any person other than Tenant, or (iii) Tenant's interest in this lease shall have been assigned, the word “Tenant”, as used in subsection (iii) and (iv) of Article 29.A, shall be deemed to mean any one or more of the persons primarily or secondarily liable for Tenant's obligations under this lease.  Any monies received by Landlord from or on behalf of Tenant during the pendency of any proceeding of the types referred to in said subsections (iii) and (iv) shall be deemed paid as compensation for the use and occupation of the Demised Premises and the acceptance of any such compensation by Landlord shall not be deemed an acceptance of rent or a waiver on the part of Landlord of any rights under Article 29.A.

REMEDIES

30.       A.         If Tenant shall default in the payment when due of any installment of rent or in the payment when due of any additional rent and such default shall continue for a period of five (5) days after notice by Landlord to Tenant of such default, or if this lease and the Demised Term shall expire and come to an end as provided in Article 29:

i.         Landlord and its agents and servants may immediately, or at any time after such default or after the date upon which this lease and the Demised Term shall expire and come to an end, re-enter the Demised Premises or any part thereof, without notice, either by summary proceedings or by any other applicable action or proceeding, and may repossess the Demised Premises and dispossess Tenant and any other persons from the Demised Premises and remove any and all of their property and effects from the Demised Premises; and

ii.         Landlord, at Landlord's option, may relet the whole or any part or parts of the Demised Premises from time to time, either in the name of Landlord or otherwise, to such tenant or tenants, for such term or terms ending before, on or after the Expiration Date, at such rental or rentals and upon such other conditions, which may include concessions and free rent periods, as Landlord, in its sole reasonable discretion, may determine.  Landlord shall have no obligation to relet the Demised Premises or any part thereof and shall in no event be liable for refusal or failure to relet the Demised Premises or any part thereof, or, in the event of any such reletting, for refusal or failure to collect any rent due upon any such reletting, and no such refusal or failure shall operate to relieve Tenant of any liability under this lease or otherwise to affect any such liability.  Landlord, at Landlord's option, may make such repairs, replacements, alterations, additions, improvements, decorations and other physical changes in and to the Demised Premises as Landlord, in its sole reasonable discretion, considers commercially advisable or necessary in connection with any such reletting or proposed reletting, without relieving Tenant of any liability under this lease or otherwise affecting any such liability.

B.         Tenant, on its own behalf and on behalf of all persons claiming through or under Tenant, including all creditors, does hereby waive any and all rights which Tenant and all such persons might otherwise have under any present or future law to redeem the Demised Premises, or to re-enter or repossess the Demised Premises, or to restore the operation of this lease, after (i) Tenant shall have been dispossessed by a judgment or by warrant of any court or judge, or (ii) any re-entry by Landlord, or (iii) any expiration or termination of this lease and the Demised Term, whether such dispossess, re-entry, expiration or termination shall be by operation of law or pursuant to the provisions of this lease.  In the event of a breach or threatened breach by Tenant, or any persons claiming through or under Tenant, of any term, covenant or condition of this lease on Tenant's part to be observed or performed, Landlord shall have the right to enjoin such breach and the right to invoke any other remedy allowed by law or in equity as if re-entry, summary proceedings and other special remedies were not provided in this lease for such breach. The rights to invoke the remedies hereinbefore set forth are cumulative and shall not preclude Landlord from invoking any other remedy allowed at law or in equity.

DAMAGES

31.       A.         If this lease and the Demised Term shall expire and come to an end as provided in Article 29 or by or under any summary proceeding or any other action or proceeding, or if Landlord shall re-enter the Demised Premises as provided in Article 30 or by or under any summary proceeding or any other action or proceeding, then, in any of said events:

i.         Tenant shall pay to Landlord all rent, additional rent and other charges payable under this lease by Tenant to Landlord to the date upon which this lease and the Demised Term shall have expired and come to an end or to the date of re-entry upon the Demised Premises by Landlord, as the case may be; and

ii.         Tenant shall also be liable for and shall pay to Landlord, as damages, any deficiency (referred to as “Deficiency”) between the rent and additional rent reserved in this lease for the period which otherwise would have constituted the unexpired portion of the Demised Term and the net amount, if any, of rents collected under any reletting effected pursuant to the provisions of Section 30.A for any part of such period (first deducting from the rents collected under any such reletting all of Landlord's expenses in connection with the termination of this lease or Landlord's re-entry upon the Demised Premises and such reletting including, but not limited to, all repossession costs, brokerage commissions, legal expenses, attorney's fees, alteration costs and other expenses of preparing the Demised Premises for such reletting).  Any such Deficiency shall be paid in monthly installments by Tenant on the days specified in this lease for payment of installments of rent.  Landlord shall be entitled to recover from Tenant each monthly Deficiency as the same shall arise, and no suit to collect the amount of the Deficiency for any month shall prejudice Landlord's right to collect the Deficiency for any subsequent month by a similar proceeding; and

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iii.         At any time after the Demised Term shall have expired and come to an end or Landlord shall have re-entered upon the Demised Premises, as the case may be, whether or not Landlord shall have collected any monthly Deficiencies as aforesaid, Landlord shall be entitled to recover from Tenant, and Tenant shall pay to Landlord, on demand, as and for liquidated and agreed final damages, a sum equal to the amount by which the rent and additional rent reserved in this lease for the period which otherwise would have constituted the unexpired portion of the Demised Term exceeds the then fair and reasonable rental value of the Demised Premises for the same period, both discounted to present worth at the rate of the prime rate in effect at the time.  If, before presentation of proof of such liquidated damages to any court, commission or tribunal, the Demised Premises, or any part thereof, shall have been relet by Landlord for the period which otherwise would have constituted the unexpired portion of the Demised Term, or any part thereof, the amount of rent reserved upon such reletting shall be deemed, prima facie, to be the fair and reasonable rental value for the part or the whole of the Demised Premises so relet during the term of the reletting.

B.         If the Demised Premises, or any part thereof, shall be relet together with other space in the Building, the rents collected or reserved under any such reletting and the expenses of any such reletting shall be equitably apportioned for the purposes of this Article 31.  Tenant shall in no event be entitled to any rents collected or payable under any reletting, whether or not such rents shall exceed the rent reserved in this lease.  Solely for the purposes of this Article, the term rent as used in Article 31.A shall mean the rent in effect immediately prior to the date upon which this lease and the Demised Term shall have expired and come to an end, or the date of re-entry upon the Demised Premises by Landlord, as the case may be, plus any additional rent payable pursuant to the provisions of Article 11 for the Lease Year immediately preceding such event.  Nothing contained in Articles 29 and 30 or this Article shall be deemed to limit or preclude the recovery by Landlord from Tenant of the maximum amount allowed to be obtained as damages by any statute or rule of law, or of any sums or damages to which Landlord may be entitled in addition to the damages set forth in Section 31.A.

FEES AND EXPENSES

32.       If Tenant shall default in the performance of any covenant on Tenant's part to be performed in this lease, Landlord may immediately, or at any time thereafter, upon written notice and the expiration of any applicable cure periods (except in the event of an emergency), perform the same for the account of Tenant.  If Landlord at any time is compelled to pay or elects to pay any sum of money, or do any act which will require the payment of any sum of money, by reason of the failure of Tenant to comply with any provision hereof, or, if Landlord is compelled to or does incur any expense including reasonable attorneys' fees, instituting, prosecuting and/or defending any action or proceeding instituted by reason of any default beyond any applicable notice and cure period of Tenant hereunder, the sum or sums so paid by Landlord with all interest, costs and damages, shall be deemed to be additional rent hereunder and shall be due from Tenant to Landlord on the first day of the month following the incurring of such respective expenses, or at Landlord's option on the first day of any subsequent month.  In the event that Landlord shall institute any such action or proceeding by reason of a default by Tenant hereunder, and Tenant shall thereafter cure such default before judgment is entered in such action or proceeding, the sum of $500 shall immediately become due and payable from Tenant to Landlord as and for liquidated damages on account of Landlord's attorneys' fees and other costs and expenses in connection therewith (said sum not to be deemed to be, or construed as, a limitation on Landlord's right to obtain reasonable attorneys' fees in a greater amount where such default is not so cured or where expenses were incurred prior to curing).  Any sum of money (other than rent) accruing from Tenant to Landlord pursuant to any provision of this lease, whether prior to or after the Term Commencement Date, may, at Landlord's option, be deemed additional rent, and Landlord shall have the same remedies for Tenant's failure to pay any item of additional rent when due as for Tenant's failure to pay any installment of rent when due.  Tenant’s obligations under this Article shall survive the expiration or sooner termination of the Demised Term.

NO WAIVER

33.       A.         No act or thing done by Landlord or Landlord's agents during the Demised Term shall be deemed an acceptance of a surrender of said Demised Premises, and no agreement to accept such surrender shall be valid unless in writing signed by Landlord.  No employee of Landlord or of Landlord's agents shall have any power to accept the keys of said Demised Premises prior to the termination of this lease.  The delivery of keys to any employee of Landlord or of Landlord's agents shall not operate as a termination of this lease or a surrender of the Demised Premises.  In the event of Tenant at any time desiring to have Landlord underlet the Demised Premises for Tenant's account, Landlord or Landlord's agents are authorized to receive said keys for such purposes without releasing Tenant from any of the obligations under this lease, and Tenant hereby relieves Landlord of any liability for loss of or damage to any of Tenant's effects in connection with such underletting.  The failure of Landlord to seek redress for violation of, or to insist upon the strict performance of, any covenant or condition of this lease, or any of the Rules and Regulations annexed hereto and made a part hereof, or hereafter adopted by Landlord, shall not prevent a subsequent act, which would have originally constituted a violation, from having all the force and effect of an original violation.  The receipt by Landlord of rent with knowledge of the breach of any covenant of this lease shall not be deemed a waiver of such breach.  The failure of Landlord to enforce any of the Rules and Regulations annexed hereto and made a part hereof, or hereafter adopted, against Tenant and/or any other tenant in the Building shall not be deemed a waiver of any such Rules and Regulations.  No provision of this lease shall be deemed to have been waived by Landlord, unless such waiver be in writing signed by Landlord.  No payment by Tenant or receipt by Landlord of a lesser amount than the monthly rent herein stipulated shall be deemed to be other than on account of the earliest stipulated rent then owing nor shall any endorsement or statement on any check or any letter accompanying any check or payment as rent be deemed an accord and satisfaction, and Landlord may accept such check or payment without prejudice to Landlord's right to recover the balance of such rent or pursue any other remedy in this lease provided.

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B.         Landlord's failure to render a Landlord's Statement with respect to any Lease Year per Article 11 or Schedule C-2 shall not prejudice Landlord's right to render a Landlord's Statement with respect to any subsequent Lease Year provided it is not for any subsequent year extending beyond the prior Lease Year.  The obligations of Landlord and Tenant under the provisions of Article 11 or Schedule C with respect to any additional rent for any Lease Year shall survive the expiration or any sooner termination of the Demised Term.

WAIVER OF TRIAL BY JURY

34.       To the extent such waiver is permitted by law, Landlord and Tenant hereby waive trial by jury in any action, proceeding or counterclaim brought by Landlord or Tenant against the other on any matter whatsoever arising out of or in any way connected with this lease, the relationship of landlord and tenant, the use or occupancy of the Demised Premises by Tenant or any person claiming through or under Tenant, any claim of injury or damage, and any emergency or other statutory remedy.  The provisions of the foregoing sentence shall survive the expiration or any sooner termination of the Demised Term.  If Landlord commences any summary proceeding for nonpayment of rent or otherwise to recover possession of the Demised Premises, Tenant agrees not to interpose any counterclaim of any nature or description in any such proceeding.

BILLS AND NOTICES

35.       Except as otherwise expressly provided in this lease, any bills, statements, notices, demands, requests or other communications given or required to be given under this lease shall be effective only if rendered or given in writing, sent by registered or certified mail (return receipt requested), or by Federal Express, UPS, or any similar national overnight delivery service, addressed (A) to Tenant (i) at Tenant's address set forth in this lease, Attn: Seth R. Horowitz, Vice President and General Counsel, or (ii) at any place where Tenant or any agent or employee of Tenant may be found if mailed subsequent to Tenant's vacating, deserting, abandoning or surrendering the Demised Premises in either case with copy to Westerman, Ball ,Ederer, Miller & Sharfstein, LLP., 1201 RXR Plaza, Uniondale, New York 11556, Attn: Jonathan M. Hoffman, Esq. (B) to Landlord at Landlord's address set forth in this lease, or (C) addressed to such other address as either Landlord or Tenant may designate as its new address for such purpose by notice given to the other in accordance with the provisions of this Article.  Any such bill, statement, notice, demand, request or other communication shall be deemed to have been rendered or given on (i) the next business day after sending it by overnight courier; or (ii) three calendar days after mailing.  Notices on behalf of Landlord may be signed and sent by Landlord’s attorneys.

INABILITY TO PERFORM

36.       A.         Inability.  If, by reason of strikes or other labor disputes, fires or other casualty (or reasonable delays in adjustment of insurance), accidents, orders or regulations of any Federal, State, County or Municipal authority, or any other cause beyond Landlord's reasonable control, whether or not such other cause shall be similar in nature to those hereinbefore enumerated, Landlord is unable to furnish or is delayed in furnishing any utility or service required to be furnished by Landlord under the provisions of this lease or any collateral instrument, or is unable to perform or make or is delayed in performing or making any installations, decorations, repairs, alterations, additions or improvements, whether or not required to be performed or made under this lease or under any collateral instrument, or is unable to fulfill or is delayed in fulfilling any of Landlord's other obligations under this lease or any collateral instrument, no such inability or delay shall constitute an actual or constructive eviction, in whole or in part, or impose any liability upon Landlord or its agents by reason of inconvenience or annoyance to Tenant, or injury to or interruption of Tenant's business, or otherwise, nor shall any such delay or inability to perform on the part of Landlord in any way affect this lease and the obligation of Tenant to pay rent hereunder and to perform all of the other covenants and agreements to be performed by Tenant hereunder.

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 B.          Interruption of Service.  Landlord reserves the right to stop the services of the air conditioning, elevator, escalator, plumbing, electrical or other mechanical systems or facilities in the Building upon prior notice to Tenant (if reasonably feasible) when necessary by reason of accident or emergency, or upon prior written notice for repairs, alterations, replacements or improvements which in the reasonable judgment of Landlord are desirable or necessary, until such repairs, alterations, replacements or improvements shall have been completed.   Landlord shall use commercially reasonable efforts to restore service as soon as possible.  The exercise of such rights by Landlord shall not constitute an actual or constructive eviction, in whole or in part, or entitle Tenant to any abatement or diminution of rent, or relieve Tenant from any of its obligations under this lease, or impose any liability upon Landlord or its agents by reason of inconvenience or annoyance to Tenant, or injury to or interruption of Tenant's business, or otherwise.

CONDITIONS OF LANDLORD'S LIABILITY

37.       A.         Tenant shall not be entitled to claim a constructive eviction from the Demised Premises unless Tenant shall have first notified Landlord of the condition or conditions giving rise thereto, and if the complaints be justified, unless Landlord shall have failed to remedy such conditions within a reasonable time after receipt of such notice.

TENANT'S TAKING POSSESSION

38.       As of the Term Commencement Date, Tenant shall be conclusively deemed to have agreed that Landlord up to the time of such occupancy has performed all of its obligations hereunder and that the Demised Premises were in satisfactory condition as of the date of such occupancy (excepting latent defects), unless Tenant shall have given written notice to Landlord specifying the respects in which the same were not in such condition.

LIABILITY INSURANCE

39.       A.      Tenant will keep in force, at Tenant's expense at all times during the Demised Term and during such other times as Tenant occupies the Demised Premises or any part thereof:

(i)         commercial general liability insurance or comprehensive general liability insurance with broad form endorsement with respect to the Demised Premises and the operations of Tenant and any persons under Tenant’s control in, on or about the Demised Premises in which the limits of coverage shall be not less than Seven Million Dollars ($7,000,000) combined single limit per occurrence;

(ii)        statutory workers' compensation coverage and employers' liability as required by state law;

(iii)       business interruption insurance for a period of not less than one year and such other insurance as Tenant deems necessary to protect its property and its business against all perils commonly insured against by prudent tenants;

(iv)       such other insurance with respect to the Demised Premises and in such amounts as Landlord may from time to time reasonably require against such other insurable hazards or risks which at the time are commonly insured against in the case of property similar to the Demised Premises and used as provided herein.

