SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Registrant's telephone number, including area code: 631-777-5188

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

20202021 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

PART I

 

OVERVIEW

 

facilitate learning, improve product design and drive competitive advantage. Our products are software-defined, which means that our technology allows our solutions tocan be used regardless of the underlying hardware, cloud and source-data, agnostic, givingwhich enables our enterprise customers maximumto leverage oftheir existing hardware and software investments.

 

INDUSTRY BACKGROUND

 

Enterprises of all sizes are increasingly challenged to securely archive, replicate and make available their data assets. TheirThis challenge is increased as business pressures to reduce cost and increase efficiency push the enterpriseenterprises to adopt cloud-based technologies, which are critical to handling the growth in data and strategic uses of enterprise data.data, despite an increasing amount of records and data that has been compromised over the past several years. For example, according to the 2020 Year End Report published by RiskBased Security, approximately 37 billion records of sensitive data were lost from various breaches, as compared to the approximately 15 billion and 5 billion that were lost in 2019 and 2018, respectively.

Long-termWe believe long-term data archive is the fastest-growing segment of an enterprise’s data assets. This growth is accelerating as enterprises are increasingly subject to complex regulatory compliance, such as that driven by the Food and Drug Administration, (FDA), the Health Insurance Portability and Accountability Act, (HIPAA), European Union’s General Data Protection Regulation (GDPR), and the Sarbanes-Oxley Act. As the volume of long-term archive continues to expand, the need for enterprises to securely and cost-effectively store the associated data will only increase.

The introduction of new long-term archive storage options has also given rise to a growth in managed service providers (MSPs)MSPs remotely managing data protection, primarily to smaller enterprises with a less complex array of data assets. The MSPs are able to leverage modern broadband connectivity and offer more scalable long-term storage options, which will serve to reduce data protection costs for their customers. We believe this trend to outsourced long-term archive data protection will continue.

 

OUR SOFTWARE PRODUCTS AND SUPPORTING TECHNOLOGY

 

 

Long-Term Data Retention and Recovery Products

 

private-cloud based virtual tape archive storage, which are all now seamlessly integrated into our solution.storage. We are dedicated to providing our enterprise customers with the highest performing VTL product in the industry. As such, we subjecthave subjected our VTL solution to independent performance testing, which hasat the time demonstrated that our product iswas 25% faster than the closesta competitor and cancould be executed on hardware that is 1/3was one-third the cost of that required by our closest competitor.

 

 

 

Our core long-term archive and business continuity driven products are complemented by a set of underlying technologies that streamline usability and overall solution performance.

 

BUSINESS STRATEGY

 

FalconStor‘sFalconStor’s products and supporting technologies serve enterprise IT organizations and managed service providersMSPs worldwide and are guided by the following strategies.

 

 

 

 

 

As the managed service providerMSP segment continues to grow, theyMSPs increasingly have a need to support heterogeneous storage environments across their own data centers and their customer’scustomers’ environments. Further, MSPs often have different hardware and software capabilities, making it significantly challenging to offer consistent data services across these environments. We believe FalconStor offers severalthat we offer strategic benefits for MSPs:

 

 

The Flash/SSD, High-Density ShingleSingle Disk and Cloud Data Archival markets should beare key opportunities for us on two fronts: targeting customers wanting to integrate this new Flash/SSD, High-Density Shingle Disk, Cloud Data Archival technology into existing IT environments, and OEMs needing to enhance their software stack in order to offer data movement and protection services on their platform. Cloud Service Providers (CSPs)service providers (“CSPs”) such as AWS, Microsoft Azure, Wasabi and AliyunAlibaba Cloud also represent a growth opportunity. Our mutual customers and partners need help moving data from the customer site to their own facilities, as well as a way to deliver common data services across disparate and often incompatible hardware typically found across the provider and end customer environments. We believe FalconStor isthat we are positioned to continue to take advantage of these key opportunities in the global marketplace. Our strategic relationships with Hitachi Data Systems, Hitachi Vantara, Fujitsu, DSI, and others should fuel growth across all three major geographies.

 

We willplan to continue to enhancefocus our products to address the ever-changing market dynamics to ensure that FalconStor can be a leader in the data protection marketplace.

 

 

New regulations and laws governing the processing, storage, retention, protection, and reinstatement of high-value information assets are driving double-digit growth in the data protection markets. Additionally, we believe that data archives will play an increasing role in training and validating AI and Machine Learning algorithms and optimizing strategic analytic model outcomes. Given FalconStor's long history and deep skillset of the unique challenges associated with long-term storage, we feel we are in an excellent position to capitalize on data assets that are subject to new protection requirements with our existing product portfolio. Our innovative StorSafe product is designed and architected to leverage the scale-up and scale-out capabilities found in today's public and private clouds to support the expanding long-term data protection market demand that is estimated to grow into the Zettabyte (10^21) range by 2030 (IDC). In addition, we believe our innovative integration of long-term archive storage into modern cloud-based technologies will enable our customers to dramatically improve the portability, security, and accessibility of their enterprise data. We believe, this accessibility will be key in our modern world, where data is not only protected, but also intelligently leveraged to facilitate learning, improve product design, and drive competitive advantage.

 

FalconStor continues to sell products through:

  

 

FalconStor’s Professional Services personnel are also available to assist customers and partners throughout the lifecycle of FalconStor product deployments. The Professional Services team includes experienced Storage Architects (expert field engineers) who can assist in the assessment, planning/design, implementation, and test phases of the deployment project, and a Technical Support Group for post-deployment assistance and ongoing support.

 

MARKETING

 

We focus our efforts to increase awareness and demand for FalconStor products by targeting our efforts at our extensive global installed base and the expanding awareness in the emerging long-term data protection market. 

 

PRODUCT LICENSING

 

Historically, the majority of our software licenses have been sold on a per terabyte capacity basis and have included a perpetual right to use the licensed capacity. We now also offered our capacity-based licenses on a subscription or term-based model, which gives a customer the right to utilize the licensed terabyte capacity over a designated period of time. In addition,

we provide a unique subscription offering to MSPs that allow them to license our technology on a per tenant instance per month basis. We expect revenue from subscription-based per terabyte licensing to increase over the next several years.

 

COMPETITION

 

 

We believe our VTLStorSafe and StorSafeVTL products are positioned well in the marketplace. Given the fact that these products are designed to integrate with an enterprise’s legacy backup and archive software and processes, the level of competition we believe we typically face is limited to DellEMC’s Data Domain virtual tape library product.