B.        All policies required by this lease shall be written on an occurrence basis. Such policies are to be written by a company having a general policy holder's rating of not less than A and a rating in financial size of not less than XI, as rated in the most current “Best's” insurance reports, and authorized and licensed to issue such policies in the State of New York. Any such insurance required of Tenant hereunder may be furnished by Tenant under any blanket policy carried by it, providing the policy properly allocates the required limits to the Demised Premises, or under a separate policy thereof. Each policy evidencing insurance as required to be carried by Tenant pursuant to this Article shall contain the following provisions and/or clauses: (i) a cross-liability clause; (ii) a provision in such policy that the coverage carried by Landlord shall be excess to the coverage afforded by Tenant’s policy; (iii) a provision including Landlord, Landlord's managing agent and other parties (including mortgagees) designated by Landlord as additional insureds (except with respect to workers' compensation insurance); (iv) a waiver by the insurer of any right of subrogation against Landlord, its agents, employees and representatives which arises or might arise by reason of any payment under such policy or by reasons of any act or omission of Landlord, its agents, employees, or representatives; (v) a severability clause; and (vi) a provision that the insurer will not cancel, materially change, reduce aggregates or coverage or fail to renew the coverage provided by such policy without first giving Landlord and all additional insureds thirty (30) days' prior written notice.

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C.         A copy of each paid-up policy or certificate of insurance accompanied by original endorsements signed by the insurance company evidencing the policies required hereunder, along with evidence of payment and appropriately authenticated by the insurer or its authorized agent certifying that such policy has been issued providing the coverage required by this Article, and containing provisions specified herein, shall be delivered to Landlord not less than fifteen (15) days prior to the earlier of (x) the Term Commencement Date, or (y) the date Tenant shall first take possession of the Demised Premises for any purpose, and, upon renewals, not less than thirty (30) days prior to the expiration of such coverage.

D.         If Tenant fails to deliver to Landlord on time any required evidence of insurance coverage, or fails to carry any insurance required hereunder, or by law or governmental regulations, then Landlord may (but is not obligated to), after notice to Tenant, purchase the required coverage on behalf of Tenant, as provided above, in which event Tenant shall pay to Landlord on demand the cost of such insurance coverage plus ten percent (10%) of the amount of such cost as a service charge to Landlord. No such purchase by Landlord shall be deemed a waiver of Tenant's default and Landlord may pursue its full rights and remedies on account of such default.

E.         Landlord will not unreasonably withhold or delay Landlord's consent to a commercially reasonable and viable and financially sound plan whereby Tenant self-insures the risks enumerated in this Article 39 A(iii) (business interruption insurance) ; provided that such plan establishes an actual, non-attachable and non-lienable segregated reserve for such purpose; provided further that such plan provides comparable protection against risks and loss to the insurance required by this Article 39A (iii) and provided finally that the holder of any mortgage encumbering the Building consents thereto (which consent Landlord does not warrant).  In such case, Tenant shall not seek any recourse from Landlord on account of any liability that would normally have been covered under business interruption insurance.

ENTIRE AGREEMENT

40.       This lease contains the entire agreement between the parties and all prior negotiations and agreements are merged herein.  Neither Landlord nor Landlord's agent or representative has made any representation, or statement, or promise, upon which Tenant has relied regarding any matter or thing relating to the Building, the land allocated to it, (including the Building Parking Area) or the Demised Premises, or any other matter whatsoever, except as is expressly set forth in this lease, including, but without limiting the generality of the foregoing, any statement, representation or promise as to the fitness of the Demised Premises for any particular use, the services to be rendered to the Demised Premises or the prospective amount of any item of additional rent.  No oral or written statement, representation or promise whatsoever with respect to the foregoing or any other matter made by Landlord, its agents or any broker, whether contained in an affidavit, information circular, or otherwise shall be binding upon the Landlord unless expressly set forth in this lease.  No rights, easements or licenses are or shall be acquired by Tenant by implication or otherwise unless expressly set forth in this lease.  This lease may not be changed, modified or discharged, in whole or in part, orally, and no executory agreement shall be effective to change, modify or discharge, in whole or in part, this lease or any obligations under this lease, unless such agreement is set forth in a written instrument executed by the party against whom enforcement of the change, modification or discharge is sought.  All references in this lease to the consent or approval of Landlord shall be deemed to mean the written consent of Landlord, or the written approval of Landlord, as the case may be, and no consent or approval of Landlord shall be effective for any purpose unless such consent or approval is set forth in a written instrument executed by Landlord.  Landlord and Tenant understand, agree, and acknowledge that (i) this lease has been freely  negotiated by both parties; (ii) Tenant is sophisticated in real estate matters or has employed professionals to assist Tenant in the negotiation of this lease; and (iii) that, in any controversy, dispute, or contest over the meaning, interpretation, validity, or enforceability of this lease or any of its terms or conditions, there shall be no inference, pre­sumption, or conclusion drawn whatsoever against either party by reason of that party having drafted this lease or any portion thereof.

DEFINITIONS

41.       The term “Landlord” as used in this lease means only the owner, or the mortgagee in possession, for the time being of the land and Building (or the owner of a lease of the Building or of the land and Building) of which the Demised Premises form a part, so that in the event of any sale or other transfer of said land and Building or of said lease, or in the event of a lease of the Building, or of the land and Building, the said Landlord shall be and hereby is entirely freed and relieved of all covenants and obligations of Landlord hereunder, and it shall be deemed and construed as a covenant running with the land without further agreement between the parties or their successors in interest, or between the parties and the purchaser or other transferee at any such sale, or the said lessee of the Building, or of the land and Building, provided that the purchaser, transferee or the lessee of the Building assumes and agrees to carry out any and all covenants and obligations of Landlord hereunder.  The words “re-enter”, “re-entry” and “re-entered” as used in this lease are not restricted to their technical legal meanings.  The term “business days” as used in this lease shall exclude Saturdays, (except such portion thereof as is covered by specific hours in Article 6 hereof), Sundays and all days observed by the State and Federal Government as legal holidays.

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The terms “person” and “persons” as used in this lease shall be deemed to include natural persons, firms, corporations, associations and any other private or public entities, whether any of the foregoing are acting on their own behalf or in a representative capacity.

42.       INTENTIONALLY OMITTED.

SUCCESSORS, ASSIGNS, ETC.

43.       The covenants, conditions and agreements contained in this lease shall bind and inure to the benefit of Landlord and Tenant and their respective heirs, distributees, executors, administrators, successors, and, except as otherwise provided in this lease, their respective assigns.

APPLICATION OF INSURANCE PROCEEDS, WAIVER OF SUBROGATION

44.       In any case in which Tenant shall be obligated under any provisions of this lease to pay to Landlord any loss, cost, damage, liability or expense suffered or incurred by Landlord, Landlord shall allow to Tenant as an offset against the amount thereof the net proceeds of any insurance collected by Landlord for or on account of such loss, cost, damage, liability or expense, provided that the allowance of such offset does not invalidate or prejudice the policy or policies under which such proceeds were payable.  In any case in which Landlord shall be obligated under any provisions of this lease to pay to Tenant any loss, cost, damage, liability or expense suffered or incurred by Tenant, Tenant shall allow to Landlord as an offset against the amount thereof the net proceeds of any insurance collected by Tenant for or on account of such loss, cost, damage, liability or expense, provided that the allowance of such offset does not invalidate or prejudice the policy or policies under which such proceeds were payable.

CAPTIONS AND INDEX

45.       The captions and the index at the beginning of the lease, if any, are included only as a matter of convenience and for reference, and in no way define, limit or describe the scope of this lease nor the intent of any provisions thereof.

RECOVERY FROM LANDLORD

46.       A.         Tenant shall look solely to the estate and property, the sale proceeds and the insurance proceeds and condemnation proceeds of Landlord in the land and Building of which the Demised Premises are a part, for the satisfaction of Tenant's remedies for the collection of a judgment (or other judicial process) requiring the payment of money by Landlord in the event of any default or breach by Landlord with respect to any of the terms, covenants and/or conditions of the lease to be observed and/or performed by Landlord, and no other property or assets of such Landlord shall be subject to levy, execution or other enforcement procedure for the satisfaction of Tenant's remedies.

B.         With respect to any provision of this lease which provides for Landlord's approval and/or consent, Tenant, in no event, shall be entitled to make, nor shall Tenant make any claim, and Tenant hereby waives any claim, for money damages; nor shall Tenant claim any money damages by way of set-off, counterclaim or defense, based upon any claim or assertion by Tenant that Landlord has unreasonably withheld or unreasonably delayed any such consent or approval.

BROKER

47.       Tenant represents and warrants to Landlord that CBRE, Inc. is the sole broker with whom Tenant has negotiated in bringing about this lease.  Tenant agrees to indemnify, defend and save Landlord harmless of, from and against any and all claims (and all expenses and fees, including attorneys fees, related thereto) for commissions or compensation made by any other broker or entity, arising out of or relating  to the breach by Tenant of the foregoing representation . As, if and when this lease shall be fully executed and unconditionally delivered by both Landlord and Tenant, Landlord agrees to pay any commission that may be due the above-named broker in connection with this lease in accordance with a separate agreement between Landlord and said broker. In the event that there is a claim for commission or compensation is made by any other broker arising out of or relating to any transaction between Landlord and Tenant, then Tenant shall assist and participate in Landlord’s defense against such claim, and make its agents and employees available to assist and participate in such defense without cost to Landlord.

Page 21

SECURITY DEPOSIT

48.       Tenant has deposited with Landlord the sum of $750,000.00 (the “security deposit”), as security for the faithful performance and observance by Tenant of the terms, provisions and conditions of this lease; it is agreed that in the event Tenant defaults beyond any applicable notice and grace period in respect of any of the terms, provisions and conditions of this Lease, Landlord may use, apply or retain the whole or any part of the security so deposited to the extent required for the payment of any sum as to which Tenant is in default beyond any applicable notice and grace period.  Landlord shall hold Tenant’s security deposit in a separate interest bearing account (of which Tenant shall receive the interest) less a 1% administrative fee and shall not commingle said deposit with any of Landlord’s other monies.  In the event that Tenant shall fully and faithfully comply with all of the terms, provisions, covenants and conditions of this lease, the security shall be returned to Tenant after the date fixed as the end of this lease and after delivery of entire possession of the Demised Premises to Landlord.  In the event of a sale of the land and Building or leasing of the Building, Landlord shall have the right to transfer the security to the vendee or lessee and Landlord shall thereupon be released by Tenant from all liability for the return of such security. If, as a result of any application of all or any part of the security deposit, the amount of the security deposit being held by Landlord shall be less than the amount required to be held hereunder, Tenant shall forthwith provide Landlord with additional funds in an amount equal to the deficiency.  Notwithstanding the foregoing, Tenant shall have the right during the Demised Term to substitute the security deposit with an irrevocable letter of credit for the same amount in form satisfactory to Landlord.

SEVERABILITY OF PROVISIONS

49.       If any provision or any portion of any provision of this lease or the application of any such provision or any portion thereof to any person or circumstance, shall be held invalid or unenforceable, the remaining portion of such provision and the remaining provisions of this lease, or the application of such provision or portion of such provision as is held invalid or unenforceable to persons or circumstances other than those as to which it is held invalid or unenforceable, shall not be affected thereby and such provision or portion of any provision as shall have been held invalid or unenforceable shall be deemed limited or modified to the extent necessary to make it valid and enforceable; in no event shall this lease be rendered void or unenforceable.

RENEWAL OPTIONS

50.       A.         The Tenant shall have the options, to be exercised as hereinafter provided, to extend the Demised Term for two (2) successive periods of five (5) years each, subject to and upon the following terms and conditions:

B.          That at the time of the exercise of either such option the Tenant shall not be in default beyond any applicable notice and cure period in the performance of any of the terms, covenants or conditions herein contained with respect to a matter as to which notice of default has been given hereunder and which has not been remedied within the time limited in this lease.

C.           That at the time of the exercise of either of such options and at the time of the commencement of such extended periods the Tenant shall not have assigned this lease or sublet any portion of the Demised Premises (except per subsection 21. F hereof), unless Landlord in consenting to such sublet or assignment agrees that this renewal option shall remain in effect.

D.          That such extensions shall be upon the same terms, covenants and conditions as in this lease provided, except that (i) there will be no further privilege of extension for the Demised Term beyond the periods referred to above and (ii) the Base annual rent shall be the “Fair Market Rental Rate” as defined in Article 52. H. hereinbelow.

E.           Notwithstanding anything contained in this Article to the contrary, the Tenant shall not be entitled to an extension if at the time of the commencement of the extended period the Tenant shall be in default under any of the terms, covenants or conditions of this lease with respect to a matter as to which notice of default has been given hereunder and which has not been remedied within the time limited in this lease therefor, or if this lease shall have terminated prior to the commencement of said period.

F.           The Tenant shall exercise its first option to the extension of the Demised Term by notifying the Landlord of the Tenant's election to exercise such option at least twelve (12) months (but no greater than 24 months) prior to the expiration of the initial Demised Term. The Tenant shall exercise its second option to the extension of the Demised Term by notifying the Landlord of the Tenant's election to exercise such option at least twelve (12) months (but no greater than 24 months) prior to the expiration of the Demised Term, as extended by the exercise of the first option to extend the Demised Term.  Upon the giving of these forgoing notices, this lease shall be deemed extended for the specified period, subject to the provisions of this Article, without execution of any further instrument.

Page 22

G.                     In the event that Tenant fails to exercise its first option to extend the Demised Term as provided in this Article 50, then the second option to extend the Demised Term shall be rendered null, void, and of no further force or effect.

H.          (i)       The base annual rent during each extension period shall be hereinafter referred to as the “Fair Market Rental Rate” and shall be determined as provided herein, however, during the first lease year of the first extension of the Demised Term, the Fair Market Rental rate shall be an amount no greater than $1,650,342.99 and no less than $1,402,791.55. During the first lease year of the second extension of the Demised Term, the Fair Market Rental Rate shall be no greater than $1,913,199.85 and no less than $1,626,219.87.

                                      (ii)      Landlord shall determine the "Fair Market Rental Rate" based on the annual amount per rentable square foot that a willing, comparable, non-occupying, non-equity, non-renewal, non-expansion, new tenant would pay and a willing, comparable landlord of a similar quality office building in the area of Melville, New York would accept at arm's length, giving appropriate consideration to then current annual rental rates per rentable square foot, the type of escalation clauses, the extent of liability under the escalation clauses, and other generally applicable terms and conditions of tenancy for a single floor or the space in question, if smaller.

                                      (iii)     In the event Tenant disputes Landlord’s determination of the Fair Market Rental Rate, Tenant, by written demand served upon Landlord within ten (10) business days after Landlord notifies Tenant of Landlord’s determination of the Fair Market Rental Rate, may commence arbitration strictly in accordance with the terms and conditions of this Subparagraph.  If Tenant shall fail to demand arbitration as set forth above within said ten (10) business day period, Tenant shall be deemed to have accepted Landlord’s determination of the Fair Market Rental Rate.  The sole issue to be determined by such arbitration shall be the Fair Market Rental Rate in accordance with this Subparagraph. Such written demand shall contain the name and address of the arbitrator appointed by Tenant.  Within thirty (30) days after its receipt of the written demand, Landlord will give Tenant written notice of the name and address of its arbitrator.  Within ten (10) days after the date of the appointment of the second arbitrator, the two (2) arbitrators will meet.  If the two (2) arbitrators are unable to agree on the Fair Market Rental Rate as provided herein within ten (10) days after their first meeting, they will select a third arbitrator.  The third arbitrator will be designated as chairman and will immediately give Landlord and Tenant written notice of his/her appointment.  The three (3) arbitrators will meet within ten (10) days after the appointment of the third arbitrator.  If they are unable to agree on the Fair Market Rental Rate within ten (10) days after their first meeting, the third arbitrator will select a time, date and place for a hearing and will give Landlord and Tenant thirty (30) days prior written notice of it.  The date of the hearing will not be more than sixty (60) days after the date of appointment of the third arbitrator.  The arbitrators must be licensed real estate appraisers with at least five (5) years of experience in the Long Island, New York commmercial real estate market.  No arbitrator may be an active real estate broker.  The arbitration will be governed by the laws of the State of New York and, when not in conflict with such law, by the general procedures in the commercial arbitration rules of the American Arbitration Association, but will not be administered by the American Arbitration Association.  The arbitrators will not have the power to add to, modify, detract from or alter in any way the provisions of this lease or any amendments or supplements to this lease.  The arbitrators will not have any power to decide or consider anything other than the specific issue of the Fair Market Rental Rate rent in accordance with the terms of this lease.  The written decision of at least two (2) arbitrators shall be conclusive and binding upon Landlord and Tenant.  No arbitrator is authorized to make an award for damages of any kind including, without limitation, an award for punitive, exemplary, consequential or incidental damages, nor is an arbitrator authorized to establish a Fair Market Rental Rate outside of the ranges set forth in paragraph 51. H. (i) above.  Landlord and Tenant will pay for the services of its appointees, attorneys and witnesses plus one-half of all other proper costs relating to the arbitration (including the third arbitrator, if one is appointed).  The decision of the arbitrators will be final and non-appealable and may be enforced according to the laws of the State of New York.  Notwithstanding anything to the contrary contained herein, in the event Tenant disputes Landlord’s determination of the Fair Market Rental Rate, Tenant shall nevertheless continue to pay rent at the rate determined by Landlord as the Fair Market Rental Rate.  In the event the rent as determined hereunder is at variance with the rent being paid by Tenant, Tenant shall within 10 days thereafter either pay the difference in a lump sum or receive a credit against future rent, as the case may be.  In the event that Landlord is sustained in its determination of Fair Market Rental Rate, Tenant shall pay all Landlord’s (as well as its own) costs and attorneys’ fees incurred in connection with the arbitration.