One could argue that weWe also compete with legacy backup and archive vendors such as Veritas, and Commvault; however, in practice, we believe our products are more complimentary to their solutions than competitive, as our solutions do not require their solutions to be retired or replaced. In fact, our enterprise customers view the ability to maintain their legacy software solutions and processes as a key differentiator for selecting FalconStor products, as it is common for them to use backup and archive products from multiple vendors. By inserting our StorSafe or VTL or StorSafe product, theycustomers are able to aggregate all of their archive data easily and control global data deduplication and archive storage from one central point.

 

We believe our enterprise and MSP customers also view the fact that our VTLStorSafe and StorSafeVTL products operate effectively with Windows, Linux, and IBM i operating system (OS) environments as a key differentiator. As a result, we execute specific go-to-market efforts to identify enterprise and MSP customers that have multiple OS environments in production.

 

 

Competition within the business continuity driven data replication space is significant and includes products from Veeam, Rubrik, Cohesity, Commvault, Veritas, DellEMC, DataCore, and others. As a result, it is imperative that we carefully select the areas in which we will compete to ensure they are aligned with our key product differentiations. Accordingly, our two areas of

 

INTELLECTUAL PROPERTY

 

FalconStor’s success is dependent in part upon its proprietary technology. We currently have forth sevenforty-three patents and pending patent applications. The Company has multiple registered trademarks - including “FalconStor Software”, “StorSight”, “StorSafe”, and “Intelligent Abstraction” - as well as pending trademark applications related to FalconStor and its products.

 

FalconStor seeks to protect its proprietary rights and other intellectual property through a combination of copyright, patents, trademark, and trade secret protection, as well as through contractual protections such as proprietary information agreements and nondisclosure agreements. The technological and creative skills of its personnel, new product developments, frequent product enhancements, and reliable product maintenance are essential to establishing and maintaining a technology leadership.

 

FalconStor generally enters into confidentiality or license agreements with employees, consultants, and corporate partners and generally controls access to and distribution of its software, documentation, and other proprietary information. Despite the Company’s efforts to protect its proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use FalconStor’s products or technology. Monitoring unauthorized use of FalconStor’s products is difficult, and there can be no assurance that the steps FalconStor has taken will prevent misappropriation of its technology, particularly in foreign countries where laws may not protect its proprietary rights as fully as do the laws of the United States.

For the yearyears ended December 31, 2021 and December 31, 2020, we had two customers that accounted for 10% or more of total revenue. For the year ended December 31, 2019, we hadone and two customers that accounted for 10% or more of total revenue.

As of December 31, 20202021 and 2019,2020, we had two and one customercustomers who accounted for more than 10% of our gross accounts receivable balance, respectively.

Our internet address is www.falconstor.com. The Company makes available free of charge, on or through its Internet website, the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Sections 13(a) or (15)(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. The Company complied with this policy for every Exchange Act (the "Exchange Act"), report filed during the year ended December 31, 2020.2021.

Risks Related to Our Financial Condition

We have had limited liquidity as evidenced by our working capital deficiency of $4.5 million at December 31, 2020 and our future prospects are dependent on our ability to execute our business plan of which there can be no assurance.

Our revenues decreased in 20202021 compared to 2019.2020. There is no guarantee that we will be able or to maintain, profitability.

    Despite generating $1.1a $0.2 million in GAAP Net Income for the fiscal year ended December 31, 2020,2021, our revenues decreased to $14.2 million for the year ended December 31, 2021, as compared with $14.8 million for the year ended December 31, 2020, as compared with $16.5 million for the year ended December 31, 2019.2020. If we are unable to stabilize or increase revenue, we will be unable to maintain profitability, 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.

We have undertaken a restructuring and other cost reduction initiatives to reduce our expenses and to better align our expenses with our business. There can be no assurance that we have made enough reductions or the right reductions.

For the past several years, we have taken several actions to reduce expenses significantly in an attempt to help return the Companyour company to profitability. These actions include a reduction in personnel; closing offices in geographic locations where our expenses have continued to outpace our revenue; and reducing other expenditures. To date, the reduction in expenses has not

If actual results or events differ materially from our estimates and assumptions, our reported financial condition and results of operations for future periods could be materially affected.

The preparation of consolidated financial statements and related disclosure in accordance with generally accepted accounting principles requires management to establish policies that contain estimates and assumptions that affect the amounts reported in the consolidated financial statements and the accompanying notes. Note 1 to the Consolidated Financial Statements in our Annual Report onthis Form 10-K for the fiscal year ended December 31, 2020 describes the significant accounting policies and estimates essential to preparing our financial statements. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures. We base our estimates on historical experience and assumptions that we believe to be reasonable under the circumstances. Actual future results may differ materially from these estimates. We evaluate, on an ongoing basis, our estimates and assumptions.

Our future business, financial and operating results are substantially dependent on the market acceptance of our products.

The effects of the COVID-19 pandemic have materially affected and will continue to materially affect how we and our customers are operating our businesses, and the duration and extent to which this will impact our future results of operations and overall financial performance remains uncertain.

As a result of the COVID-19 pandemic, we temporarily closed our office locations, introduced remote working for many of our employees that remains in effect, and implemented certain travel restrictions, all of which has caused disruptions to how we operate our business. Our operations have been negatively affected by a range of external factors related to the COVID-19 pandemic that are not within our control. Many of our customers are non-essential businesses within the meaning of applicable regulations that have been forced, in some jurisdictions, to temporarily suspend or greatly reduce operations, resulting in a lay off or termination of workers, whichworkers. This has had a direct impact on our revenue, as this results in a decrease in overall payrollproduct spend by our customers. Additionally, we have shifted certain of our customer events to virtual-only experiences and we may deem it advisable to similarly alter, postpone or cancel entirely additional customer, employee or industry events in the future. The conditions caused by the COVID-19 pandemic have affected and may continue to affect the rate of IT spending and our customer's ability or willingness to attend our events or to purchase our offerings, our prospective customers' purchasing decisions, our ability to provide on-site consulting services to our customers and the provisioning of our offerings, and may lengthen payment terms, reduce the value or duration of our contracts, or affect attrition rates, all of which has and may continue to adversely affect our future sales, operating results and overall financial information.

The loss of any of our key personnel could harm our business.

Our success depends upon the continued contributions of our key employees, many of whom would be extremely difficult to replace. We do not have key person life insurance on any of our personnel. Worldwidepersonnel, and worldwide competition for skilled employees in the network storage software industry is extremely intense. In particular, our success is dependent on our executive management team, including Todd Brooks, our Chief Executive Officer. If we are unable to retain existing employees or hire and integrate new employees, our business, financial condition and operating results could suffer.

Due to the uncertain and shifting development of the data protection and network storage software markets and our reliance on our partners, we may have difficulty accurately predicting revenue for future periods and appropriately budgeting for expenses.

The rapidly evolving nature of the data protection and network storage software markets in which we sell our products, the degrees of effort and success of our partners’ sales and marketing efforts, and other factors that are beyond our control, reduce our ability to accurately forecast our quarterly and annual revenue. However, we must use our forecasted revenue to establish our expense budget. Most of our expenses are fixed in the short term or incurred in advance of anticipated revenue. As a result, we may not be able to decrease our expenses in a timely manner to offset any shortfall in revenue.

If we are unable to develop new products that achieve acceptance in the data protection and the network storage software markets, our operating results may suffer.

The data protection and the network storage software markets continue to evolve and as a result there is continuing demand for new products. Accordingly, we may need to develop new products that address additional data protection or network storage software market segments and emerging technologies to remain competitive in the data storage software industry. We are uncertain whether we will successfully qualify new data protection or network storage software products with our customers by meeting customer performance and quality specifications. Any failure to address additional market segments could harm our business, financial condition and operating results.

Our products must conform to industry standards in order to be accepted by customers in our markets.

Our current products are only one part of a storage system. All components of these systems must comply with the same industry standards in order to operate together efficiently. We depend on companies that provide other components of these systems to conform to industry standards. Some industry standards may not be widely adopted or implemented uniformly, and competing standards may emerge that may be preferred by OEM customers or end users. If other providers of components do not support the same industry standards as we do, or if competing standards emerge, our products may not achieve market acceptance and we may be required to invest considerable resources to shifting our products to meet such industry standards, either of which wouldcould adversely affect our business.

Our products handle mission-critical data for our end-customers and are highly technical in nature. If our products have defects, failures occur or end-customer data is lost or corrupted, our reputation and business could be harmed.

Our products are highly technical and complex and are involved in storing and replicating mission-critical data for our end-customers. Our products may contain undetected defects and failures when they are first introduced or as new versions are released. We have in the past and may in the future discover software errors in new versions of our existing products, new products or product enhancements after their release or introduction, which could result in lost revenue. Despite testing by us and by current and potential end-customers, errors might not be found in new releases or products until after commencement of commercial shipments, resulting in loss of or delay in market acceptance. Our products may have security vulnerabilities and be subject to intentional attacks by viruses that seek to take advantage of these bugs, errors or other weaknesses. If defects or failures occur in our products, a number of negative effects in our business could result, including:

We rely on our resellers and our OEM partners for most of our sales.

The vast majority of our sales come from sales to end users of our productscome from sales by our resellers and by our OEM partners. These resellers and OEM partners have limited resources and sales forces and sell many different products, both in the data protection and the network storage software markets and in other markets. The resellers and OEM partners may choose to focus their sales efforts on other products in the data protection and the network storage software markets or other markets. The OEM

The failure of our resellers to sell our products effectively could have a material adverse effect on our revenue and results of operations.

We rely significantly on our MSPs, value-added resellers, direct market resellers, systems integrators and corporate resellers, which we collectively refer to as resellers, for the marketing and distribution of our software products and our services. However, our agreements with resellers are generally not exclusive, are generally renewable annually and in many cases may be terminated by either party without cause. Many of our resellers carry products that are competitive with ours. These resellers may give a higher priority to other products, including those of our competitors, or may not continue to carry our products at all. If a number of resellers were to discontinue or reduce the sales of our products, or were to promote our competitors’ products in lieu of ours, it would have a material adverse effect on our future revenue. Events or occurrences of this nature could seriously harm our sales and results of operations. In addition, we expect that a significant portion of our sales growth will depend upon our ability to identify and attract new reseller partners. The use of resellers is an integral part of our distribution network. We believe that our competitors also use reseller arrangements. Our competitors may be more successful in attracting reseller partners and could enter into exclusive relationships with resellers that make it difficult to expand our reseller network. Any failure on our part to expand our network of resellers could impair our ability to grow revenue in the future.

Our growth depends in part on the success of our strategic relationships with third parties.

Our future growth will depend on our ability to enter into successful strategic relationships with third parties. For example, our strategic relationships with DSI, Fujitsu and Hitachi Data Systems,Vantara are intended to enhance their software stack in order to offer data movement and protection services on their platform. In addition, we work with global distributors to streamline and grow our sales channel. These relationships may not result in additional customers or enable us to generate significant revenue. These relationships are typically non-exclusive and do not prohibit the other party from working with our competitors or from offering competing services. If we are unsuccessful in establishing or maintaining our relationships with these third parties, our ability to compete in the marketplace or to grow our revenue could be impaired and our operating results could suffer.

We rely on channel partners to sell our solutions, and disruptions to, or our failure to develop and manage our channel partners would harm our business.

Our future success is partially dependent upon establishing and maintaining successful relationships with the right channel partners. A majority of our revenue is generated by sales through our channel partners, and we expect channel sales to continue to make up the majority of our total revenue in the future. Accordingly, our revenue is largely dependent on the effective sales and lead generation activities of these channel partners.

Recruiting and retaining qualified channel partners and training them in our technology and product offerings requires significant time and resources. In order to develop and expand our distribution channel, we must continue to scale and improve our processes and procedures that support our channel, including investment in systems and training. Those processes and procedures may become increasingly complex and difficult to manage as we grow our organization. We have no minimum purchase commitments from any of our channel partners, and our contracts with these channel partners do not prohibit them from offering products or services that compete with ours. Our competitors may provide incentives to existing and potential channel partners to favor their products or to prevent or reduce sales of our solutions. Our channel partners may choose not to offer our solutions exclusively or at all. Establishing relationships with channel partners who have a history of selling our competitors’ products may also prove to be difficult. In addition, some of our channel partners are also competitors. Our failure to establish and maintain successful relationships with channel partners would harm our business and operating results.

We face intense competition in our market, especially from larger, well-established companies, and we may lack sufficient financial or other resources to maintain or improve our competitive position.

Many of our existing competitors have, and some of our potential competitors could have, substantial competitive advantages such as:

Our ability to sell our products is highly dependent on the quality of our services offerings, and our failure to offer high quality support and professional services would have a material adverse effect on our sales of our products and results of operations.

Failure to achieve anticipated growth could harm our business and operating results.

Adverse economic conditions or reduced IT spending may adversely impact our business.

Our business depends on the overall demand for IT and on the economic health of our current and prospective customers. In general, worldwide economic conditions remain unstable, and these conditions make it difficult for our current and prospective customers and us to forecast and plan future business activities accurately, and they could cause our customers or prospective customers to reevaluate their decision to purchase our products or services. Also, global or national health concerns, including the outbreak of pandemic or contagious disease such as the recent coronavirus outbreak, can negatively impact the global economy and demand for our services. Weak global economic conditions, or a reduction in IT spending even if economic conditions improve, could adversely impact our business and operating results in a number of ways, including longer sales cycles, lower prices for our products, reduced bookings and lower or no growth.