      (iv)           The base annual rent shall be increased on each anniversary of the Term Commencement Date throughout each of the Renewal Terms by an amount equal to three percent (3%) of the fixed annual rent payable during the Lease Year immediately preceding such anniversary (excluding escalations pursuant to Article 11 or Schedule C-2) (e.g., if the Fair Market Rental Rate is $1,402,791.55 during the first lease year of the first extended term, then during the second (2nd)  Lease Year of the first extended term, the fixed annual rent shall be $1,444,875.29 ($1,402,791.55 and 3% of $1,402,791.55), andduring the third (3rd)  Lease Year of the first extended term, the fixed annual rent shall be $1,488,221.55 ($1,444,875.29 and 3% of $1,444,875.29)).

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      (v)           During each extension period, the base year for determining additional rent under the escalation clauses in Article 11, Schedule C-2, and for determining the common area electric charge shall remain unchanged and continue to be the base year established at the commencement of the initial Demised Term.

ATTORNEY’S FEES

52.         In the event of a dispute hereunder, and an action or proceeding shall be commenced against the Tenant by Landlord, or by Landlord against Tenant, as the case may be, the prevailing party, after final court determination with appeals exhausted, shall be entitled to the reimbursement of reasonable attorney’s fees incurred by it from the non-prevailing party upon demand.

TENANT’S RIGHT OF OFFER

53.       Provided this Lease is in full force and effect, and that there shall not be an Event of Default beyond any applicable notice and cure periods in the performance of any of the terms, covenants or conditions (as defined in Article 29) herein contained with respect to a matter as to which notice of an Event of Default has been given hereunder and which has not been remedied within the time specified in this Lease, on and after the Term Commencement Date, subject and subordinate to (i) any rights of first offer, rights of first refusal, or any similar such rights of any existing tenants in the Building (including, without limitation, those of ADP, Inc.), (ii) any renewal rights of any tenants in the Building (including, without limitation, those of ADP, Inc.), and (iii) the right of Landlord to negotiate a renewal or extension of a lease with any tenants in the Building (including, without limitation, those of ADP, Inc.), Tenant shall have the right of offer with respect to the leasing of space in the Building on the first and third floors of the Building’s south wing (an “Expansion Space”) during the term of the Lease.  Such right of offer shall be exercisable, and shall be subject to the conditions following:

A.        Before offering a lease for an Expansion Space to a third party, Landlord shall send to Tenant written notice of its intention to rent an Expansion Space (a "Landlord's Notice").  Tenant shall have ten (10) business days from the date of delivery of such Landlord’s Notice to deliver to Landlord written notice (an “Acceptance Notice") wherein Tenant may agree to lease the Expansion Space on the terms specified herein.

B.         If Tenant declines to lease an Expansion Space or fails to reply to Landlord's Notice within said ten (10) business day period, Landlord may lease such Expansion Space to any third party upon any terms as Landlord may desire.

C.        If Tenant timely delivers an Acceptance Notice to Landlord, the parties shall promptly enter into a modification of lease agreement for the Expansion Space reflecting the terms herein, and shall make appropriate pro rata adjustments with respect to all items of additional rent which depend on the amount of space occupied by Tenant, including, but not limited to, tax escalations pursuant to Article 11, electric rent pursuant to Schedule C-2, and the number of parking spaces to be used by the Tenant pursuant to Article 9.

D.        If Tenant timely exercises its right of offer Landlord shall prepare and renovate such Expansion Space for use and occupancy by the Tenant (the “Expansion Space Work”) subject to a mutually agreeable plan and using building standard materials, and at a cost to Landlord not to exceed the “Pro Rata Work Letter” based upon the remaining term of this Lease.  The Pro Rata Work Letter shall be calculated by multiplying (i) the $14.26 cost per rentable square foot of Landlord’s Initial Construction to the Demised Premises, and Landlord Contribution to the Extra Work, including Landlord’s general contractor’s overhead and profit, paid by Landlord, multiplied by the rentable square feet of such Expansion Space and again multiplied by (ii) the ratio of the number of months remaining term of this Lease (at the time of the substantial completion of the Expansion Space Work) to   the 86 month period comprising the Demised Term.

E.         Upon substantial completion of the Expansion Space Work, the base annual rental rate, electricity rate and additional rent for the Demised Premises shall be increased by the rent allocable to such Expansion Space (the “Expansion Space Rent”).  The initial Expansion Space Rent shall be computed by multiplying (i) the total number of rentable square feet comprising such Expansion Space times (ii) the amount of base annual rental rate, electricity rate and additional rent per square foot then being paid by Tenant for the original Demised Premises hereunder, as theretofore escalated as in Articles “3” and “11” and Schedule C-2 hereof provided, and otherwise on the same terms and conditions as set forth in this Lease.

F.         In the event Tenant exercises its right of offer as hereinabove provided, upon substantial completion of such Expansion Space Work, should the Expiration Date be a date less than five (5) years from the date Landlord completes such Expansion Space Work, the Demised Term of this Lease shall be deemed amended and extended to terminate five (5) years from the date Landlord completes such Expansion Space Work, it being intention of Landlord and Tenant that the term of the Lease for the Demised Premises and the Expansion Space (including the expiration dates thereof) shall for all purposes be co-terminus. The Renewal Option set forth in Article 50 shall remain unaffected by an exercise of Tenant’s right of offer.

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G.        If Tenant declines to lease an Expansion Space, Tenant acknowledges and agrees that Landlord may grant such tenants of such Expansion Space renewal options therefor and that the right of offer set forth in this Article 51 shall be subject and subordinate thereto.

H.        Landlord does not warrant the availability of Expansion Space.

SPACE REDUCTION OPTION

54.       Tenant shall have the ongoing right, upon six (6) months prior written notice to Landlord to surrender a portion of the Demised Premises, as shown on Exhibit 4 annexed hereto (the “Surrender Space”), provided that:

(a)         all fixed annual rent and additional rent associated with the Surrender Space shall be paid through and apportioned as of the date of such surrender, and Tenant shall surrender the demised premises in the condition required under this lease.

(b)         Upon Tenants surrender of the Surrender Space, the base annual rental rate payable by Tenant shall be reduced by the product of the number of feet comprising the Surrender Space multiplied by the escalated per square foot annual rental rate for the date of the surrender as set forth in Article 3. Tenant’s percentage of taxes due pursuant to Article 11 of the Lease and allowance of parking spaces pursuant to Article 9 shall also be correspondingly reduced.

IN WITNESS WHEREOF, Landlord and Tenant have executed this lease as of the date first above written.

LANDLORD:

HUNTINGTON QUADRANGLE 2, LLC

By:

Name:

Title:

TENANT:  

FALCONSTOR SOFTWARE, INC.

By:

Name:

Title:

Page 25

State of                                   )

 )ss.:

County of                               )

On the ____ day of ______________, 2013, before me, the undersigned, a Notary Public in and for said State, personally appeared _________________________, personally known to me or proved to me on the basis of satisfactory evidence to be the individual(s) whose name(s) is (are) subscribed to the within instrument and acknowledged to me that he/she/they executed the same in his/her/their capacity(ies), and that by his/her/their signature(s) on the instrument, the individual(s), or the person upon behalf of which the individual(s) acted, executed the instrument.

State of                                   )

 )ss.:

County of                               )

On the ____ day of ______________, 2013, before me, the undersigned, a Notary Public in and for said State, personally appeared _________________________, personally known to me or proved to me on the basis of satisfactory evidence to be the individual(s) whose name(s) is (are) subscribed to the within instrument and acknowledged to me that he/she/they executed the same in his/her/their capacity(ies), and that by his/her/their signature(s) on the instrument, the individual(s), or the person upon behalf of which the individual(s) acted, executed the instrument.

Page 26

XML

(11) Segment Reporting

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(11) Segment Reporting

The Company is organized in a single operating segment for purposes of making operating decisions and assessing performance. Revenues from the United States to customers in the following geographical areas for the three and six months ended June 30, 2013 and 2012, and the location of long-lived assets as of June 30, 2013 and December 31, 2012, are summarized as follows: 

Segment Reporting
	Three Months Ended June 30,				Six Months Ended June 30,
Revenues:	2013		2012		2013		2012
Americas	$	5,195,655	$	7,085,505	$	11,631,581	$	15,201,737
Asia Pacific		4,715,039		4,833,526		9,111,042		10,744,801
Europe, Middle East, Africa and Other		4,063,445		4,547,170		8,516,333		9,887,735
Total Revenues	$	13,974,139	$	16,466,201	$	29,258,956	$	35,834,273
		June 30,		December 31,
Long-lived assets:		2013		2012
Americas	$	10,541,103	$	10,263,056
Asia Pacific		918,148		1,041,470
Europe, Middle East, Africa and Other		564,310		434,353
Total long-lived assets	$	12,023,561	$	11,738,879

For the three months ended June 30, 2013 and 2012, the Company had two customers that accounted for 10% or more of total revenues. As of June 30, 2013, the Company had two customers that accounted for 14% and 10% of the accounts receivable balance. As of December 31, 2012, the Company had one customer that accounted for 20% of the accounts receivable balance.

The Company recorded provisions for returns of less than $0.1 million and approximately $0.3 million during the three months ended June 30, 2013 and 2012, respectively. Due to cash collections of previously reserved accounts receivable balances, the Company recorded benefits of $0.1 million and $0.3 million during the six months ended June 30, 2013 and 2012, respectively. These amounts are included within revenues in the accompanying condensed consolidated statement of operations.

XML

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
Revenues:
Product revenues	$ 6,542,429	$ 7,835,568	$ 14,301,885	$ 18,498,521
Support and services revenues	7,431,710	8,630,633	14,957,071	17,335,752
Total revenues	13,974,139	16,466,201	29,258,956	35,834,273
Cost of revenues:
Product	963,102	1,787,186	2,262,756	3,807,672
Support and service	2,861,992	3,091,055	5,870,395	6,252,411
Total cost of revenues	3,825,094	4,878,241	8,133,151	10,060,083
Gross profit	10,149,045	11,587,960	21,125,805	25,774,190
Operating expenses:
Research and development costs	4,395,823	4,848,500	9,044,432	9,627,675
Selling and marketing	6,879,315	9,189,953	13,719,886	18,874,598
General and administrative	3,361,881	3,018,154	6,608,948	6,129,029
Investigation, litigation, and settlement related costs	62,392	851,123	176,458	(439,797)
Total operating expenses	14,699,411	17,907,730	29,549,724	34,191,505
Operating loss	(4,550,366)	(6,319,770)	(8,423,919)	(8,417,315)
Interest and other loss, net	(487,176)	(105,533)	(817,966)	(244,864)
Loss before income taxes	(5,037,542)	(6,425,303)	(9,241,885)	(8,662,179)
Provision for income taxes	169,751	195,283	345,853	407,815
Net loss	$ (5,207,293)	$ (6,620,586)	$ (9,587,738)	$ (9,069,994)
Basic net loss per share	$ (0.11)	$ (0.14)	$ (0.20)	$ (0.19)
Diluted net loss per share	$ (0.11)	$ (0.14)	$ (0.20)	$ (0.19)
Weighted average basic shares outstanding	47,996,027	47,472,909	47,929,799	47,258,696
Weighted average diluted shares outstanding	47,996,027	47,472,909	47,929,799	47,258,696

XML

(4) Fair Value Measurements

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(4) Fair Value Measurements

The Company measures its cash equivalents and marketable securities at fair value. Fair value is an exit price, representing the amount that would be received on the sale of an asset or that would be paid to transfer a liability in an orderly transaction between market participants. As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value.

 Fair Value Hierarchy 

The methodology for measuring fair value specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs) or reflect the Company’s own assumptions of market participant valuation (unobservable inputs). As a result, observable and unobservable inputs have created the following fair value hierarchy:

· Level 1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities. The Level 1 category includes money market funds, which at June 30, 2013 and December 31, 2012 totaled $5.5 million and $4.3 million, respectively, which are included within cash and cash equivalents in the condensed consolidated balance sheets.

· Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly. The Level 2 category includes government securities and corporate debt securities, which at June 30, 2013 and December 31, 2012 totaled $7.8 million and $10.5 million, respectively, which are included within cash and cash equivalents and marketable securities in the condensed consolidated balance sheets.

· Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. The Company did not hold any cash, cash equivalents or marketable securities categorized as Level 3 as of June 30, 2013 or December 31, 2012.

Measurement of Fair Value

The Company measures its cash equivalents and marketable securities at fair value. Fair value is an exit price, representing the amount that would be received on the sale of an asset or that would be paid to transfer a liability in an orderly transaction between market participants. As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value.

Items Measured at Fair Value on a Recurring Basis

  The following table presents the Company’s assets that are measured at fair value on a recurring basis at June 30, 2013:

			Fair Value Measurements at Reporting Date Using
				Quoted Prices in				Significant
				Active Markets for		Significant other		Unobservable
				Identical Assets		Inputs		Inputs
		Total		(Level 1)		(Level 2)		(Level 3)
Cash equivalents:
Money market funds	$	5,501,965	$	5,501,965	$	—	$	—
Total cash equivalents		5,501,965		5,501,965		—		—
Marketable securities:
Corporate debt and government securities		7,838,590		—		7,838,590		—
Total marketable securities		7,838,590		—		7,838,590		—
Total assets measured at fair value	$	13,340,555	$	5,501,965	$	7,838,590	$	—
The following table presents the Company’s assets that are measured at fair value on a recurring basis at December 31, 2012:
			Fair Value Measurements at Reporting Date Using
				Quoted Prices in				Significant
				Active Markets for		Significant other		Unobservable
				Identical Assets		Inputs		Inputs
		Total		(Level 1)		(Level 2)		(Level 3)
Cash equivalents:
Money market funds	$	4,285,309	$	4,285,309	$	—	$	—
Total cash equivalents		4,285,309		4,285,309		—		—
Marketable securities:
Corporate debt and government securities		10,530,942		—		10,530,942		—
Total marketable securities		10,530,942		—		10,530,942		—
Total assets measured at fair value	$	14,816,251	$	4,285,309	$	10,530,942	$	—

XML

(6) Inventories (Tables)

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

Schedule Of Inventory

		June 30,		December 31,
		2013		2012
Component materials	$	15,365	$	18,989
Finished systems		888,833		623,830
	$	904,198	$	642,819

XML

(12) Subsequent Events

6 Months Ended

Jun. 30, 2013

Subsequent Events [Abstract]

(12) Subsequent Events

On August 5, 2013, the Company reached an agreement in principle, and signed a term sheet, for an investment of between $7.5 million and $15.0 million from a private equity group. The investment will be in the form of redeemable convertible preferred stock. Closing of the investment is subject to the negotiation of definitive documents and certain other conditions.

On August 7, 2013, the Company signed an Equity Transfer Agreement, to sell its interest in Tianjin Zhongke Blue Whale Information Technologies Co., Ltd. (“Blue Whale”), a Chinese joint venture, for $3.0 million. Closing of the sale is subject to certain conditions, including the approval of the appropriate government entities in China.

Both the private equity investment and the sale of the Company’s Blue Whale investment are subject to various closing conditions, including, with regard to the Blue Whale investment sale, government approvals, and there can be no guarantee that either transaction will close.

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(9) Accumulated Other Comprehensive Loss (Details) (USD $)	3 Months Ended	6 Months Ended
	Jun. 30, 2013	Jun. 30, 2013
Accumulated other comprehensive (loss) income at beginning of period	$ (1,616,074)	$ (1,650,050)
Other comprehensive (loss) income before reclassifications	(20,524)	11,310
Amounts reclassified from accumulated other comprehensive (loss) income	(1,058)	1,084
Total other comprehensive (loss) income	(21,582)	12,394
Accumulated other comprehensive (loss) income at end of period	(1,637,656)	(1,637,656)
Foreign Currency Translation
Accumulated other comprehensive (loss) income at beginning of period	(1,566,611)	(1,601,138)
Other comprehensive (loss) income before reclassifications	(19,737)	14,790
Amounts reclassified from accumulated other comprehensive (loss) income	0	0
Total other comprehensive (loss) income	(19,737)	14,790
Accumulated other comprehensive (loss) income at end of period	(1,586,348)	(1,586,348)
Net Unrealized Gains On Marketable Securities
Accumulated other comprehensive (loss) income at beginning of period	10,217	6,210
Other comprehensive (loss) income before reclassifications	(2,258)	1,749
Amounts reclassified from accumulated other comprehensive (loss) income	(3,199)	(3,199)
Total other comprehensive (loss) income	(5,457)	(1,450)
Accumulated other comprehensive (loss) income at end of period	4,760	4,760
Net Minimum Pension Liability
Accumulated other comprehensive (loss) income at beginning of period	(59,680)	(55,122)
Other comprehensive (loss) income before reclassifications	1,471	(5,229)
Amounts reclassified from accumulated other comprehensive (loss) income	2,141	4,283
Total other comprehensive (loss) income	3,612	(946)
Accumulated other comprehensive (loss) income at end of period	$ (56,068)	$ (56,068)

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(2) Share-Based Payment Arrangements (Details Narrative) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
Common stock, shares outstanding	48,014,717		48,014,717		47,610,737
Proceeds From Stock Options Exercised	$ 0	$ 421,290	$ 697,500	$ 624,155
Intrinsic Value of Stock Options Exercised	0	188,609	121,819	266,862
Total unrecognized compensation	3,905,864		3,905,864
Intrinsic value of restricted stock for which the restrictions lapsed during the period	$ 64,361	$ 178,592	$ 185,497	$ 1,038,739
Options Contractual term			10 years
Vesting period for options granted	3 years
FalconStor Software, Inc., 2006 Incentive Stock Plan Member
Total shares available for issuance under the FalconStor Software, Inc., 2006 Incentive Stock Plan, prior to increase	1,169,323		1,169,323
Total shares available for issuance under the FalconStor Software, Inc., 2006 Incentive Stock Plan, subsequent to increase	2,400,736		2,400,736
Common stock, shares outstanding	48,014,717		48,014,717
Minimum Percentage of shares outstanding under 2006 Plan			5.00%
Increase in shares available for issuance under 2006 Plan			1,231,413
NonEmployee | Maximum
Vesting period for options granted	3 years

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(11) Segment Reporting (Tables)

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

Schedule Of Revenues And Long Lived Assets By Geographical Areas

Segment Reporting
	Three Months Ended June 30,				Six Months Ended June 30,
Revenues:	2013		2012		2013		2012
Americas	$	5,195,655	$	7,085,505	$	11,631,581	$	15,201,737
Asia Pacific		4,715,039		4,833,526		9,111,042		10,744,801
Europe, Middle East, Africa and Other		4,063,445		4,547,170		8,516,333		9,887,735
Total Revenues	$	13,974,139	$	16,466,201	$	29,258,956	$	35,834,273
		June 30,		December 31,
Long-lived assets:		2013		2012
Americas	$	10,541,103	$	10,263,056
Asia Pacific		918,148		1,041,470
Europe, Middle East, Africa and Other		564,310		434,353
Total long-lived assets	$	12,023,561	$	11,738,879

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(9) Accumulated Other Comprehensive Loss (Tables)

6 Months Ended

Jun. 30, 2013

Accumulated Other Comprehensive Loss Tables

Schedule of accumulated other comprehensive loss

				Net Unrealized
	Foreign Currency			Gains on Marketable			Net Minimum
	Translation			Securities			Pension Liability			Total
Accumulated other comprehensive (loss) income at March 31, 2013	$	(1,566,611	)	$	10,217		$	(59,680	)	$	(1,616,074	)
Other comprehensive (loss) income
Other comprehensive (loss) income       before reclassifications		(19,737	)		(2,258)			1,471			(20,524	)
Amounts reclassified from accumulated       other comprehensive (loss) income		—			(3,199)			2,141			(1,058)
Total other comprehensive (loss) income		(19,737	)		(5,457	)		3,612			(21,582	)
Accumulated other comprehensive (loss) income at June 30, 2013	$	(1,586,348	)	$	4,760		$	(56,068	)	$	(1,637,656	)
					Net Unrealized
		Foreign Currency			Gains on Marketable			Net Minimum
		Translation			Securities			Pension Liability			Total
Accumulated other comprehensive (loss) income at January 1, 2013	$	(1,601,138	)	$	6,210		$	(55,122	)	$	(1,650,050	)
Other comprehensive income (loss)
Other comprehensive income (loss)       before reclassifications		14,790			1,749			(5,229	)		11,310
Amounts reclassified from accumulated       other comprehensive income		—			(3,199)			4,283			1,084
Total other comprehensive income (loss)		14,790			(1,450	)		(946	)		12,394
Accumulated other comprehensive (loss) income at June 30, 2013	$	(1,586,348	)	$	4,760		$	(56,068	)	$	(1,637,656	)

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(8) Commitments and Contingencies (Details) (USD $)	Jun. 30, 2013
Operating Lease Payment
2013	$ 1,397,075
2014	2,460,386
2015	1,687,643
2016	1,512,699
2017	1,462,447
Thereafter	5,036,525
Total Future Minimum Lease Payments Due	$ 13,556,775

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(2) Share-Based Payment Arrangements (Details 3) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
Recognized share-based compensation expense	$ 240,795	$ 1,090,076	$ 1,131,530	$ 2,538,378
Cost of revenues - Product
Recognized share-based compensation expense	50	49	99	99
Cost of revenues - Support and Service Member
Recognized share-based compensation expense	53,936	(21,124)	104,192	49,844
Research and development costs Member
Recognized share-based compensation expense	87,028	125,231	221,938	444,188
Selling and marketing Member
Recognized share-based compensation expense	(11,848)	398,031	272,190	884,656
General and administrative Member
Recognized share-based compensation expense	$ 111,629	$ 587,889	$ 533,111	$ 1,159,591

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(3) Income Taxes (Details Narrative) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
Notes to Financial Statements
Income Tax Provision	$ 169,751	$ 195,283	$ 345,853	$ 407,815
Effective Income Tax Rate			3.70%
Pre-Tax Loss	(5,037,542)	(6,425,303)	(9,241,885)	(8,662,179)
Valuation Allowance	40,300,000		40,300,000
Unrecognized Tax Benefits	5,100,000		5,100,000		5,100,000
Accrued Interest and Penalties	446,000		446,000		373,000
Unrecognized Tax Benefits that Would Impact Effective Tax Rate	$ 2,500,000		$ 2,500,000

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(10) Litigation (Details Narrative) (USD $)		6 Months Ended		12 Months Ended	30 Months Ended
	Jun. 30, 2013 Prepaid Expenses and other current assets	Jun. 30, 2013 Internal and Government Investigations	Jun. 30, 2013 Stockholder Litigation	Dec. 31, 2012 Stockholder Litigation	Jun. 30, 2013 Stockholder Litigation	Jan. 20, 2013 Proposed Settlement Class Action Lawsuit
Deferred Prosecution Agreement (DPA) with the USAO		Under the DPA, the USAO agrees that it will defer prosecution of the Company in connection with the matter, and ultimately not prosecute the Company if the Company satisfies its obligations during the 18 month term of the DPA. The DPA acknowledges the remedial actions taken by the Company in response to its discovery of the improper payments and does not require the Company to make any additional control or compliance changes. Under the DPA, the Company will forfeit $2.9 million over eighteen months.
Settlement with United States Attorney's Office amount paid		$ 4,100,000
Settlement amount		5,800,000				5,000,000
Settlement with United States Attorney's Office amount accrued, payable in December 2013		1,700,000
Receivables included in prepaid expenses and other current assets	1,200,000
Class Action agreement			Company will pay $5.0 million to settle the Class Action
Company’s Directors and Officers (“D&O”) Insurance Agreement			Company entered into an agreement with the carrier of the first $5.0 million layer of the Company’s D&O insurance. Pursuant to this agreement, the Company accepted a payment of $3.9 million from the first layer insurance carrier in satisfaction of the carrier’s obligations to the Company under the first layer D&O insurance policy. The combined costs of (i) defense of the Class Action and the Derivative Action, and (ii) the proposed $5.0 million settlement of the Class Action exceeds $3.9 million, and the Company is responsible for paying the next $1.1 million of costs, settlement amounts or liability up to $5.0 million, before the next layer of the Company’s D&O insurance might cover the Company. This $5.0 million payment, when and if made, will negatively impact its cash flows and its cash reserves when paid. In addition, as part of the October 2012 agreement with the carrier, the Company agreed to indemnify the carrier of the first layer of D&O insurance against potential claims by certain named insured persons under the first layer D&O insurance policy. The Company cannot predict the likelihood or the outcome of any such claims by the named insureds.
Accrued liability for costs associated with the Class Action and the Derivative Actions			5,300,000		5,300,000
Cost recorded associated with the Class Action and the Derivative Actions					7,000,000
Total investigation, litigation, and settlement related costs related to the class action and derivative lawsuits that are not or may not be recoverable through insurance			100,000
Insurance recovery				$ 3,900,000

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(2) Share-Based Payment Arrangements (Details)				6 Months Ended
	Jun. 30, 2013	Mar. 31, 2013	Dec. 31, 2012	Jun. 30, 2013 FalconStor Software, Inc., 2006 Incentive Stock Plan Member	Jun. 30, 2013 FalconStor Software, Inc., 2013 Outside Directors Equity Compensation Plan
Shares Authorized				12,224,133	400,000
Shares Available for grant				1,169,323	350,000
Shares Outstanding	11,200,955	10,876,047	11,360,842	8,411,478	50,000
Last date for grant of shares				May 17, 2016	May 09, 2016

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(5) Marketable Securities (Details) (USD $)	6 Months Ended	12 Months Ended
	Jun. 30, 2013	Dec. 31, 2012
Aggregate Fair Value	$ 7,838,590	$ 10,530,942
Cost or Amortized Cost	7,833,830	10,524,732
Net Unrealized Gains / (loss)	4,760	6,210
Government Securities Member
Aggregate Fair Value	7,838,590	8,328,392
Cost or Amortized Cost	7,833,830	8,324,372
Net Unrealized Gains / (loss)	4,760	4,020
Corporate Debt Securities Member
Aggregate Fair Value	0	2,202,550
Cost or Amortized Cost	0	2,200,360
Net Unrealized Gains / (loss)	$ 0	$ 2,190

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(8) Commitments and Contingencies (Tables)

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

Schedule Of Future Minimum Payments For Operating Leases

2013	$	1,397,075
2014		2,460,386
2015		1,687,643
2016		1,512,699
2017		1,462,447
Thereafter		5,036,525
	$	13,556,775

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (USD $)	6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012
Cash flows from operating activities:
Net loss	$ (9,587,738)	$ (9,069,994)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation and amortization	1,369,782	1,702,187
Share-based payment compensation	1,131,530	2,508,448
Non-cash professional services expenses	0	29,930
Realized gain on marketable securities	(3,199)	(546)
Provision for returns and doubtful accounts	(378,923)	(325,591)
Deferred income tax provision	(7,772)	7,928
Changes in operating assets and liabilities:
Accounts receivable	4,791,340	9,248,544
Prepaid expenses and other current assets	281,372	43,214
Inventory	(261,379)	668,363
Other assets	(39,742)	(20,718)
Accounts payable	(712,032)	(222,903)
Accrued expenses and other liabilities	(2,168,298)	(6,202,916)
Deferred revenue	(1,237,922)	(837,581)
Net cash used in operating activities	(6,822,981)	(2,471,635)
Cash flows from investing activities:
Sales of marketable securities	7,480,733	11,818,443
Purchases of marketable securities	(4,789,832)	(7,341,816)
Purchases of property and equipment	(1,116,911)	(1,612,104)
Capitalized software development costs	(247,429)	(461,555)
Security deposits	(250,000)	(41,746)
Purchase of intangible assets	(61,781)	(44,610)
Net cash provided by investing activities	1,014,780	2,316,612
Cash flows from financing activities:
Proceeds from exercise of stock options	697,500	624,155
Net cash provided by financing activities	697,500	624,155
Effect of exchange rate changes on cash and cash equivalents	(246,987)	(242,694)
Net (decrease) increase in cash and cash equivalents	(5,357,688)	226,438
Cash and cash equivalents, beginning of period	18,651,468	16,257,694
Cash and cash equivalents, end of period	13,293,780	16,484,132
Cash paid/(refund received) for income taxes, net	$ (132,217)	$ 528,714

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(2) Share-Based Payment Arrangements

6 Months Ended

Jun. 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  June 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	12,224,133	1,169,323	8,411,478	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 June 30, 2013:

	Shares Available	Shares
Name of Plan	for Grant	Outstanding
FalconStor Software, Inc., 2000 Stock Option Plan	--	1,646,397
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	--	805,200
the Company and James P. McNiel
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 six months ended June 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
Options Exercisable at June 30, 2013	7,173,298	$5.46	4.10	$                      -

Stock option exercises are fulfilled with new shares of common stock. The total cash received from stock option exercises for the three months ended June 30, 2013 and 2012 was $0 and $421,290, respectively. The total cash received from stock option exercises for the six months ended June 30, 2013 and 2012 was $697,500 and $624,155, respectively. The total intrinsic value of stock options exercised during the three months ended June 30, 2013 and 2012 was $0 and $188,609, respectively. The total intrinsic value of stock options exercised during the six months ended June 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 six months ended June 30, 2013 and 2012:

	Three months ended June 30,					Six months ended June 30,
	2013		2012			2013		2012
Cost of revenues - Product	$	50	$	49		$	99	$	99
Cost of revenues - Support and Service		53,936		(21,124	)		104,192		49,844
Research and development costs		87,028		125,231			221,938		444,188
Selling and marketing		(11,848)		398,031			272,190		884,656
General and administrative		111,629		587,889			533,111		1,159,591
	$	240,795	$	1,090,076		$	1,131,530	$	2,538,378

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 June 30,				Six months ended June 30,
	2013		2012		2013		2012
Directors, officers and employees	$	32,551	$	130,164	$	95,748	$	407,580
Non-employee consultants		—		—		—		—
	$	32,551	$	130,164	$	95,748	$	407,580

As of June 30, 2013, an aggregate of 2,926,068 shares of restricted stock awards had been issued, of which, 2,325,817 had vested and 477,631 had been forfeited. As of June 30, 2012, an aggregate of 2,871,054 shares of restricted stock awards had been issued, of which, 2,193,552 had vested and 464,889 had been forfeited.

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

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 June 30, 2013 and 2012 was $64,361 and $178,592, respectively. The total intrinsic value of restricted stock for which the restrictions lapsed during the six months ended June 30, 2013 and 2012 was $185,497 and $1,038,739, 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 June 30,					Six months ended June 30,
	2013		2012			2013		2012
Non-qualified stock options	$	—	$	(25,262	)	$	—	$	29,930
Restricted stock awards		—		—			—		—
	$	—	$	(25,262	)	$	—	$	29,930

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 June 30, 2013, there was approximately $3,905,864 of total unrecognized compensation cost related to the Company’s unvested options and restricted shares granted under the Company’s equity plans.

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(5) Marketable Securities

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(5) Marketable Securities

The Company’s marketable securities consist of available-for-sale securities, which are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity. Unrealized gains and losses are computed on the specific identification method. Realized gains, realized losses and declines in value judged to be other-than-temporary, are included in interest and other income, net. The cost of available-for-sale securities sold is based on the specific identification method and interest earned is included in interest and other income.