Our future quarterly results may fluctuate significantly, which could cause our stock price to decline.

Our previous results are not necessarily indicative of our future performance and our future quarterly results may fluctuate significantly. Our future performance will depend on many factors, including:

Many of our expenses are relatively fixed and difficult to reduce or modify. As a result, the fixed nature of our expenses will magnify any adverse effect of a decrease in revenue on our operating results.

The ability to predict our future effective tax rates could impact our ability to accurately forecast future earnings.

We are subject to income taxes in both the United States and the various foreign jurisdictions in which we operate. Judgment is required in determining our provision for income taxes and there are many transactions and calculations where the tax determination may be uncertain. Our future effective tax rates could be affected by changes in our (i) earnings or losses; (ii) changes in the valuation of our deferred tax assets; (iii) changes in tax laws; and (iv) other factors. Our ability to correctly predict our future effective tax rates based upon these possible changes could significantly impact our forecasted earnings.

Our business could be materially affected as a result of a natural disaster, terrorist acts, or other catastrophic events.

While our headquarters facilities contain redundant power supplies and generators, our domestic and foreign operations, and the operations of our industry partners, remain susceptible to fire, floods, power loss, power shortages, telecommunications failures, break-ins and similar events. Terrorist actions domestically or abroad could lead to business disruptions or to cancellations of customer orders or a general decrease in corporate spending on information technology, or could have direct impact on our marketing, administrative or financial functions and our financial condition could suffer. We continually look for alternatives to help mitigate any supply chain disruptions due to natural disasters, terrorist acts or other catastrophic events, including public health epidemics such as the recent outbreak of coronavirus, first identified in China. However, our failure to mitigate these supply chain disruptions could impact our ability to procure and deliver products to our customers, which could adversely impact our overall financial condition.

We are dependent on a variety of IT and telecommunications systems, and any failure of these systems could adversely impact our business and operating results.

We depend on IT and telecommunications systems for our operations. These systems support a variety of functions including order processing, shipping, shipment tracking, billing, support center and internal information exchange.

United States Governmentgovernment export restrictions could impede our ability to sell our software to certain end users.

The international nature of our business could have an adverse effect on our operating results.

We sell our products worldwide. Accordingly, our operating results could be materially adversely affected by various factors including regulatory, political, or economic conditions in a specific country or region, trade protection measures and other regulatory requirements, and acts of terrorism and international conflicts.

Foreign currency fluctuations may impact our revenue.

Our licenses and services in Japan are sold in Yen. Many of our licenses and services in Australia, Canada, and in Europe are sold in Australian dollars, Canadian dollars and European Monetary Units (“Euros”)( or Euros), respectively. Changes in economic or political conditions globally and in any of the countries in which we operate could result in exchange rate movements, new currency or exchange controls or other restrictions being imposed on our operations.

Fluctuations in the value of the U.S. dollar may adversely affect our results of operations. Because our consolidated financial results are reported in U.S. dollars, translation of sales or earnings generated in other currencies into U.S. dollars can result in a significant increase or decrease in the reported amount of those sales or earnings. Significant changes in the value of these foreign currencies relative to the U.S. dollar could have a material adverse effect on our financial condition or results of operations. For example, the U.S. dollar has weakened against the Japanese Yen by 5% from December 31, 2019 to December 31, 2020.

Fluctuations in currencies relative to currencies in which our earnings are generated make it more difficult to perform period- to-period comparisons of our reported results of operations. For purposes of accounting, the assets and liabilities of our foreign operations, where the local currency is the functional currency, are translated using period-end exchange rates, and the revenue, expenses and cash flows of our foreign operations are translated using average exchange rates during each period.

In addition to currency translation risks, we incur currency transaction risk whenever we enter into either a purchase or a sales transaction using a currency other than the local currency of the transacting entity. Given the volatility of exchange rates, we cannot be assured we will be able to effectively manage our currency transaction and/or translation risks. Volatility in currency exchange rates may have a material effect on our financial condition or results of operations. Currency exchange rate fluctuations have not, in the past, resulted in a material impact on earnings. However, we may experience at times in the future an impact on earnings as a result of foreign currency exchange rate fluctuations.

If we are unable to protect our intellectual property, our business will suffer.

We also rely on trade secret, copyright and trademark laws, as well as the confidentiality and other restrictions contained in our respective sales contracts and confidentiality agreements to protect our proprietary rights. These legal protections afford only limited protection and if we are unable to protect our intellectual property our business and operating results may suffer.

Our efforts to protect our intellectual property may cause us to become involved in costly and lengthy litigation, which could seriously harm our business.

In recent years, there has been significant litigation in the United States involving patents, trademarks and other intellectual property rights.

Cyber-attacks and breaches could cause operational disruptions, fraud or theft of sensitive information.

Developments limiting the availability of Open Source software could impact our ability to deliver products and could subject us to costly litigation.

Our redemption obligation under the Series A Preferred Stock and indebtedness could adversely affect our financial health.

Our redemption obligation and indebtedness could have important consequences to you. For example, it could:

In addition, the terms of the Amended and Restated Term Loan Credit Agreement contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests which could have a material adverse effect on our business, financial condition or prospects.

To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control. As such, we may not be able to generate sufficient cash to service the Term Notes or our other indebtedness, and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

Our ability to make payments on and to refinance the term notes under our Amended and Restated Term Loan Agreement, (the “Term Notes”) to fund planned capital expenditures, maintain sufficient working capital and fund any redemption of theour Series A Preferred Stock will depend

We cannot assure you that our business will generate sufficient cash flow from operations or future borrowings from other sources in an amount sufficient to enable us to service our obligations under the the Amended and Restated Term Loan Agreement or our Series A Preferred Stock, or to fund our other liquidity needs. If our cash flows and capital resources are insufficient to allow us to make scheduled payments on our indebtedness, we may need to reduce or delay capital expenditures, sell assets, seek additional capital, restructure or refinance the Amended and Restated Term Loan Agreement,Notes, on or before the maturity thereof or seek a waiver of any redemption rights under our Series A Preferred Stock, any of which could have a material adverse effect on our operations. We cannot assure you that we will be able to refinance the Amended and Restated Term Loan Agreement,Notes, on commercially reasonable terms or at all, or that the terms of that indebtedness will allow any of the above alternative measures or that these measures would satisfy our scheduled debt service obligations. If we are unable to generate sufficient cash flow to repay or refinance our debt on favorable terms, it could significantly adversely affect our financial condition, and our ability to make any required cash payments under theour Term Notes or fund any redemption of theour Series A Preferred Stock. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at that time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. In addition, any future credit facility may be secured by a priority lien on substantially all of our assets. As such, our ability to refinance theour Term Notes or seek additional financing could be impaired as a result of such security interest.