The cost and fair values of the Company’s available-for-sale marketable securities as of June 30, 2013, are as follows:

	Aggregate		Cost or Amortized		Net Unrealized
	Fair Value		Cost		Gains / (Loss)
Government securities	$	7,838,590	$	7,833,830	$	4,760
Corporate debt securities		—		—		—
	$	7,838,590	$	7,833,830	$	4,760
The cost and fair values of the Company’s available-for-sale marketable securities as of December 31, 2012, are as follows:
		Aggregate		Cost or Amortized		Net Unrealized
		Fair Value		Cost		Gains / (Loss)
Government securities	$	8,328,392	$	8,324,372	$	4,020
Corporate debt securities		2,202,550		2,200,360		2,190
	$	10,530,942	$	10,524,732	$	6,210

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(3) Income Taxes

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(3) Income Taxes

The Company’s provision for income taxes consists of state and local, and foreign taxes, as applicable, in amounts necessary to align the Company’s year-to-date tax provision with the effective rate that it expects to achieve for the full year.

For the six months ended June 30, 2013 and June 30, 2012, the Company recorded an income tax provision of $0.3 million on its pre-tax loss of $9.2 million and $0.4 million on its pre-tax loss of $8.7 million, respectively, consisting primarily of state and local and foreign taxes. The effective tax rate for the six months ended June 30, 2013 was (3.7%). As of June 30, 2013, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and, therefore, the Company has not recorded any benefit for its expected net domestic deferred tax assets for the full year 2013 estimated annual effective tax rate. As of June 30, 2013, the valuation allowance totaled approximately $40.3 million.

The Company’s total unrecognized tax benefits, excluding interest and penalties for June 30, 2013 and December 31, 2012 were approximately $5.1 million. At June 30, 2013, $2.5 million including interest, if recognized, would reduce the Company’s effective tax rate. As of June 30, 2013 and December 31, 2012, the Company recorded an aggregate of approximately $446,000 and $373,000, respectively, of accrued interest and penalties.

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(4) Fair Value Measurements (Details) (USD $)	Jun. 30, 2013	Dec. 31, 2012
Cash equivalents:
Total cash equivalents	$ 5,501,965	$ 4,285,309
Marketable securities:
Total marketable securities	7,838,590	10,530,942
Total assets measured at fair value	13,340,555	14,816,251
Fair Value, Inputs, Level 1
Cash equivalents:
Total cash equivalents	5,501,965	4,285,309
Marketable securities:
Total assets measured at fair value	5,501,965	4,285,309
Fair Value, Inputs, Level 2
Marketable securities:
Total marketable securities	7,838,590	10,530,942
Total assets measured at fair value	7,838,590	10,530,942
Money Market Funds
Cash equivalents:
Total cash equivalents	5,501,965	4,285,309
Money Market Funds | Fair Value, Inputs, Level 1
Cash equivalents:
Total cash equivalents	5,501,965	4,285,309
Money Market Funds | Fair Value, Inputs, Level 2
Cash equivalents:
Total cash equivalents	0	0
Money Market Funds | Fair Value, Inputs, Level 3
Cash equivalents:
Total cash equivalents	0	0
Corporate Debt Securities Member
Marketable securities:
Total marketable securities	7,838,590	10,530,942
Corporate Debt Securities Member | Fair Value, Inputs, Level 1
Marketable securities:
Total marketable securities	0	0
Corporate Debt Securities Member | Fair Value, Inputs, Level 2
Marketable securities:
Total marketable securities	7,838,590	10,530,942
Corporate Debt Securities Member | Fair Value, Inputs, Level 3
Marketable securities:
Total marketable securities	$ 0	$ 0

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(1) Summary of Significant Accounting Policies (Details) (USD $)	Jun. 30, 2013	Dec. 31, 2012
Notes to Financial Statements
Goodwill	$ 4,150,339	$ 4,150,339
Other intangible assets
Gross carrying amount	3,190,369	3,128,588
Accumulated amortization	3,011,391	2,954,162
Net carrying amount	$ 178,978	$ 174,426

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(2) Share-Based Payment Arrangements (Details 1)	Jun. 30, 2013	Mar. 31, 2013	Dec. 31, 2012
Shares outstanding	11,200,955	10,876,047	11,360,842
FalconStor Software, Inc., 2000 Stock Option Plan Member
Shares Available for grant	0
Shares outstanding	1,646,397
2004 Outside Directors Stock Option Plan Member
Shares Available for grant	0
Shares outstanding	190,000
FalconStor Software, Inc., 2007 Outside Directors Equity Compensation Plan Member
Shares Available for grant	0
Shares outstanding	170,000
Stand-Alone Stock Option Agreement between the Company and James P. McNiel Member
Shares Available for grant	0
Shares outstanding	805,200
FalconStor 2010 Outside Directors Equity Compensation Plan
Shares Available for grant	0
Shares outstanding	50,500

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(2) Share-Based Payment Arrangements (Details 6) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
Notes to Financial Statements
Non-qualified stock options	$ 0	$ (25,262)	$ 0	$ 29,930
Restricted stock awards	0	0	0	0
Total Share Based Compensation - Nonemployee	$ 0	$ (25,262)	$ 0	$ 29,930

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(11) Schedule Of Segment Reporting By Geographical Areas (Details 2) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
Revenues:
Total Revenues	$ 13,974,139	$ 16,466,201	$ 29,258,956	$ 35,834,273
Long-lived assets:
Total long-lived assets	12,023,561		12,023,561		11,738,879
Americas
Revenues:
Total Revenues	5,195,655	7,085,505	11,631,581	15,201,737
Long-lived assets:
Total long-lived assets	10,541,103		10,541,103		10,263,056
Asia Pacific Member
Revenues:
Total Revenues	4,715,039	4,833,526	9,111,042	10,744,801
Long-lived assets:
Total long-lived assets	918,148		918,148		1,041,470
Europe, Middle East, Africa and Other Member
Revenues:
Total Revenues	4,063,445	4,547,170	8,516,333	9,887,735
Long-lived assets:
Total long-lived assets	$ 564,310		$ 564,310		$ 434,353

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(7) Stockholders' Equity (Details Narrative) (USD $)	6 Months Ended		138 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Dec. 31, 2012	Feb. 28, 2009
Stockholders Equity Details Narrative
Authorization for the repurchase of common stock					14,000,000
Total shares repurchased	0	0	8,005,235
Payment for shares repurchased since October 2001			$ 46,916,339
Preferred stock, par value	$ 0.001		$ 0.001	$ 0.001
Preferred stock, shares authorized	2,000,000		2,000,000	2,000,000

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CONDENSED CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $)	Jun. 30, 2013	Dec. 31, 2012
Statement of Financial Position [Abstract]
Allowances on accounts receivable	$ 419,332	$ 940,101
Accumulated depreciation on Property and equipment	$ 17,260,956	$ 16,131,570
Preferred stock, par value	$ 0.001	$ 0.001
Preferred stock, shares authorized	2,000,000	2,000,000
Common stock, par value	$ 0.001	$ 0.001
Common stock, shares authorized	100,000,000	100,000,000
Common stock, shares issued	56,019,952	55,615,972
Common stock, shares outstanding	48,014,717	47,610,737
Common Stock held in treasury, shares	8,005,235	8,005,235

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(8) Commitments and Contingencies

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(8) Commitments and Contingencies

During the second quarter of 2013 the Company signed a new operating lease covering its corporate office facility that expires in April 2021. The Company also has several operating leases related to offices in the United States and foreign countries. The expiration dates for these leases range from 2013 through 2017. The following is a schedule of future minimum lease payments for all operating leases as of June 30, 2013:

2013	$	1,397,075
2014		2,460,386
2015		1,687,643
2016		1,512,699
2017		1,462,447
Thereafter		5,036,525
	$	13,556,775

The Company typically provides its customers a warranty on its software products for a period of no more than 90 days. Such warranties are accounted for in accordance with the authoritative guidance issued by the FASB on contingencies. To date, the Company has not incurred any costs related to warranty obligations.

Under the terms of substantially all of its software license agreements, the Company has agreed to indemnify its customers for all costs and damages arising from claims against such customers based on, among other things, allegations that the Company’s software infringes the intellectual property rights of a third party. In most cases, in the event of an infringement claim, the Company retains the right to (i) procure for the customer the right to continue using the software; (ii) replace or modify the software to eliminate the infringement while providing substantially equivalent functionality; or (iii) if neither (i) nor (ii) can be reasonably achieved, the Company may terminate the license agreement and refund to the customer a pro-rata portion of the license fee paid to the Company. Such indemnification provisions are accounted for in accordance with the authoritative guidance issued by the FASB on guarantees. As of June 30, 2013 and 2012, there were no claims outstanding under such indemnification provisions.

On July 23, 2013, the Company entered into an Employment Agreement (“Quinn Employment Agreement”) with Gary Quinn. Pursuant to the Quinn Employment Agreement, the Company agreed to employ Mr. Quinn as President and Chief Executive Officer of the Company effective July 23, 2013 through July 22, 2015, at an annual salary of $400,000 per annum. The Quinn Employment Agreement also provides for the grant of 500,000 restricted shares which will vest over a two-year period at 50% and 50% annually. The 500,000 restricted shares were granted to Mr. Quinn by the Company’s Compensation Committee on August 5, 2013.

On June 28, 2013, the President and Chief Executive Officer, and a Director, of FalconStor Software, Inc. (the “Company”), James P. McNiel, resigned from all of his positions with the Company, effective immediately. The Company also entered into a Severance Agreement and General Release (the “Agreement”), with Mr. McNiel.  Pursuant to the Agreement, among other things, the Company agreed to pay to Mr. McNiel $400,000 in severance pay and to purchase certain office furniture from Mr. McNiel for $20,000. These payments were made in July 2013.

On December 1, 2005, the Company adopted the 2005 FalconStor Software, Inc., Key Executive Severance Protection Plan, which was amended January 4, 2013 (“Severance Plan”). Pursuant to the Severance Plan, the Company’s Chief Executive Officer, Chief Financial Officer and certain other key personnel are entitled to receive certain contingent benefits, as set forth in the Severance Plan, including lump sum payments and acceleration of stock option vesting, each in certain circumstances.

As of June 30, 2013, the Company had a total of $1.7 million of payables outstanding relating to its settlement with the United States Attorney’s Office, which is to be paid in December 2013. In addition, on January 20, 2013, the Company announced that it had reached a proposed settlement of the Class Action lawsuit between the Company and class plaintiffs for $5.0 million. Court approval of the settlement is required. A joint stipulation of settlement and motion for preliminary approval of the settlement was filed with the Court on June 14, 2013, and as of the date of the filing of this quarterly report on Form 10-Q, no ruling has been made.

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CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
Statement of Comprehensive Income [Abstract]
Net Loss	$ (5,207,293)	$ (6,620,586)	$ (9,587,738)	$ (9,069,994)
Other comprehensive income (loss), net of taxes (benefits):
Foreign currency translation	(19,737)	(34,261)	14,790	(163,860)
Net unrealized gains on marketable securities	(5,457)	13,513	(1,450)	58,357
Net minimum pension liability	3,612	1,669	(946)	7,120
Total other comprehensive income (loss), net of taxes (benefits):	(21,582)	(19,079)	12,394	(98,383)
Total comprehensive loss, net	$ (5,228,875)	$ (6,639,665)	$ (9,575,344)	$ (9,168,377)

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CONDENSED CONSOLIDATED BALANCE SHEETS (USD $)	Jun. 30, 2013	Dec. 31, 2012
Current assets:
Cash and cash equivalents	$ 13,293,780	$ 18,651,468
Restricted cash	750,000	750,000
Marketable securities	7,838,590	10,530,942
Accounts receivable, net of allowances of $419,332 and $940,101, respectively	9,737,521	14,130,302
Prepaid expenses and other current assets	2,556,121	2,796,665
Inventory	904,198	642,819
Deferred tax assets, net	407,008	464,031
Total current assets	35,487,218	47,966,227
Property and equipment, net of accumulated depreciation of $17,260,956 and $16,131,570, respectively	3,930,107	3,980,679
Deferred tax assets, net	86,465	86,465
Software development costs, net	1,245,126	1,161,822
Other assets, net	2,432,546	2,185,148
Goodwill	4,150,339	4,150,339
Other intangible assets, net	178,978	174,426
Total assets	47,510,779	59,705,106
Current liabilities:
Accounts payable	2,076,073	2,801,372
Accrued expenses	14,363,908	16,720,582
Deferred revenue, net	17,524,607	17,831,653
Total current liabilities	33,964,588	37,353,607
Other long-term liabilities	2,689,636	2,618,818
Deferred tax liabilities, net	175,647	167,875
Deferred revenue, net	5,174,282	6,311,865
Total liabilities	42,004,153	46,452,165
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.001 par value, 2,000,000 shares authorized	0	0
Common stock - $.001 par value, 100,000,000 shares authorized, 56,019,952 and 55,615,972 shares issued, respectively and 48,014,717 and 47,610,737 shares outstanding, respectively	56,020	55,616
Additional paid-in capital	164,502,458	162,673,833
Accumulated deficit	(110,497,857)	(100,910,119)
Common stock held in treasury, at cost (8,005,235 and 8,005,235 shares, respectively)	46,916,339	46,916,339
Accumulated other comprehensive loss, net	(1,637,656)	(1,650,050)
Total stockholders' equity	5,506,626	13,252,941
Total liabilities and stockholders' equity	$ 47,510,779	$ 59,705,106

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(11) Segment Reporting (Details Narrative) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013 Customer One	Dec. 31, 2012 Customer One	Jun. 30, 2013 Customer Two
Percentage of accounts receivable from one major customer					14.00%	20.00%	10.00%
Percentage of revenue from two major customer	10.00%	10.00%
Sales return reserve (benefit) expense	$ 100,000	$ 300,000	$ (100,000)	$ (300,000)

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(1) Summary of Significant Accounting Policies (Details 1) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
Basic EPS
Net Loss (Numerator)	$ (5,207,293)	$ (6,620,586)	$ (9,587,738)	$ (9,069,994)
Shares (Denominator)	47,996,027	47,472,909	47,929,799	47,258,696
Basic net loss per share (in dollars per share)	$ (0.11)	$ (0.14)	$ (0.20)	$ (0.19)
Effect of dilutive securities:
Stock options and restricted stock	0	0	0	0
Diluted EPS
Net Loss (Numerator)	$ (5,207,293)	$ (6,620,586)	$ (9,587,738)	$ (9,069,994)
Diluted Shares Outstanding	47,996,027	47,472,909	47,929,799	47,258,696
Diluted net loss per share (in dollars per share)	$ (0.11)	$ (0.14)	$ (0.20)	$ (0.19)

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(5) Marketable Securities (Tables)

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

Schedule Of Available For Sale Securities

	Aggregate		Cost or Amortized		Net Unrealized
	Fair Value		Cost		Gains / (Loss)
Government securities	$	7,838,590	$	7,833,830	$	4,760
Corporate debt securities		—		—		—
	$	7,838,590	$	7,833,830	$	4,760
		Aggregate		Cost or Amortized		Net Unrealized
		Fair Value		Cost		Gains / (Loss)
Government securities	$	8,328,392	$	8,324,372	$	4,020
Corporate debt securities		2,202,550		2,200,360		2,190
	$	10,530,942	$	10,524,732	$	6,210

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(6) Inventories (Details) (USD $)	Jun. 30, 2013	Dec. 31, 2012
Notes to Financial Statements
Component materials	$ 15,365	$ 18,989
Finished systems	888,833	623,830
Total Inventory	$ 904,198	$ 642,819

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(2) Share-Based Payment Arrangements (Details Narrative 1)	6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012
Restricted Stock
Restricted stock issued	2,926,068	2,871,054
Restricted stock vested	2,325,817	2,193,552
Restricted stock forfeited	477,631	464,889
Restricted Stock Unit
Restricted stock issued	90,412	90,412
Restricted stock vested	79,065	78,555
Restricted stock forfeited	11,347	11,347

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(2) Share-Based Payment Arrangements (Details 4) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
Notes to Financial Statements
Directors, officers and employees	$ 32,551	$ 130,164	$ 95,748	$ 407,580
Non-employee consultants	0	0	0	0
Total restricted stock expense	$ 32,551	$ 130,164	$ 95,748	$ 407,580

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(2) Share-Based Payment Arrangements (Details 5)	3 Months Ended
	Jun. 30, 2013	Mar. 31, 2013
Notes to Financial Statements
Number of Restricted Stock Awards/Units Non-Vested, Beginning	118,030	171,190
Granted	50,000	0
Vested	45,410	48,570
Forfeited	0	4,590
Number of Restricted Stock Awards/Units Non-Vested Ending	122,620	118,030

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(7) Stockholders' Equity

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(7) Stockholders' Equity

Stock Repurchase Activity

At various times from October 2001 through February 2009, the Company’s Board of Directors authorized the repurchase of up to 14 million shares of the Company’s outstanding common stock in the aggregate.