We are subject to a number of covenants and other conditions, which may restrict our business and financing activities.

The Amended and Restated Term Loan Credit Agreement has customary representations, warranties and affirmative and negative covenants. The Amended and Restated Term Loan Credit Agreement also contains customary events of default, including but not limited to payment defaults, cross defaults with certain other indebtedness, breaches of covenants, bankruptcy events and a change of control. In the case of an event of default, as administrative agent under the Amended and Restated Loan Agreement, HCP-FVA may (and upon the written request of lenders holding in excess of 50% of the Term Loan, which must include HCP-FVA, is required to) accelerate payment of all obligations under the Amended and Restated Loan Agreement, and seek other available remedies.

The restrictions in the Amended and Restated Term Loan Credit Agreement may prevent us from taking actions that we believe would be in the best interests of our business, and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted. In addition, our ability to comply with the financial and other covenants and restrictions in the Amended and Restated Term Loan Credit Agreement will largely depend on the pricing of our products and services, and our ability to successfully implement our overall business strategy. We cannot assure you that we will be granted waivers or amendments to the Amended and Restated Term Loan Credit Agreement if for any reason we are unable to comply with these covenants and restrictions. The breach of any of these covenants and restrictions could result in a default under the Amended and Restated Term Loan Credit Agreement, which could result in an acceleration of our indebtedness.

The likelihood of a change of control in our company could be impacted by the fact that we have a significant amount of authorized but unissued preferred stock, protective provisions in our charter, outstanding Series A Preferred Stock, a staggered Boardboard of Directorsdirectors and change of control agreements as well as certain provisions under Delaware law.

Our Boardboard of Directorsdirectors has the authority, without further action by our common stockholders, to issue up to an additional 1,100,000 shares of preferred stock on such terms and with such rights, preferences and designations, including, without limitation restricting dividends on our common stock, dilution of the voting power of our common stock and impairing the liquidation rights of the holders of our common stock, as the Boardboard may determine without any vote of our common stockholders. Issuance of such preferred stock, depending upon the rights, preferences and designations thereof may have the effect of delaying, deterring or preventing a change in control. Moreover, our outstanding Series A Preferred Stock provides the holders with certain rights in the event of a merger with a third party and if we are unable to redeem the Series A Preferred Stock prior to July 30, 20212023 or if the holders of the Series A Preferred Stock elect to exercise their rights to require the Companyus to redeem the Series A Preferred Stock due to theour failure of the Company to comply with the financial covenants covering the Series A Preferred Stock. In addition,

The conversion and exercise of our outstanding securities and the anticipated grant of restricted stock to our employees will dilute the then-existing stockholders’ percentage ownership of our common stock.

We have outstanding options to purchase 9,7805,690 shares of our common stock, an aggregate of 1,386,2131,513,380 outstanding unvested restricted shares and outstanding Series A Preferred Stock convertible into 87,815 shares of our common stock. Over the next several years a significant number of shares of common stock are potentially issuable as dividends with respect to the Series A Preferred Stock (including 4,354 share53,570 shares of common stock reserved for issuance related to the accrued dividend as of December 31, 2020)2021).

The exercise of all of the outstanding warrants, options and/or the vesting of all outstanding restricted shares, the conversion of our outstanding Series A Preferred Stock into common stock, the payment of dividends on our Series A Preferred Stock through the issuance of common stock and/or the grant and exercise of additional options and/or the grant and vesting of restricted stock and restricted stock units to our employees 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.

Trading in our common stock is conducted in the over-the-counter market. In addition, we currently fail to qualify for listing on either the NASDAQ Capital Market or the NYSE American. As a result, an investor may find it difficult to dispose of or to obtain accurate quotations as to the market value of our common stock, and our common stock may be less attractive for margin loans, for investment by larger financial institutions, as consideration in possible future acquisition transactions or other purposes.

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 twelve months ended December 31, 2020,2021, the closing market price of our common stock as quoted on the OTC MKTS

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.

The holders of the Series A Preferred Stock are entitled to dividends on the Series A Preferred Stock they hold. Depending on whether these dividends are paid in cash or stock, the payment of these dividends will either decrease cash that is available to us to invest in our business or dilute the holdings of all other stockholders.

The potential concentration of equity ownership by Hale Capital and ESW Capital LLC may limit your ability to influence corporate matters.

Hale Capital currently owns approximately 61.5%50.8% of our outstanding common stock and ESW currently owns approximately 22.2%18.2% of our outstanding common stock. In addition, the beneficial ownership of Hale Capital and ESW Capital LLC is higher when calculated in accordance with Section 13(d) of the Exchange Act due to their ownership of derivative securities. In addition, Hale Capital and ESW have additional rights through their ownership of Series A Preferred Stock and their holdings of Company debt.

Such ownership could enable Hale Capital and ESW to exert significant influence over all corporate activities, including the election or removal of directors and the outcome of tender offers, mergers, proxy contests or other purchases of common stock that could give our stockholders the opportunity to realize a premium over the then-prevailing market price for their shares of common stock. This concentrated control will limit your ability to influence corporate matters and, as a result, we may take actions that our stockholders do not view as beneficial. In addition, such concentrated control could discourage others from initiating changes of control. In such cases, the perception of our prospects in the market may be adversely affected and the market price of our common stock may decline.

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.

The Company’s headquarters are locatedCompany currently maintains a mailing address and rents virtual office facilities at 501 Congress Avenue, Suite 150, Austin, Texas 78701. The Company also rents virtual and physical office space in an approximately 3,711 square foot facilityTaiwan, Germany, France, China, Korea and Japan. As discussed in Austin, Texas.  Offices are also leased for development, support, and sales and marketing personnel, which total an aggregate of approximately 68,496 square feetNote 14 to our consolidated financial statements, our prior office lease in Melville, N.Y.; Munich, Germany;NY, which ended on April 30, 2021 with a gross annualized rental cost of $1.5 million, will not be replaced. FalconStor is primarily a virtual company and Taichung, Taiwan. Initial lease terms range from oneis redeploying this savings to two years.more productive uses.

In view of the inherent difficulty of predicting the outcome of litigation, particularly where the claimants seek very large or indeterminate damages, we 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 Financial Accounting Standards Board ("FASB") on contingencies, we accrue anticipated costs of settlement, damages and losses for claims to the extent specific losses are probable and estimable. We record 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, we 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, we will accrue the minimum amount of the range.

Other Claims

 

We continue to assess certain litigation and claims to determine the amounts, if any, that we believe 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 our financial results, cash flows and cash reserves.

Not applicable

PART II

We had approximately 4644 holders of record of common stock as of February 28, 2021.2022. This does not reflect persons or entities that hold common stock in nominee or “street” name through various brokerage firms.

We have not paid any cash dividends on our common stock since inception. We expect to reinvest any future earnings to finance growth, and therefore do not intend to pay cash dividends on our common stock in the foreseeable future. In addition, the terms of our Series A Preferred Stock and the Amended and Restated Term Loan Credit Agreement restrict our ability to pay dividends on our common stock. Our board of directors may determine to pay future cash dividends on our common stock if it determines that dividends are an appropriate use of Company capital.

Holders of the Series A Preferred Stock are entitled to receive quarterly dividends at the Prime Rate (Wall Street Journal Eastern Edition) plus 5% (up to a maximum amount of 10%), payable in cash, provided, that if we will not have at least $1.0 million in positive cash flow for any calendar quarter after giving effect to the payment of such dividends, we, at our election, can pay such dividends in whole or in part in cash, provided that cash flow from operations is not negative, and the remainder can be accrued or paid in common stock to the extent certain equity conditions are satisfied. Due to the lack of sufficient surplus to pay dividends as required by the Delaware General Corporation Law, the Company was not permitted to pay the fourth quarter 2016 dividend in cash or common stock and has been accruing its quarterly dividends since then. As of December 31, 2020,2021, the Company’s liability for dividends to the holders of the Series A Preferred Stock totaled $4.4$5.5 million. While the Term Loans areLoan is outstanding, we are only permitted to pay in-kind dividends on the Series A Preferred Stock.

None

 

Our products are utilized by enterprises and managed service providers across the globe andMSPs to address two key areas of enterprise data protection;protection: (i) long-term data retention and recovery, and (ii) data replication to preserve business continuity driven data replication.continuity. Our innovative integration with modern cloud-based data storage environments, such as IBM, AWS and Microsoft Azure, enables our enterprise customers to significantly reduce costs and improve the portability, security and accessibility of their enterprise data.This We believe this accessibility is key in our modern world, where data is not onlymust be protected but alsoand intelligently leveraged to facilitate learning, improve product design and drive competitive advantage. Our products are software-defined, which means that our technology allows our solutions tocan be used regardless of the underlying hardware, cloud and source-data, agnostic, givingwhich enables our enterprise customers maximumto leverage oftheir existing hardware and software investments.

GAAP subscription revenue increased 40% in year ended 2021 from year ended 2020. Despite the cloud, while carefully managing operating expenses.increase in GAAP subscription revenue, GAAP total revenue in the year ended 2021 decreased 4.0% year-over-year. During the year ended 2021, we generated a net income of $0.2 million, compared to a net income of $1.1 million in the year ended 2020.

During 2020, we delivered 26% year-over-year new customer bookings growth despite the economic turmoil caused by the global COVID-19 pandemic. While uncertainties continue to exist as a result of COVID-19, we have seen our customers and prospects continue to invest in the business critical area of data production in which we sell our solutions.

GAAP revenue decreased by $1.8 million duringDuring the year, compared to 2019. However, the proactive expense management plan we implemented at the endfourth quarter of Q1, allowed us to deliver $1.1 million of net income in the quarter, compared to a net loss of $1.8 million in 2019. Our significantly improved profitability has allowed us to make additional targeted investments, primarily related to Sales, R&D, and Support personnel, while maintaining a profitable expense base.

Through StorSafe,StorSafeTM, we are making significant progress expanding our technology to deliver an enterprise-class, highly flexible and efficient backup and archivelong-term data storage optimization solution.solution for the hybrid cloud world.

FalconStor continues to focus on MSPs, enterprise customers, managed service providers, and OEM partners. These markets offer the most significant opportunity and are best suited to realize the value of FalconStor products, and provide an efficient and effective access to broad, worldwide markets. Most of our revenue comes from sales to MSPs and to enterprise customers through resellers. As service providers to companies, resellers’ reputations are dependent on satisfying their customers’ needs efficiently and effectively. Resellers have wide choices in fulfilling their customers’ needs. If resellers determine that a product they have been providing to their customers is not functioning as promised, or is not providing adequate return on investment, or if the customers are not satisfied with the level of support they are receiving from the suppliers, the resellers will move quickly to offer different solutions to their customers. Additional sales by resellers are therefore an important indicator of our business prospects.

Our “Business Partner” program for our MSPs and resellers provides financial incentives for those resellerspartners that are willing to make a commitment to FalconStor through training, marketing and revenue. As part of our review of all of our operations to maximize savings without sacrificing sales, and in connection with our Business Partner program, we continually review our relationship with each of our resellerspartners in all regions. We decided to focus on only those resellerspartners who have the expertise, personnel and networks to identify potential customers and to service our end users.

Fluctuation in our revenue is driven by the volume and mix of sales from period to period. Revenue allocated to perpetual and term software licenses are recognized at a point in time upon electronic delivery of the download link and the license keys, as these products have significant standalone functionality. Product maintenance and support services are satisfied over time as they are stand-ready obligations throughout the support period. As a result, revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract. Revenues associated with professional services are recognized at a point in time upon customer acceptance.

Total cost of revenue for the year ended December 31, 2020 decreased 37%2021 increased 7% to $2.0 million for the year ended December 31, 2021, compared with $1.8 million for the year ended December 31, 2020, compared with $2.9 million for the year ended December 31, 2019.2020. Total gross profit decreased $0.7

Net loss attributable to common stockholders, which includes the effects of the Series A Preferred Stock dividends (including accrued dividends) and accretion, was $0.5$1.2 million for the year ended December 31, 2020,2021, compared with a net loss of $3.3$0.6 million for the year ended December 31, 2019.2020.

Product revenue is comprised of sales of both licenses for our software solutions and sales of the platforms on which the software is installed. This includes stand-alone software applications and, on occasion, software integrated with industry standard hardware. We no longer primarily source or sell hardware, sold as one complete integrated solution or sold on a subscription or consumption basis. Therather we facilitate our customers in buying their own hardware. Our products are sold through our OEMs, and through (i) value-added resellers, (ii) distributors, and/or (iii) directly to end-users (collectively “non-OEMs”).end-users. These revenues are recognized when all the applicable criteria under accounting principles generally accepted in the United States are met.

Product revenue increased 5%2% from $6.8 million for the year ended December 31, 2019 to $7.1 million for the year ended December 31, 2020.2020 to $7.3 million for the year ended December 31, 2021, which resulted from an increase in new customers purchasing both subscription and perpetual licenses. Product revenue represented 48%51% and 41%48% of our total revenue for the years ended December 31, 20202021 and 2019,2020, respectively.