During the six months ended June 30, 2013 and 2012, the Company did not repurchase any shares of its common stock. Since October 2001, the Company has repurchased a total of 8,005,235 shares of its common stock at an aggregate purchase price of $46,916,339.

Preferred Stock

The Company is authorized to issue two million shares of $0.001 par value preferred stock. No preferred stock has been issued or outstanding for any period presented. See Note 12 Subsequent Events for further information.

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(1) Summary of Significant Accounting Policies (Details Narrative) (USD $)	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
Cash And Cash Equivalents Fair Value	$ 5,501,965		$ 5,501,965		$ 4,285,309
Restricted cash	750,000		750,000		750,000
Marketable Securities Fair Value	7,838,590		7,838,590		10,530,942
Depreciation Expense	561,448	709,241	1,148,428	1,506,800
Amortization Expense	27,687	29,862	57,229	58,249
Capitalized Software Development Costs	247,429	73,921	247,429	461,555
Capitalized Computer Software Amortization	82,063	78,983	164,125	137,138
Foreign Currency Transaction Gain (Loss)	500,000	100,000	800,000	300,000
Common stock equivalents excluded from diluted net loss per share	11,323,575	12,377,255	11,323,575	12,377,255
Cost method investments	$ 900,000		$ 900,000		$ 900,000
Minimum
Estimated useful lives of the assets			3 years	3 years
Maximum
Estimated useful lives of the assets			7 years	7 years

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(4) Fair Value Measurements (Details Narrative) (USD $)	Jun. 30, 2013	Dec. 31, 2012
Money Market Funds - Level 1	$ 5,501,965	$ 4,285,309
Government Securities and Corporate Debt Securities - Level 2	7,838,590	10,530,942
Money Market Funds
Money Market Funds - Level 1	5,501,965	4,285,309
Fair Value, Inputs, Level 1
Money Market Funds - Level 1	5,501,965	4,285,309
Fair Value, Inputs, Level 1 | Money Market Funds
Money Market Funds - Level 1	5,501,965	4,285,309
Fair Value, Inputs, Level 2
Government Securities and Corporate Debt Securities - Level 2	7,838,590	10,530,942
Fair Value, Inputs, Level 2 | Money Market Funds
Money Market Funds - Level 1	0	0
Fair Value, Inputs, Level 2 | Government Securities and Corporate Debt Securities
Government Securities and Corporate Debt Securities - Level 2	$ 7,838,590	$ 10,530,942

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(10) Litigation

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(10) Litigation

In view of the inherent difficulty of predicting the outcome of litigation, particularly where the claimants seek very large or indeterminate damages, the Company generally cannot predict what the eventual outcome of the pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties related to each pending matter may be.

In accordance with the authoritative guidance issued by the FASB on contingencies, the Company accrues anticipated costs of settlement, damages and losses for claims to the extent specific losses are probable and estimable. The Company records a receivable for insurance recoveries when such amounts are probable and collectable. In such cases, there may be an exposure to loss in excess of any amounts accrued. If, at the time of evaluation, the loss contingency related to a litigation is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable and, the Company will expense these costs as incurred. If the estimate of a probable loss is a range and no amount within the range is more likely, the Company will accrue the minimum amount of the range.

The Internal and Government Investigations

As previously disclosed, both the United States Attorney’s Office for the Eastern District of New York (“USAO”) and the Securities and Exchange Commission (“SEC”) commenced investigations of the Company in October, 2010, in response to the Company’s announcement that it had accepted the resignation of ReiJane Huai, its President and Chief Executive Officer, and the Chairman of its Board of Directors, following his disclosure to the Company that certain improper payments allegedly were made in connection with the Company’s licensing of software to one customer.

The Company conducted its own investigation into the matter and cooperated with the USAO and SEC investigations.

On June 27, 2012, the Company announced that it had entered into settlements with the USAO and the SEC.

The Company entered into a Deferred Prosecution Agreement (DPA) with the USAO. Under the DPA, the USAO agreed that it will defer prosecution of the Company in connection with the matter, and ultimately not prosecute the Company if the Company satisfies its obligations during the 18 month term of the DPA. The DPA acknowledges the remedial actions taken by the Company in response to its discovery of the improper payments and does not require the Company to make any additional control or compliance changes. Under the DPA, the Company will forfeit $2.9 million over eighteen months.

The Company agreed with the SEC to the entry of a Consent Judgment (CJ) to settle a civil action filed by the SEC. Pursuant to the CJ, the Company agreed not to violate the anti-fraud and registration provisions of Sections 17(a)(2), 5(a) and 5(c) of the Securities Act of 1933, and the books and records provisions of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934. The Company further agreed to pay a civil penalty of $2.9 million to the SEC.

As of June 30, 2013, the Company has paid a total of $4.1 million of the total $5.8 million, for which the Company had previously accrued. The balance of $1.7 million is payable in December 2013.

Stockholder Litigation

The Company is a defendant in a class action lawsuit brought in United Stated District Court for the Eastern District of New York, by Company shareholders (the “Class Action”). The other defendants are James Weber, our former CFO and Vice President for Operations, and the estate of ReiJane Huai. Mr. Huai was the Company’s former Chairman, President and CEO.

The Class Action complaint alleges that the defendants defrauded shareholders by falsely certifying in the Company’s SEC filings that they had disclosed any fraud, whether or not material, that involved management or other employees who had a significant role in the registrant’s internal control over financial reporting. The Class Action complaint alleges that the defendants were in fact aware of fraud.

In January, 2013, the parties to the Class Action reached an agreement in principle to settle the Class Action. Pursuant to a Memorandum of Understanding signed by counsel for the class plaintiffs and by counsel for all defendants, the Company will pay $5.0 million to settle the Class Action. This amount includes damages, plaintiffs’ attorneys’ fees, and costs of administration of the settlement. The Company expects to pay this settlement with a combination of cash on hand and insurance proceeds. A stipulation of settlement and a joint motion for preliminary approval of the settlement were submitted to the court for its approval on June 14, 2013. Final settlement of the Class Action is subject to certain conditions and to approval by the court. We cannot predict if or when the court might approve the settlement. Certain of the defendants may be entitled to indemnification by the Company under the laws of Delaware and/or our by-laws.

Company stockholders filed actions in the Suffolk County Division of the Supreme Court of the State of New York, putatively derivatively on behalf of the Company, against the Company, each of the Company’s Directors, Mr. Weber, Wayne Lam, a former Vice president of the Company, the estate of Mr. Huai, and Jason Lin, a former employee of the Company (the “Derivative Action”). The consolidated amended Derivative Action complaint alleged that the defendants breached their duties to the Company by: (1) causing or allowing the dissemination of false and misleading information; (2) failing to maintain internal controls; (3) failing to manage the Company properly; (4) unjustly enriching themselves; (5) abusing their control of the Company; and (6) wasting Company assets.

On March 5, 2013, the Suffolk County Division of the Supreme Court of the State of New York granted a motion made by all of the defendants in the Derivative Action, except Mr. Lin, and dismissed the Derivative Action as to all defendants other than Mr. Lin. The stockholders have filed a notice of appeal of the dismissal of the Derivative Action. The Company cannot predict when the appeal will be resolved or the ultimate outcome of the matter. Certain of the defendants may be entitled to indemnification by the Company under the laws of Delaware and/or the Company’s by-laws.

The Company has insurance policies that were purchased to cover, among other things, lawsuits like the Class Action and the Derivative Action. The Company’s Directors and Officers (“D&O”) Insurance, is composed of more than one layer, each layer written by a different insurance company. However, the events that gave rise to the claims in the Class Action and the Derivative Action caused the Company’s insurers to reserve their rights to disclaim, rescind, or otherwise not be obligated to provide coverage to the Company and certain other insureds under the policies. In light of these uncertainties, the Company has entered into settlements with two of its insurers. Pursuant to these settlements, the Company will not receive repayment of all amounts it might otherwise have received.

In October, 2012, the Company entered into an agreement with the carrier of the first $5.0 million layer of the Company’s D&O insurance. Pursuant to this agreement, the Company accepted a payment of $3.9 million from the first layer insurance carrier in satisfaction of the carrier’s obligations to the Company under the first layer D&O insurance policy. In addition, as part of the October 2012 agreement with the carrier, the Company agreed to indemnify the carrier of the first layer of D&O insurance against potential claims by certain named insured persons under the first layer D&O insurance policy. The Company cannot predict the likelihood or the outcome of any such claims by the named insureds.

Because the carrier of the next layer of insurance would not be obligated to make payment to the Company until the full $5.0 million first layer limit had been exhausted, this means that the Company is responsible for $1.1 million out of pocket before it can again seek reimbursement from its insurers.

On July 31, 2013, after the close the second quarter, the Company entered into an agreement with the carrier of the second $5.0 million layer of the Company’s D&O insurance. Pursuant to the agreement, the insurer agreed to pay seventy five percent (75%) of the Company’s losses attributable to the Class Action and the Derivative Action above the first $5.25 million of such losses. In addition, as part of the July 31, 2013 agreement with the carrier, the Company agreed to indemnify the carrier of the second layer of D&O insurance against potential claims by certain named insured persons under the second layer D&O insurance. The agreement with the carrier is contingent on final approval of the Class Action settlement. The Company cannot predict the likelihood or the outcome of any such claims by the named insureds.

While, at present, the Company does not believe that the amounts it will pay in connection with the Class Action and the Derivative Action will exceed the limits of the first two layers of its coverage, there can be no assurance that if the Company seeks recovery from the additional layers, the recovery the Company makes on the remainder of its insurance will be adequate to cover the costs of its defense or settlement of the Class Action, or any damages that might ultimately be awarded against the Company or anyone to whom the Company might owe indemnification if the settlement is not approved by the court. The Company’s insurers may deny coverage under the policies. If the Company’s insurance recovery is not adequate to cover the costs of defense, settlement, damages and/or indemnification, or its insurers deny coverage, the amounts to be paid by the Company could have a significant negative impact on its financial results, its cash flows and its cash balances.

The Company’s remaining insurers may deny coverage under the policies. If the plaintiffs are awarded damages and the Company’s insurance is not adequate to cover the amounts, or its insurers deny coverage, the amounts to be paid by the Company could have a significant negative impact on our financial results, our cash flow and our cash reserves.

To date, the Company has recorded $7.0 million of total costs associated with the Class Action and the Derivative Actions. The Company has recorded a liability in the amount of $5.2 million in “accrued expenses” in the condensed consolidated balance sheets as of June 30, 2013 which includes estimated costs of resolutions and legal fees for both the Class Action and the Derivative Action to date. As a result of the agreement reached with the insurance carrier for the first layer of the Company’s D&O insurance carrier in the prior year, the Company has recorded an insurance recovery in 2012 of approximately $3.9 million of legal expenses previously incurred related to the class action and derivative lawsuits as well as the potential settlement of the class action lawsuit. The $3.9 million insurance recovery was reimbursed by the Company’s insurance carrier during 2012. As a result of the agreement reached with the insurer of the Company’s next layer of D&O insurance regarding that insurer’s obligations to the Company, the Company has recorded a $1.3 million receivable in “prepaid expenses and other current assets” in the condensed consolidated balance sheet as of June 30, 2013 as collection is deemed probable.

During the three and six months ended June 30, 2013, our total investigation, litigation, and settlement related costs consisted of $0.1 million and $0.2 million, respectively, of net legal expenses related to the class action and derivative lawsuits that are not recoverable through insurance.

Avazpour Litigation

The Company is the defendant in an action brought by Avazpour Networking Services, Inc., and its former principals (collectively, “Avazpour”), pending in the United States District Court for the Eastern District of New York. Avazpour alleged that the Company gave grossly negligent advice in connection with an upgrade of Avazpour’s storage system resulting in damages to Avazpour and breached its contract with Avazpour. On March 13, 2013, the Court granted the Company’s motion to dismiss all of the claims except for the claim of breach of contract. In June, 2013, the Company and the Avazpour reached an agreement in principle to settle the claim for $250,000. This amount will be paid by the Company’s insurers.

Other Claims

The Company is subject to various legal proceedings and claims, asserted or unasserted, which arise in the ordinary course of business. While the outcome of any such matters cannot be predicted with certainty, such matters are not expected to have a material adverse effect on the Company’s financial condition or operating results.

The Company continues to assess certain litigation and claims to determine the amounts, if any, that the Company believes may be paid as a result of such claims and litigation and, therefore, additional losses may be accrued and paid in the future, which could materially adversely impact the Company’s financial results, its cash flows and its cash reserves.

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(6) Inventories

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(6) Inventories

Inventories consist of component materials and finished systems. Inventories are stated at the lower of cost (first-in, first-out) or market, not in excess of net realizable value. Component material consists of certain key replacement parts for the finished systems. Inventories are as follows:

		June 30,		December 31,
		2013		2012
Component materials	$	15,365	$	18,989
Finished systems		888,833		623,830
	$	904,198	$	642,819

As of June 30, 2013 and December 31, 2012, the Company has not recorded any reserve for excess and/or obsolete inventories in arriving at estimated net realizable value of its inventory.

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(1) Summary of Significant Accounting Policies

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(1) Summary of Significant Accounting Policies

(1) Summary of Significant Accounting Policies

(a) The Company and Nature of Operations

FalconStor Software, Inc., a Delaware Corporation (the "Company"), develops, manufactures and sells data protection solutions and provides the related maintenance, implementation and engineering services.

(b) Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

(c) Reclassifications

Certain prior year’s amounts have been reclassified to conform to the current year presentation. Certain costs previously recorded within “selling and marketing” are now presented within “research and development” to better align these costs with functions performed.

(d) Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include those related to revenue recognition, accounts receivable allowances, share-based payment compensation, cost-based investments, marketable securities, software development costs, goodwill and other intangible assets and income taxes. Actual results could differ from those estimates.

The financial market volatility in many countries where the Company operates has impacted and may continue to impact the Company’s business. Such conditions could have a material impact to the Company’s significant accounting estimates discussed above.

(e) Unaudited Interim Financial Information

The accompanying unaudited interim condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements.

In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company at June 30, 2013, and the results of its operations for the three and six months ended June 30, 2013 and 2012. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year.

 (f) Cash Equivalent, Restricted Cash and Marketable Securities

The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. The Company records its cash equivalents and marketable securities at fair value in accordance with the authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) on fair value measurements and disclosures. As of June 30, 2013 and December 31, 2012, the Company’s cash equivalents consisted of money market funds. At June 30, 2013 and December 31, 2012, the fair value of the Company’s cash equivalents amounted to approximately $5.5 million and $4.3 million, respectively.

As of June 30, 2013 and December 31, 2012, the Company had $0.8 million of restricted cash. The restricted cash serves as collateral related to deposit service indebtedness with the Company’s commercial bank. As of June 30, 2013 and December 31, 2012, the Company did not have any debt service indebtedness with the Company’s bank.

As of June 30, 2013 and December 31, 2012, the Company’s marketable securities consisted of corporate bond and government securities. As of June 30, 2013 and December 31, 2012, the fair value of the Company’s current marketable securities was approximately $7.8 million and $10.5 million, respectively. All of the Company’s marketable securities are classified as available-for-sale, and accordingly, unrealized gains and losses on marketable securities, net of tax, are reflected as a component of accumulated other comprehensive loss in stockholders’ equity. Any other-than-temporary impairments are recorded within interest and other loss, net in the condensed consolidated statement of operations. See Note (5) Marketable Securities for additional information.

(g) Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability of fair value measurements, a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies, is as follows:

Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.

Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3—Valuations based on unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

As of June 30, 2013 and December 31, 2012, the fair value of the Company’s financial instruments including cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses, approximated carrying value due to the short maturity of these instruments. See Note (4) Fair Value Measurements for additional information.