We continue to invest in our product portfolio by refreshing and updating our existing product lines and developing our next generation of innovative product offerings to drive our sales volume in support of our long-term outlook.

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. Revenue derived from maintenance and technical support contracts are deferred and recognized ratably over the contractual maintenance term. Revenues associated with professional and engineering services are recognized at a point in time upon customer acceptance. Support and services revenue decreased 22%10% from $9.8 million for the year ended December 31, 2019 to $7.7 million for the year ended December 31, 2020.2020 to $6.9 million for the year ended December 31, 2021. The decrease in support and services revenue from the previous year was attributable to a

Professional services revenue decreasedincreased from $0.4 million for the year ended December 31, 2019 to $0.2 million for the year ended December 31, 2020.2020 to $0.5 million for the year ended December 31, 2021. Professional services revenue can vary 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 revenue 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.

Cost of product revenue consists primarily of personnel costshardware and amortization of capitalized software costs.warranty expenses. Cost of support and service revenue consists primarily of personnel and other costs associated with providing software implementations, technical support under maintenance contracts and training.

Cost of product revenue for the year ended December 31, 2020 decreased $0.4 million, or 59%, to2021 was substantially the same at $0.3 million compared with $0.7$0.3 million for the same period in 2019.2020. Product gross margin increased towas also essentially unchanged at 96% for the year ended December 31, 2020,2021, compared with 89%96% for the same period in 2019. The decrease in cost of product revenue and increase in product gross margin for the current year was primarily due to an intentional shift away from hardware sales in the current period, compared to the prior year period.2020. Our cost of support and service revenue for the year ended December 31, 2020 decreased $0.72021 increased $0.1 million, or 30%6%, to $1.5$1.6 million, compared with $2.2$1.5 million for the same period in 2019.2020. Support and service gross margin increaseddecreased to 80%77% for the year ended December 31, 20202021 from 78%80% for the same period in 2019.2020. The increasedecrease in support and service gross margin, as compared to the previous year, was primarily attributable to a decrease in support and services revenue combined with an increase in maintenanceconsulting services costs related to implementations and support services revenue that was greater in proportion to the increase in costs, year over year.technical support.

Research and development costs consist primarily of personnel costs for product development, and other related costs associated with the development of new products, enhancements to existing products, quality assurance and testing.  Research and development costs decreased $0.7increased $0.4 million, or 23%15%, to $2.5$2.8 million for the year ended December 31, 2020,2021, from $3.2$2.5 million in 2019.2020. The decreaseincrease in research and development costs was primarily related to a decreasean increase in professional fees as well as personnel related costs resulting from our realignment and reductionreinstatement of workforce that was reduced as part of the 2020 Restructuring Plan implemented in workforce and continued effortsresponse to allocate the appropriate level of resources based upon the product development roadmap schedule.novel coronavirus pandemic. For further information, refer to Note (14) Restructuring Costs to our consolidated financial statements. We continue to provide substantial 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.

General and administrative expenses consist primarily of personnel costs of general and administrative functions, public company related costs, directors’ and officers’ insurance, legal and professional fees, and other general corporate overhead costs.  General and administrative expenses decreased $2.6$0.1 million, or 46%4%, to $2.9 million for the year ended December 31, 2021, from $3.0 million for the year ended December 31, 2020, from $5.6 million for the year ended December 31, 2019.2020. The decrease in general and administrative expenses was due primarily to positions eliminatedreductions in professional and facilities closed as part ofcontractor fees which are partially offset by an increase in Board fees during the Company's restructuring plans. For further information, refer to Note (14) Restructuring Costs, to our consolidated financial statements.year ended December 31, 2021.

In June 2017, the Board approved the 2017 Plan, a comprehensive plan to increase operating performance (the “2017 Plan”).performance. The 2017 Plan resulted in a realignment and reduction in workforce. The 2017 Plan was substantially completed by the end of our fiscal year ended December 31, 2017 and when combined with previous workforce reductions in the second quarter of Fiscal 2017 reduced our workforce to approximately 81 employees at December 31, 2017. As part of this consolidation effort, the Company vacated a portion of theits former Melville, NY office space during the three months ended June 30, 2018. In accordance with accounting standards governing costs associated with exit or disposal activities, expenses related to future rental payments for which the Company no longer intends to receive any economic benefit are accrued, net of any anticipated sublease income, when the Company ceases use of the leased space. DuringAs the years ended December 31, 2020 and 2019, the Company incurred lease disposal-relatedhas terminated in April 2021, there are no further restructuring costs forassociated with this property of $1.0 million and $0.9 million, respectively. As of December 31, 2019, $0.1 million of the Company's remaining accrued lease disposal cost has been recorded as a component of operating lease liabilities.lease.

During the three months ended September 30, 2019, the Company adopted a Plan, a plan to better align the Company’s cost structure with the skills and resources required to more effectively execute the Company’s long-term growth strategy and to support revenue levels the Company expected to achieve on a go forward basis, implement tighter expense controls, cease non-core activities and downsize several facilities (the "2019 Plan"), implemented tighter expense controls, ceased non-core activities and downsized several facilities.. During the three monthsyears ended ended MarchDecember 31, 2021 and 2020, the Company incurred $0 and $0.1 million in severance expense, respectively as a result of this action. The 2019 Plan was substantially completed byas of March 31, 2020.

Given the commercial uncertainty caused by the novel coronavirus pandemic, or COVID-19, the Company developed and implemented an even more aggressive expense control plan in March 2020, that it is kept in place for the remainder of 2020 (the "2020

Interest and other expense increased $0.1 million for the year ended December 31, 2020 to $0.7 million, compared to $0.6 million for the year ended December 31, 2019. Interest and other expense is comprised of interest expense on our term loan, foreign currency gains and losses and the change in fair value our embedded derivatives. Interest and other expense decreased $0.1 million for the year ended December 31, 2021 to $0.7 million, compared to $0.7 million for the year ended December 31, 2020. The decrease in interest and other expense primarily relates to payments made on outstanding debt. The fluctuation in interest and other income (loss) from quarter to quarter also relates to foreign currency gains and losses, interest income, and the change in fair value of our embedded derivatives. For more information on our derivative instruments, see Note (3) Fair Value Measurements to our consolidated financial statements.

Our principal sources of liquidity are our cash and cash equivalents balances generated from operating, investing and financing activities. Our cash and cash equivalents balance as of December 31, 20202021 totaled $1.9$3.2 million, compared with $1.5$1.9 million as of December 31, 2019.2020.