(h) Revenue Recognition

The Company derives its revenue from sales of its products, support and services. Product revenue consists of the Company’s software integrated with industry standard hardware and sold as complete turn-key integrated solutions. Product revenue also consists of stand-alone software applications. Support and services revenue consists of both maintenance revenues and professional services revenues. Revenue is recorded net of applicable sales taxes.

In accordance with the authoritative guidance issued by the FASB on revenue recognition, the Company recognizes revenue from product sales when persuasive evidence of an arrangement exists, the fee is fixed and determinable, the product is delivered, and collection of the resulting receivable is deemed probable. Products delivered to a customer on a trial basis are not recognized as revenue until a permanent key code is delivered to the customer. Reseller customers typically send the Company a purchase order when they have an end user identified. For bundled arrangements that include either maintenance or both maintenance and professional services, the Company uses the residual method to determine the amount of product revenue to be recognized. Under the residual method, consideration is allocated to the undelivered elements based upon vendor-specific objective evidence (“VSOE”) of the fair value of those elements, with the residual of the arrangement fee allocated to and recognized as product revenue. The long-term portion of deferred revenue relates to maintenance contracts with terms in excess of one year. The Company provides an allowance for product returns as a reduction of revenue, based upon historical experience and known or expected trends.

Revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract. Revenues associated with software implementation and software engineering services are recognized when the services are performed. Costs of providing these services are included in cost of support and services.

The Company has entered into various distribution, licensing and joint promotion agreements with OEMs, whereby the Company has provided to the OEM a non-exclusive software license to install the Company’s software on certain hardware or to resell the Company’s software in exchange for payments based on the products distributed by these OEMs. Such payments from these OEMs or distributors are recognized as revenue in the period reported by the OEM.

(i) Property and Equipment

Property and equipment are recorded at cost. Depreciation is recognized using the straight-line method over the estimated useful lives of the assets (3 to 7 years). For the three months ended June 30, 2013 and 2012, depreciation expense was $561,448 and $709,241, respectively. For the six months ended June 30, 2013 and 2012, depreciation expense was $1,148,428 and $1,506,800, respectively. Leasehold improvements are amortized on a straight-line basis over the term of the respective leases or over their estimated useful lives, whichever is shorter.

(j) Goodwill and Other Intangible Assets

Goodwill represents the excess of the purchase price over the estimated fair value of net tangible and identifiable intangible assets acquired in business combinations. The Company has not amortized goodwill related to its acquisitions, but instead tests the balance for impairment. The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate that the carrying value may not be recoverable. The Company tests goodwill for impairment by first comparing the book value of net assets to the fair value of the reporting unit. If the fair value is determined to be less than the book value or qualitative factors indicate that it is more likely than not that goodwill is impaired, a second step is performed to compute the amount of impairment as the difference between the estimated fair value of goodwill and the carrying value.

The Company’s annual impairment assessment is performed during the fourth quarter of each year, and the Company has determined there to be no impairment for any of the periods presented. Identifiable intangible assets include (i) assets acquired through business combinations, which include customer contracts and intellectual property, and (ii) patents amortized over three years using the straight-line method.

For the three months ended June 30, 2013 and 2012, amortization expense was $27,687 and $29,862, respectively. For the six months ended June 30, 2013 and 2012, amortization expense was $57,229 and $58,249, respectively. The gross carrying amount and accumulated amortization of other intangible assets as of June 30, 2013 and December 31, 2012 are as follows:

	June 30,	December 31,
	2013	2012
Goodwill	$        4,150,339	$        4,150,339
Other intangible assets:
Gross carrying amount	$        3,190,369	$        3,128,588
Accumulated amortization	(3,011,391)	(2,954,162)
Net carrying amount	$           178,978	$           174,426

(k) Software Development Costs

In accordance with the authoritative guidance issued by the FASB on costs of software to be sold, leased, or marketed, costs associated with the development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility of the product has been established. Based on the Company’s product development process, technological feasibility is established upon completion of a working model. Amortization of software development costs is recorded at the greater of the straight-line basis over the product’s estimated life, or the ratio of current revenue of the related products to total current and anticipated future revenue of these products. During the three and six months ended June 30, 2013, the Company capitalized $247,429 of costs associated with software development projects. During the three and six months ended June 30, 2012, the Company capitalized $73,921 and $461,555, respectively, of costs associated with software development projects. During the three months ended June 30, 2013 and 2012, the Company recorded $82,063 and $78,983, respectively, of amortization expense related to capitalized software costs. During the six months ended June 30, 2013 and 2012, the Company recorded $164,125 and $137,138, respectively, of amortization expense related to capitalized software costs.

(l) Income Taxes

The Company records income taxes under the liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In determining the period in which related tax benefits are realized for financial reporting purposes, excess share-based compensation deductions included in net operating losses are realized after regular net operating losses are exhausted.

The Company accounts for uncertain tax positions in accordance with the authoritative guidance issued by the FASB on income taxes, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return, should be recorded in the financial statements. Pursuant to the authoritative guidance, the Company may recognize the tax benefit from an uncertain tax position only if it meets the “more likely than not” threshold that the position will be sustained on examination by the taxing authority, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. In addition, the authoritative guidance addresses de-recognition, classification, interest and penalties on income taxes, accounting in interim periods, and also requires increased disclosures. The Company includes interest and penalties related to its uncertain tax positions as part of income tax expense within its consolidated statement of operations. See Note (3) Income Taxes for additional information.

 (m) Long-Lived Assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the sum of the expected future cash flows, undiscounted and without interest, is less than the carrying amount of the asset, an impairment loss is recognized as the amount by which the carrying amount of the asset exceeds its fair value.

(n) Share-Based Payments

The Company accounts for share-based payments in accordance with the authoritative guidance issued by the FASB on share-based compensation, which establishes the accounting for transactions in which an entity exchanges its equity instruments for goods or services. Under the provisions of the authoritative guidance, share-based compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period), net of estimated forfeitures. The Company estimates the fair value of share-based payments using the Black-Scholes option-pricing model. The estimation of share-based awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from the Company’s current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. Additionally, share-based awards to non-employees are expensed over the period in which the related services are rendered at their fair value. All share-based awards are expected to be fulfilled with new shares of common stock. See Note (2) Share-Based Payment Arrangements for additional information.

(o) Foreign Currency

Assets and liabilities of foreign operations are translated at rates of exchange at the end of the period, while results of operations are translated at average exchange rates in effect for the period. Gains and losses from the translation of foreign assets and liabilities from the functional currency of the Company’s subsidiaries into the U.S. dollar are classified as accumulated other comprehensive loss in stockholders’ equity. Gains and losses from foreign currency transactions are included in the condensed consolidated statements of operations within interest and other loss, net.

During the three months ended June 30, 2013 and 2012, foreign currency transactional losses totaled approximately $0.5 million and $0.1 million, respectively. During the six months ended June 30, 2013 and 2012, foreign currency transactional losses totaled approximately $0.8 million and $0.3 million, respectively. 

(p) Earnings Per Share (EPS)

Basic EPS is computed based on the weighted average number of shares of common stock outstanding. Diluted EPS is computed based on the weighted average number of common shares outstanding increased by dilutive common stock equivalents, attributable to stock option awards, restricted stock awards and restricted stock unit awards outstanding. Due to the net loss for the three and six months ended June 30, 2013 and 2012, all common stock equivalents, totaling 11,323,575 and 12,377,225, respectively, were excluded from diluted net loss per share because they were anti-dilutive.

The following represents a reconciliation of the numerators and denominators of the basic and diluted EPS computation:

	Three Months Ended June 30, 2013				Three Months Ended June 30, 2012
	Net Loss	Shares	Per Share	Net Loss	Shares	Per Share
	(Numerator)	(Denominator)	Amount	(Numerator)	(Denominator)	Amount
Basic EPS	$      (5,207,293)	47,996,027	$               (0.11)	$      (6,620,586)	47,472,909	$               (0.14)
Effect of dilutive securities:
Stock options and
restricted stock		-			-
Diluted EPS	$      (5,207,293)	47,996,027	$               (0.11)	$      (6,620,586)	47,472,909	$               (0.14)
	Six Months Ended June 30, 2013				Six Months Ended June 30, 2012
	Net Loss	Shares	Per Share	Net Loss	Shares	Per Share
	(Numerator)	(Denominator)	Amount	(Numerator)	(Denominator)	Amount
Basic EPS	$      (9,587,738)	47,929,799	$               (0.20)	$      (9,069,994)	47,258,696	$               (0.19)
Effect of dilutive securities:
Stock options and
restricted stock		-			-
Diluted EPS	$      (9,587,738)	47,929,799	$               (0.20)	$      (9,069,994)	47,258,696	$               (0.19)

(q) Investments

As of June 30, 2013 and December 31, 2012, the Company maintained certain cost-method investments aggregating approximately $0.9 million, which are included within “other assets, net” in the accompanying condensed consolidated balance sheets. During the three and six months ended June 30, 2013 and 2012, the Company did not recognize any impairment charges related to any of its cost-method investments. See Note 12 Subsequent Events for further information.

(r) Treasury Stock

The Company accounts for treasury stock under the cost method and includes treasury stock as a component of stockholders’ equity.

(s) New Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (“FASB”) issued new guidance which requires companies to present information about reclassification adjustments from accumulated other comprehensive income in their financial statements or footnotes. The adoption of this new accounting guidance in the first quarter of 2013 did not have a material impact on our consolidated financial position, results of operations or cash flows. See Note (9) Accumulated Other Comprehensive Loss for the related disclosure. 

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(12) Subsequent Events (Details Narrative)	6 Months Ended
	Jun. 30, 2013
Private Equity Investment
Subsequent Event, date	Aug. 05, 2013
Subsequent Event, description	On August 5, 2013, the Company reached an agreement in principle, and signed a term sheet, for an investment of between $7.5 million and $15.0 million from a private equity group. The investment will be in the form of redeemable convertible preferred stock. Closing of the investment is subject to the negotiation of definitive documents and certain other conditions.
Sale of Blue Whale investment
Subsequent Event, date	Aug. 07, 2013
Subsequent Event, description	On August 7, 2013, the Company signed an Equity Transfer Agreement, to sell its interest in Tianjin Zhongke Blue Whale Information Technologies Co., Ltd. (“Blue Whale”), a Chinese joint venture, for $3.0 million. Closing of the sale is subject to certain conditions, including the approval of the appropriate government entities in China.

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(8) Commitments and Contingencies (Details Narrative) (USD $)	6 Months Ended
	Jun. 30, 2013	Jul. 23, 2013 Quinn Employment Agreement	Jan. 20, 2013 Proposed Settlement Class Action Lawsuit
Warranty on software products	The Company typically provides its customers a warranty on its software products for a period of no more than 90 days.
Annual salary President and Chief Executive Officer of the Company effective July 23, 2013 through July 22, 2015		$ 400,000
Severance pay	400,000
Settlement with United States Attorney's Office amount liability, payable in December 2013	1,700,000
Class Action lawsuit between the Company and class plaintiffs proposed settlement			$ 5,000,000
Restricted shares grants		500,000
Restricted shares vesting period		2 years
Percentage of shares vested in Year 1		50.00%
Percentage of shares vested in Year 2		50.00%

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(2) Share-Based Payment Arrangements (Details 2) (USD $)	3 Months Ended			6 Months Ended
	Jun. 30, 2013	Mar. 31, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
Notes to Financial Statements
Number of Options Outstanding, Beginning	10,876,047	11,360,842		11,360,842
Number of Options Granted	1,812,000	70,000
Number of Options Exercised	0	310,000
Number of Options Forfeited	1,334,592	224,795
Number of Options Expired	152,500	20,000
Number of Options Outstanding, Ending	11,200,955	10,876,047		11,200,955
Number of Options Exercisable	7,173,298			7,173,298
Weighted Average Exercise Price Outstanding, Beginning	$ 4.72	$ 4.66		$ 4.66
Weighted Average Exercise Price Granted	$ 1.38	$ 2.31
Weighted Average Exercise Price Exercised	$ 0.00	$ 2.25
Weighted Average Exercise Price Forfeited	$ 4.04	$ 4.56
Weighted Average Exercise Price Expired	$ 5.44	$ 3.96
Weighted Average Exercise Price Outstanding, Ending	$ 4.25	$ 4.72		$ 4.25
Weighted Average Exercise Price Exercisable	$ 5.46			$ 5.46
Weighted Average Remaining Contractual Life (in years) Outstanding	5 years 11 months 5 days	6 years 1 month 17 days
Weighted Average Remaining Contractual Life (in years) Exercisable				4 years 1 month 6 days
Aggregate Intrinsic Value Outstanding, Beginning	$ 1,136,141
Aggregate Intrinsic Value Exercised	0		188,609	121,819	266,862
Aggregate Intrinsic Value Outstanding, Ending	15,505	1,136,141		15,505
Aggregate Intrinsic Value Exercisable	$ 0			$ 0

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(1) Summary of Significant Accounting Policies (Policies)

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(a) The Company and Nature of Operations

FalconStor Software, Inc., a Delaware Corporation (the "Company"), develops, manufactures and sells data protection solutions and provides the related maintenance, implementation and engineering services.

(b) Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

(c) Reclassifications

Certain prior year’s amounts have been reclassified to conform to the current year presentation. Certain costs previously recorded within “selling and marketing” are now presented within “research and development” to better align these costs with functions performed.

(d) Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include those related to revenue recognition, accounts receivable allowances, share-based payment compensation, cost-based investments, marketable securities, software development costs, goodwill and other intangible assets and income taxes. Actual results could differ from those estimates.

The financial market volatility in many countries where the Company operates has impacted and may continue to impact the Company’s business. Such conditions could have a material impact to the Company’s significant accounting estimates discussed above.

(e) Unaudited Interim Financial Information

The accompanying unaudited interim condensed consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements.

In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company at June 30, 2013, and the results of its operations for the three and six months ended June 30, 2013 and 2012. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year.

(f) Cash Equivalents, Restricted Cash and Marketable Securities

The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. The Company records its cash equivalents and marketable securities at fair value in accordance with the authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) on fair value measurements and disclosures. As of June 30, 2013 and December 31, 2012, the Company’s cash equivalents consisted of money market funds. At June 30, 2013 and December 31, 2012, the fair value of the Company’s cash equivalents amounted to approximately $5.5 million and $4.3 million, respectively.

As of June 30, 2013 and December 31, 2012, the Company had $0.8 million of restricted cash. The restricted cash serves as collateral related to deposit service indebtedness with the Company’s commercial bank. As of June 30, 2013 and December 31, 2012, the Company did not have any debt service indebtedness with the Company’s bank.

As of June 30, 2013 and December 31, 2012, the Company’s marketable securities consisted of corporate bond and government securities. As of June 30, 2013 and December 31, 2012, the fair value of the Company’s current marketable securities was approximately $7.8 million and $10.5 million, respectively. All of the Company’s marketable securities are classified as available-for-sale, and accordingly, unrealized gains and losses on marketable securities, net of tax, are reflected as a component of accumulated other comprehensive loss in stockholders’ equity. Any other-than-temporary impairments are recorded within interest and other loss, net in the condensed consolidated statement of operations. See Note (5) Marketable Securities for additional information.

(g) Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability of fair value measurements, a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies, is as follows:

Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.

Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3—Valuations based on unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

As of June 30, 2013 and December 31, 2012, the fair value of the Company’s financial instruments including cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses, approximated carrying value due to the short maturity of these instruments. See Note (4) Fair Value Measurements for additional information.

(h) Revenue Recognition

The Company derives its revenue from sales of its products, support and services. Product revenue consists of the Company’s software integrated with industry standard hardware and sold as complete turn-key integrated solutions. Product revenue also consists of stand-alone software applications. Support and services revenue consists of both maintenance revenues and professional services revenues. Revenue is recorded net of applicable sales taxes.

In accordance with the authoritative guidance issued by the FASB on revenue recognition, the Company recognizes revenue from product sales when persuasive evidence of an arrangement exists, the fee is fixed and determinable, the product is delivered, and collection of the resulting receivable is deemed probable. Products delivered to a customer on a trial basis are not recognized as revenue until a permanent key code is delivered to the customer. Reseller customers typically send the Company a purchase order when they have an end user identified. For bundled arrangements that include either maintenance or both maintenance and professional services, the Company uses the residual method to determine the amount of product revenue to be recognized. Under the residual method, consideration is allocated to the undelivered elements based upon vendor-specific objective evidence (“VSOE”) of the fair value of those elements, with the residual of the arrangement fee allocated to and recognized as product revenue. The long-term portion of deferred revenue relates to maintenance contracts with terms in excess of one year. The Company provides an allowance for product returns as a reduction of revenue, based upon historical experience and known or expected trends.

Revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract. Revenues associated with software implementation and software engineering services are recognized when the services are performed. Costs of providing these services are included in cost of support and services.

The Company has entered into various distribution, licensing and joint promotion agreements with OEMs, whereby the Company has provided to the OEM a non-exclusive software license to install the Company’s software on certain hardware or to resell the Company’s software in exchange for payments based on the products distributed by these OEMs. Such payments from these OEMs or distributors are recognized as revenue in the period reported by the OEM.

(i) Property and Equipment

Property and equipment are recorded at cost. Depreciation is recognized using the straight-line method over the estimated useful lives of the assets (3 to 7 years). For the three months ended June 30, 2013 and 2012, depreciation expense was $561,448 and $709,241, respectively. For the six months ended June 30, 2013 and 2012, depreciation expense was $1,148,428 and $1,506,800, respectively. Leasehold improvements are amortized on a straight-line basis over the term of the respective leases or over their estimated useful lives, whichever is shorter.

(j) Goodwill and Other Intangible Assets

Goodwill represents the excess of the purchase price over the estimated fair value of net tangible and identifiable intangible assets acquired in business combinations. The Company has not amortized goodwill related to its acquisitions, but instead tests the balance for impairment. The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate that the carrying value may not be recoverable. The Company tests goodwill for impairment by first comparing the book value of net assets to the fair value of the reporting unit. If the fair value is determined to be less than the book value or qualitative factors indicate that it is more likely than not that goodwill is impaired, a second step is performed to compute the amount of impairment as the difference between the estimated fair value of goodwill and the carrying value.

The Company’s annual impairment assessment is performed during the fourth quarter of each year, and the Company has determined there to be no impairment for any of the periods presented. Identifiable intangible assets include (i) assets acquired through business combinations, which include customer contracts and intellectual property, and (ii) patents amortized over three years using the straight-line method.

For the three months ended June 30, 2013 and 2012, amortization expense was $27,687 and $29,862, respectively. For the six months ended June 30, 2013 and 2012, amortization expense was $57,229 and $58,249, respectively. The gross carrying amount and accumulated amortization of other intangible assets as of June 30, 2013 and December 31, 2012 are as follows:

	June 30,	December 31,
	2013	2012
Goodwill	$        4,150,339	$        4,150,339
Other intangible assets:
Gross carrying amount	$        3,190,369	$        3,128,588
Accumulated amortization	(3,011,391)	(2,954,162)
Net carrying amount	$           178,978	$           174,426

(k) Software Development Costs and Purchased Software Technology

In accordance with the authoritative guidance issued by the FASB on costs of software to be sold, leased, or marketed, costs associated with the development of new software products and enhancements to existing software products are expensed as incurred until technological feasibility of the product has been established. Based on the Company’s product development process, technological feasibility is established upon completion of a working model. Amortization of software development costs is recorded at the greater of the straight-line basis over the product’s estimated life, or the ratio of current revenue of the related products to total current and anticipated future revenue of these products. During the three and six months ended June 30, 2013, the Company capitalized $247,429 of costs associated with software development projects. During the three and six months ended June 30, 2012, the Company capitalized $73,921 and $461,555, respectively, of costs associated with software development projects. During the three months ended June 30, 2013 and 2012, the Company recorded $82,063 and $78,983, respectively, of amortization expense related to capitalized software costs. During the six months ended June 30, 2013 and 2012, the Company recorded $164,125 and $137,138, respectively, of amortization expense related to capitalized software costs.

(l) Income Taxes

The Company records income taxes under the liability method. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. In determining the period in which related tax benefits are realized for financial reporting purposes, excess share-based compensation deductions included in net operating losses are realized after regular net operating losses are exhausted.

The Company accounts for uncertain tax positions in accordance with the authoritative guidance issued by the FASB on income taxes, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return, should be recorded in the financial statements. Pursuant to the authoritative guidance, the Company may recognize the tax benefit from an uncertain tax position only if it meets the “more likely than not” threshold that the position will be sustained on examination by the taxing authority, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. In addition, the authoritative guidance addresses de-recognition, classification, interest and penalties on income taxes, accounting in interim periods, and also requires increased disclosures. The Company includes interest and penalties related to its uncertain tax positions as part of income tax expense within its consolidated statement of operations. See Note (3) Income Taxes for additional information.

(m) Long-Lived Assets

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the sum of the expected future cash flows, undiscounted and without interest, is less than the carrying amount of the asset, an impairment loss is recognized as the amount by which the carrying amount of the asset exceeds its fair value.

(n) Share-Based Payments

The Company accounts for share-based payments in accordance with the authoritative guidance issued by the FASB on share-based compensation, which establishes the accounting for transactions in which an entity exchanges its equity instruments for goods or services. Under the provisions of the authoritative guidance, share-based compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period), net of estimated forfeitures. The Company estimates the fair value of share-based payments using the Black-Scholes option-pricing model. The estimation of share-based awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from the Company’s current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. The Company considers many factors when estimating expected forfeitures, including types of awards, employee class and historical experience. Additionally, share-based awards to non-employees are expensed over the period in which the related services are rendered at their fair value. All share-based awards are expected to be fulfilled with new shares of common stock. See Note (2) Share-Based Payment Arrangements for additional information.

(o) Foreign Currency

Assets and liabilities of foreign operations are translated at rates of exchange at the end of the period, while results of operations are translated at average exchange rates in effect for the period. Gains and losses from the translation of foreign assets and liabilities from the functional currency of the Company’s subsidiaries into the U.S. dollar are classified as accumulated other comprehensive loss in stockholders’ equity. Gains and losses from foreign currency transactions are included in the condensed consolidated statements of operations within interest and other loss, net.

During the three months ended June 30, 2013 and 2012, foreign currency transactional losses totaled approximately $0.5 million and $0.1 million, respectively. During the six months ended June 30, 2013 and 2012, foreign currency transactional losses totaled approximately $0.8 million and $0.3 million, respectively.

(p) Earnings Per Share (EPS)

Basic EPS is computed based on the weighted average number of shares of common stock outstanding. Diluted EPS is computed based on the weighted average number of common shares outstanding increased by dilutive common stock equivalents, attributable to stock option awards, restricted stock awards and restricted stock unit awards outstanding. Due to the net loss for the three and six months ended June 30, 2013 and 2012, all common stock equivalents, totaling 11,323,575 and 12,377,225, respectively, were excluded from diluted net loss per share because they were anti-dilutive.

The following represents a reconciliation of the numerators and denominators of the basic and diluted EPS computation:

	Three Months Ended June 30, 2013			Three Months Ended June 30, 2012
	Net Loss	Shares	Per Share	Net Loss	Shares	Per Share
	(Numerator)	(Denominator)	Amount	(Numerator)	(Denominator)	Amount
Basic EPS	$      (5,207,293)	47,996,027	$               (0.11)	$      (6,620,586)	47,472,909	$               (0.14)
Effect of dilutive securities:
Stock options and
restricted stock		-			-
Diluted EPS	$      (5,207,293)	47,996,027	$               (0.11)	$      (6,620,586)	47,472,909	$               (0.14)
	Six Months Ended June 30, 2013			Six Months Ended June 30, 2012
	Net Loss	Shares	Per Share	Net Loss	Shares	Per Share
	(Numerator)	(Denominator)	Amount	(Numerator)	(Denominator)	Amount
Basic EPS	$      (9,587,738)	47,929,799	$               (0.20)	$      (9,069,994)	47,258,696	$               (0.19)
Effect of dilutive securities:
Stock options and
restricted stock		-			-
Diluted EPS	$      (9,587,738)	47,929,799	$               (0.20)	$      (9,069,994)	47,258,696	$               (0.19)

(q) Investments

As of June 30, 2013 and December 31, 2012, the Company maintained certain cost-method investments aggregating approximately $0.9 million, which are included within “other assets, net” in the accompanying condensed consolidated balance sheets. During the three and six months ended June 30, 2013 and 2012, the Company did not recognize any impairment charges related to any of its cost-method investments. See Note 12 Subsequent Events for further information.

(r) Treasury Stock

The Company accounts for treasury stock under the cost method and includes treasury stock as a component of stockholders’ equity.

(s) New Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (“FASB”) issued new guidance which requires companies to present information about reclassification adjustments from accumulated other comprehensive income in their financial statements or footnotes. The adoption of this new accounting guidance in the first quarter of 2013 did not have a material impact on our consolidated financial position, results of operations or cash flows. See Note (9) Accumulated Other Comprehensive Loss for the related disclosure. 

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(9) Accumulated Other Comprehensive Loss

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

(9) Accumulated Other Comprehensive Loss

The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended June 30, 2013 are as follows:

				Net Unrealized
	Foreign Currency			Gains on Marketable			Net Minimum
	Translation			Securities			Pension Liability			Total
Accumulated other comprehensive (loss) income at March 31, 2013	$	(1,566,611	)	$	10,217		$	(59,680	)	$	(1,616,074	)
Other comprehensive (loss) income
Other comprehensive (loss) income       before reclassifications		(19,737	)		(2,258)			1,471			(20,524	)
Amounts reclassified from accumulated       other comprehensive (loss) income		—			(3,199)			2,141			(1,058)
Total other comprehensive (loss) income		(19,737	)		(5,457	)		3,612			(21,582	)
Accumulated other comprehensive (loss) income at June 30, 2013	$	(1,586,348	)	$	4,760		$	(56,068	)	$	(1,637,656	)
The changes in Accumulated Other Comprehensive Loss, net of tax, for the six months ended June 30, 2013 are as follows:
					Net Unrealized
		Foreign Currency			Gains on Marketable			Net Minimum
		Translation			Securities			Pension Liability			Total
Accumulated other comprehensive (loss) income at January 1, 2013	$	(1,601,138	)	$	6,210		$	(55,122	)	$	(1,650,050	)
Other comprehensive income (loss)
Other comprehensive income (loss)       before reclassifications		14,790			1,749			(5,229	)		11,310
Amounts reclassified from accumulated       other comprehensive income		—			(3,199)			4,283			1,084
Total other comprehensive income (loss)		14,790			(1,450	)		(946	)		12,394
Accumulated other comprehensive (loss) income at June 30, 2013	$	(1,586,348	)	$	4,760		$	(56,068	)	$	(1,637,656	)

For the three and six months ended June 30, 2013, the amounts reclassified to net loss related to the Company’s defined benefit plan. These amounts are included within “Operating loss” within the condensed consolidated statements of operations.

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(4) Fair Value Measurements (Tables)

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

Schedule Of Fair Value Assets Measured On Recurring Basis

The following table presents the Company’s assets that are measured at fair value on a recurring basis at June 30, 2013:

			Fair Value Measurements at Reporting Date Using
				Quoted Prices in				Significant
				Active Markets for		Significant other		Unobservable
				Identical Assets		Inputs		Inputs
		Total		(Level 1)		(Level 2)		(Level 3)
Cash equivalents:
Money market funds	$	5,501,965	$	5,501,965	$	—	$	—
Total cash equivalents		5,501,965		5,501,965		—		—
Marketable securities:
Corporate debt and government securities		7,838,590		—		7,838,590		—
Total marketable securities		7,838,590		—		7,838,590		—
Total assets measured at fair value	$	13,340,555	$	5,501,965	$	7,838,590	$	—
The following table presents the Company’s assets that are measured at fair value on a recurring basis at December 31, 2012:
			Fair Value Measurements at Reporting Date Using
				Quoted Prices in				Significant
				Active Markets for		Significant other		Unobservable
				Identical Assets		Inputs		Inputs
		Total		(Level 1)		(Level 2)		(Level 3)
Cash equivalents:
Money market funds	$	4,285,309	$	4,285,309	$	—	$	—
Total cash equivalents		4,285,309		4,285,309		—		—
Marketable securities:
Corporate debt and government securities		10,530,942		—		10,530,942		—
Total marketable securities		10,530,942		—		10,530,942		—
Total assets measured at fair value	$	14,816,251	$	4,285,309	$	10,530,942	$	—

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(1) Summary of Significant Accounting Policies (Tables)

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

Schedule Of Intangible Assets And Goodwill

		June 30,			December 31,
		2013			2012
Goodwill	$	4,150,339		$	4,150,339
Other intangible assets:
Gross carrying amount	$	3,190,369		$	3,128,588
Accumulated amortization		(3,011,391	)		(2,954,162	)
Net carrying amount	$	178,978		$	174,426

Computation of Earnings Per Share

	Three Months Ended June 30, 2013								Three Months Ended June 30, 2012
	Net Loss			Shares		Per Share			Net Loss			Shares		Per Share
		(Numerator)			(Denominator)		Amount			(Numerator)			(Denominator)		Amount
Basic EPS	$	(5,207,293	)		47,996,027	$	(0.11	)	$	(6,620,586	)		47,472,909	$	(0.14	)
Effect of dilutive securities:
Stock options and
restricted stock					—								—
Diluted EPS	$	(5,207,293	)		47,996,027	$	(0.11	)	$	(6,620,586	)		47,472,909	$	(0.14	)
	Six Months Ended June 30, 2013								Six Months Ended June 30, 2012
		Net Loss			Shares		Per Share			Net Loss			Shares		Per Share
		(Numerator)			(Denominator)		Amount			(Numerator)			(Denominator)		Amount
Basic EPS	$	(9,587,738	)		47,929,799	$	(0.20	)	$	(9,069,994	)		47,258,696	$	(0.19	)
Effect of dilutive securities:
Stock options and
restricted stock					—								—
Diluted EPS	$	(9,587,738	)		47,929,799	$	(0.20	)	$	(9,069,994	)		47,258,696	$	(0.19	)

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Document and Entity Information	6 Months Ended
	Jun. 30, 2013	Jul. 31, 2013
Document And Entity Information
Entity Registrant Name	FALCONSTOR SOFTWARE INC
Entity Central Index Key	0000922521
Document Type	10-Q
Document Period End Date	Jun. 30, 2013
Amendment Flag	false
Current Fiscal Year End Date	--12-31
Is Entity a Well-known Seasoned Issuer?	No
Is Entity a Voluntary Filer?	No
Is Entity's Reporting Status Current?	Yes
Entity Filer Category	Accelerated Filer
Entity Common Stock, Shares Outstanding		48,014,717
Document Fiscal Period Focus	Q2
Document Fiscal Year Focus	2013

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(2) Share-Based Payment Arrangements (Tables)

6 Months Ended

Jun. 30, 2013

Notes to Financial Statements

Details of Stock Option Plan

	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		1,169,323		8,411,478	May 17, 2016
FalconStor Software, Inc., 2013 Outside Directors Equity
Compensation Plan		400,000		350,000		50,000	May 9, 2016

Schedule of Equity Awards Outstanding

	Shares Available		Shares
Name of Plan	for Grant		Outstanding
FalconStor Software, Inc., 2000 Stock Option Plan		—		1,646,397
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		—		805,200
the Company and James P. McNiel
FalconStor Software, Inc., 2010 Outside Directors Equity		—		50,500
Compensation Plan

Schedule of Stock Option Activity

			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
Options Exercisable at June 30, 2013	7,173,298	$5.46	4.10	$                      -

Schedule Of Share Based Compensation Recognized

	Three months ended June 30,					Six months ended June 30,
	2013		2012			2013		2012
Cost of revenues - Product	$	50	$	49		$	99	$	99
Cost of revenues - Support and Service		53,936		(21,124	)		104,192		49,844
Research and development costs		87,028		125,231			221,938		444,188
Selling and marketing		(11,848)		398,031			272,190		884,656
General and administrative		111,629		587,889			533,111		1,159,591
	$	240,795	$	1,090,076		$	1,131,530	$	2,538,378

Stock Based Compensation Expense - Restricted Stock

	Three months ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
Directors, officers and employees	$	32,551	$	130,164	$	95,748	$	407,580
Non-employee consultants		—		—		—		—
	$	32,551	$	130,164	$	95,748	$	407,580

Schedule of Restricted Stock Units Activity

	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

Schedule Of Share Based Compensation - Nonemployee

	Three months ended June 30,					Six months ended June 30,
	2013		2012			2013		2012
Non-qualified stock options	$	—	$	(25,262	)	$	—	$	29,930
Restricted stock awards		—		—			—		—
	$	—	$	(25,262	)	$	—	$	29,930