On December 27, 2019,As described in Note (9) Stockholders' Equity to our consolidated financial statements, on June 23, 2021, the Company entered intoissued and sold an amendmentaggregate of 811,750 shares of its common stock in a public offering underwritten by Roth, which included 86,750 shares purchased by Roth pursuant to the partial exercise of its over-allotment option. At a price of $4.10 per share, the Company received net proceeds of approximately $2.7 million after deducting the underwriting discount and estimated offering expenses paid by the Company.

The Amended and Restated Term Loan Credit Agreement has customary representations, warranties and affirmative and negative covenants. The negative covenants include financial covenants by the Company to maintain minimum cash denominated in U.S. dollars plus accounts receivable outstanding for less than 90 days of $2 million to maintain liquidity at least at $300,000 until the 2019 Term Loan is repaid, other financial covenants relating to In-Forcein-force annual contract value. The Amended and Restated Term Loan Credit Agreement also contains customary events of default, including but not limited to payment defaults, cross defaults with certain other indebtedness, breaches of covenants, bankruptcy events and a change of control. In the case of an event of default, as administrative agent under the Amended and Restated Term Loan Credit Agreement, HCP-FVA, an affiliate of Hale Capital may (and upon the written request of lenders holding in excess of 50% of the Term Loans,term loans, which must include HCP-FVA, is required to) accelerate payment of all obligations under the Amended and Restated Term Loan Credit Agreement, and seek other available remedies.

The restrictions in the Amended and Restated Term Loan Credit Agreement may prevent us from taking actions that we believe would be in the best interests of our business, and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted. In addition, our ability to comply with the financial and other covenants and restrictions in the Amended and Restated Term Loan Credit Agreement will largely depend on the pricing of our products and services, and our ability to successfully implement our overall business strategy. We cannot assure you that we will be granted waivers or amendments to the Amended and Restated Term Loan Credit Agreement if for any reason we are unable to comply with these covenants and restrictions. The breach of any of these covenants and restrictions could result in a default under the Amended and Restated Term Loan Credit Agreement, which could result in an acceleration of our indebtedness.

As of December 31, 2020,2021, we had a working capital deficiencysurplus of $4.5$1.3 million, which is inclusive of current deferred revenue of $4.6 million, and a stockholders' deficit of $14.6$13.0 million. OurDuring the year ended December 31, 2021, the Company had a net income of $0.2 million and negative cash andflow from operations of $0.9 million. The Company's total cash equivalentsbalance at December 31, 20202021 was $1.9$3.2 million, an increase of $0.4$1.3 million as compared to December 31, 2019.2020. On April 28, 2020, the Company entered into a loanthe PPP Loan with Peapack-Gladstone Bank in an aggregate principal amount of $754,000, (the "Loan"), pursuant towhich was forgiven by the Paycheck Protection Program (the "PPP")Small Business Administration on March 30, 2021. On June 30, 2021, the Company repaid $1.3 million of the $3.5 million principal amount that was outstanding as of June 2, 2021 under the Coronavirus Aid, Relief,Amended and Economic Security Act (the "CARES Act").Restated Loan Agreement.    

Cash flow information is as follows: 

Net cash provided byused in operating activities totaled $0.7$0.9 million for the year ended December 31, 20202021 compared with $1.9$0.7 million of net cash used inprovided by operating activities in the prior year period. The changes in net cash provided byused in and usedprovided by operating activities for each of the years ended December 31, 20202021 and 2019,2020, were primarily due to our net income (loss) and adjustments for net changes in operating assets and liabilities, primarily changesdriven by decreases in our accounts receivable, deferred revenue, prepaidaccrued expenses inventory,and operating lease liabilities, partially offset by increases in other assets accounts payable, and other accruedprepaid expenses.

Net cash used in investing activities totaled $0.0$0.2 million for the year ended December 31, 2020,2021, compared with net cash used in investing activities of $0.1$0.0 million for the prior year period. Included in investing activities for the years ended December 31, 20202021 and 20192020 are purchases of property and equipment, intangible assets and cash received from security deposits.

 

Net cash used inprovided by financing activities totaled $0.2$2.3 million for the year ended December 31, 2020,2021, compared with net used in by financing activities of $0.2 million for the prior year period. The change in net cash provided by financing activities in the year ended December 31, 2021 included net proceeds from public offerings of $0.5 million for the prior year period. Includedour common stock, less offering costs, and payments on our debt. The net cash used in financing activities forin the year ended December 31, 2020 are $0.8 million in proceeds fromwas attributable to the PPP loan and the $1.0 million payoff of the term loan. Included in financing activities for the year ended December 31, 2019 are $0.9 million inloan which was partially offset by proceeds from the issuance of our 2019 Term Loan in December 2019 and the partial repayment of $$0.5 million of principal under our Term Loan in January 2019.PPP Loan.

As of December 31, 2020,2021, our significant commitments are related to (i) the Amended and Restated Term Loan Credit Agreement, (ii) our operating leases for our office facilities, (iii) dividends (including accrued dividends) on our Series A Preferred Stock, and (iv) the potential redemption of the Series A Preferred Stock as discussed above. 

(b) Represents our liability for uncertain tax positions. We are unable to make a reasonably reliable estimate of the timing of payments due to uncertainties in the timing of tax audit outcomes.

As of December 31, 20202021 and 2019,2020, we had no off-balance sheet arrangements.

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.

 

Judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. For products and services aside from maintenance and support, we estimate SSP by adjusting the list price by historical discount percentages. SSP for software and hardware maintenance and support fees is based on the stated percentages of the fees charged for the respective products.

Our perpetual and term software licenses have significant standalone functionality and therefore revenue allocated to these performance obligations are recognized at a point in time upon electronic delivery of the download link and the license keys.

Product maintenance and support services are satisfied over time as they are stand-ready obligations throughout the support period. As a result, revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract.

Revenues associated with professional services are recognized at a point in time upon customer acceptance.

 

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 or under statute expirations. 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

 

 

As of both December 31, 20202021 and 2019,2020, we had $4.2 million of goodwill. As of both December 31, 20202021 and 2019,2020, we had $0.1 million (net of accumulated amortization), respectively, of other identifiable intangible assets. We do not amortize goodwill, but we assess for impairment at least annually on December 31st and more often if a trigger event occurs. In accordance with FASB Accounting Standards Codification ("ASC") 350, "Goodwill and Other" ("ASC 350") our goodwill impairment test includes only one step, which is a comparison of the carrying value of our one reporting unit to its fair value. Pursuant to ASC 350, any excess carrying value, up to the amount of goodwill allocated to that reporting unit, is impaired. At December 31, 20202021 and 2019,2020, the fair value of the Company's single reporting unit for purposes of its goodwill impairment test exceeded it carrying value and thus the Company determined there was no impairment of goodwill.

We have served as the Company’s auditor since 2019.

Costa Mesa, CA

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICITOPERATIONS