UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended ~~March 31,~~June 30, 2020

o TRANSITION 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.)

701 Brazos Street, Suite 400, Austin, TX	78701
(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)

Securities registered pursuant to Section 12(b) of the Act: None.

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 ý No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ý No o

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



Large accelerated filer o	Accelerated filer o
Non-accelerated filer x	Smaller reporting company x
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 ý

The number of shares of common stock outstanding as of ~~April 30,~~July 31, 2020 was 5,919,837.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX



		Page
PART I.	Financial Information	4

Item 1.	Financial Statements	4

	Condensed Consolidated Balance Sheets at ~~March 31,~~June 30, 2020 (unaudited) and December 31, 2019	4

	Unaudited Condensed Consolidated Statements of Operations for the three and six months ended ~~March 31,~~June 30, 2020 and 2019	5

	Unaudited Condensed Consolidated Statements of Comprehensive (Loss) Income for the three and six months ended ~~March 31,~~June 30, 2020 and 2019	6

	Unaudited Condensed Consolidated Statements of Stockholders' Deficit for the three and six months ended ~~March 31,~~June 30, 2020 and 2019	7

	Unaudited Condensed Consolidated Statements of Cash Flows for the ~~three~~six months ended ~~March 31,~~June 30, 2020 and 2019	89

	Notes to the Unaudited Condensed Consolidated Financial Statements	910

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	2528

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	3339

Item 4.	Controls and Procedures	3340

PART II.	Other Information	3542

Item 1.	Legal Proceedings	3542

Item 1A.	Risk Factors	3542

Item 6.	Exhibits	3643

SIGNATURES		3744

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS


	March 31, 2020			December 31, 2019			June 30, 2020			December 31, 2019
	(unaudited)						(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	976,121		$	1,475,166		$	1,514,351		$	1,475,166
Accounts receivable, net of allowances	1,758,213			3,406,550			1,856,839			3,406,550
Prepaid expenses and other current assets	2,127,422			2,252,372			1,892,842			2,252,372
Contract assets	593,834			749,515			423,556			749,515
Inventory	14,173			30,014			14,571			30,014
Total current assets	5,469,763			7,913,617			5,702,159			7,913,617
Property and equipment, net of accumulated depreciation and amortization	321,714			369,273			278,345			369,273
Operating lease right-of-use assets, net	1,488,539			1,842,254			1,155,028			1,842,254
Deferred tax assets, net	259,008			258,841			258,985			258,841
Software development costs, net	24,221			27,012			22,577			27,012
Other assets	911,425			829,335			923,275			829,335
Goodwill	4,150,339			4,150,339			4,150,339			4,150,339
Other intangible assets, net	84,249			57,718			91,463			57,718
Long-term contract assets	254,397			327,757			254,397			327,757
Total assets	$	12,963,655		$	15,776,146		$	12,836,568		$	15,776,146
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable	$	868,266		$	1,302,290		$	696,459		$	1,302,290
Accrued expenses	2,280,901			2,533,824			2,309,524			2,533,824
Current portion of lease liabilities	1,699,377			1,655,522			1,438,448			1,655,522
Short-term loan, net of debt issuance costs and discounts	1,001,327			947,501			1,812,210			947,501
Deferred revenue	3,478,006			5,270,190			2,926,017			5,270,190
Total current liabilities	9,327,877			11,709,327			9,182,658			11,709,327
Other long-term liabilities	768,910			745,254			688,441			745,254
Notes payable, net of debt issuance costs and discounts	3,015,993			2,906,133			3,113,267			2,906,133
Operating lease liabilities, net of current portion	177,905			624,859			31,507			624,859
Deferred tax liabilities, net of current portion	457,060			432,520			432,301			432,520
Deferred revenue, net	2,671,420			2,085,080
Deferred revenue, net of current portion							2,442,373			2,085,080
Total liabilities	16,419,165			18,503,173			15,890,547			18,503,173
Commitments and contingencies (Note 11)
Series A redeemable convertible preferred stock, $.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $12,548,444 and $12,262,685, respectively	11,616,129			11,304,279
Series A redeemable convertible preferred stock, $.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $12,809,039 and $12,262,685, respectively							12,041,865			11,304,279
Stockholders' deficit:
Common stock - $.001 par value, 30,000,000 shares authorized, 5,919,837 shares and 5,918,733 shares issued and outstanding, respectively	5,920			5,919			5,920			5,919
Additional paid-in capital	111,420,547			111,727,888			110,997,871			111,727,888
Accumulated deficit	(124,591,693		)	(123,871,853		)	(124,185,135		)	(123,871,853		)
Accumulated other comprehensive loss, net	(1,906,413		)	(1,893,260		)	(1,914,500		)	(1,893,260		)
Total stockholders' deficit	(15,071,639		)	(14,031,306		)	(15,095,844		)	(14,031,306		)
Total liabilities and stockholders' deficit	$	12,963,655		$	15,776,146		$	12,836,568		$	15,776,146

See accompanying notes to unaudited condensed consolidated financial statements.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)


	Three Months Ended March 31,						Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019			2020			2019
Revenue:
Product revenue	$	1,048,963		$	1,745,784		$	1,632,055		$	1,470,430		$	2,681,018		$	3,216,214
Support and services revenue	2,131,224			2,747,194			1,867,557			2,528,959			3,998,781			5,276,153
Total revenue	3,180,187			4,492,978			3,499,612			3,999,389			6,679,799			8,492,367
Cost of revenue:
Product	139,460			79,669			61,830			755,796			201,290			835,470
Support and service	407,920			563,745			334,396			537,105			742,316			1,107,590
Total cost of revenue	547,380			643,414			396,226			1,292,901			943,606			1,943,060
Gross profit	2,632,807			3,849,564			3,103,386			2,706,488			5,736,193			6,549,307
Operating expenses:
Research and development costs	674,924			947,384			534,000			764,276			1,208,924			1,720,847
Selling and marketing	981,191			1,040,289			1,019,940			1,296,909			2,001,131			2,369,347
General and administrative	1,093,169			1,476,296			845,581			1,397,886			1,938,750			2,826,085
Restructuring costs	287,460			157,693			153,685			202,679			441,145			360,372
Total operating expenses	3,036,744			3,621,662			2,553,206			3,661,750			5,589,950			7,276,651
Operating income (loss)	(403,937		)	227,902			550,180			(955,262		)	146,243			(727,344		)
Interest and other expense	(245,839		)	(265,223		)	(180,249		)	(80,217		)	(426,088		)	(345,456		)
Loss before income taxes	(649,776		)	(37,321		)
Income tax expense	70,064			87,586
Net loss	$	(719,840	)	$	(124,907	)
Income (loss) before income taxes							369,931			(1,035,479		)	(279,845		)	(1,072,800		)
Income tax expense (benefit)							(36,627		)	136,244			33,437			223,830
Net income (loss)							$	406,558		$	(1,171,723	)	$	(313,282	)	$	(1,296,630	)
Less: Accrual of Series A redeemable convertible preferred stock dividends	285,760			247,027			260,595			256,553			546,355			503,580
Less: Accretion to redemption value of Series A redeemable convertible preferred stock	26,090			129,239			165,141			134,223			191,231			263,462
Net loss attributable to common stockholders	$	(1,031,690	)	$	(501,173	)
Basic net loss per share attributable to common stockholders	$	(0.17	)	$	(0.09	)
Diluted net loss per share attributable to common stockholders	$	(0.17	)	$	(0.09	)
Net income (loss) attributable to common stockholders							$	(19,178	)	$	(1,562,499	)	$	(1,050,868	)	$	(2,063,672	)
Basic net income (loss) per share attributable to common stockholders							$	0.00		$	(0.27	)	$	(0.18	)	$	(0.35	)
Diluted net income (loss) per share attributable to common stockholders							$	0.00		$	(0.27	)	$	(0.18	)	$	(0.35	)
Weighted average basic shares outstanding	5,919,643			5,887,988			5,919,837			5,879,225			5,919,740			5,875,907
Weighted average diluted shares outstanding	5,919,643			5,887,988			5,919,837			5,879,225			5,919,740			5,875,907

See accompanying notes to unaudited condensed consolidated financial statements.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

Three Months Ended March 31,
2020 2019
Net loss $ (719,840 ) $ (124,907 )
Other comprehensive loss, net of applicable taxes

Foreign currency translation (13,153 ) 19,392
Total other comprehensive loss, net of applicable taxes: (13,153 ) 19,392
Total comprehensive loss $ (732,993 ) $ (105,515 )
Less: Accrual of Series A redeemable convertible preferred stock dividends 285,760
247,027
Less: Accretion to redemption value of Series A redeemable convertible preferred stock 26,090
129,239
Total comprehensive loss attributable to common stockholders $ (1,044,843 ) $ (481,781 )



	Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019
Net income (loss)	$	406,558		$	(1,171,723	)	$	(313,282	)	$	(1,296,630	)
Other comprehensive income (loss), net of applicable taxes
Foreign currency translation	(8,087		)	(49,410		)	(21,240		)	(30,018		)
Total other comprehensive income (loss), net of applicable taxes:	(8,087		)	(49,410		)	(21,240		)	(30,018		)
Total comprehensive income (loss)	$	398,471		$	(1,221,133	)	$	(334,522	)	$	(1,326,648	)
Less: Accrual of Series A redeemable convertible preferred stock dividends	260,595			256,553			546,355			503,580
Less: Accretion to redemption value of Series A redeemable convertible preferred stock	165,141			134,223			191,231			263,462
Total comprehensive income (loss) attributable to common stockholders	$	(27,265	)	$	(1,611,909	)	$	(1,072,108	)	$	(2,093,690	)

See accompanying notes to unaudited condensed consolidated financial statements.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT

(UNAUDITED)


	Common Stock Outstanding	Common Stock		Additional Paid-In Capital			Accumulated Deficit			Accumulated Other Comprehensive Loss, Net			Total Stockholders' Deficit			Common Stock Outstanding	Common Stock		Additional Paid-In Capital			Accumulated Deficit			Accumulated Other Comprehensive Loss, Net			Total Stockholders' Deficit
Balance at January 1, 2020	5,918,733	$	5,919	$	111,727,888		$	(123,871,853	)	$	(1,893,260	)	$	(14,031,306	)	5,918,733	$	5,919	$	111,727,888		$	(123,871,853	)	$	(1,893,260	)	$	(14,031,306	)
Net loss							(719,840		)				(719,840		)
Net income (loss)																						(719,840		)				(719,840		)
Restricted stock issued	1,104	1		(1		)							—			1,104	1		(1		)							—
Share-based compensation to employees				4,510									4,510						4,510									4,510
Accretion of Series A redeemable convertible preferred stock				(26,090		)							(26,090		)				(26,090		)							(26,090		)
Dividends on Series A redeemable convertible preferred stock				(285,760		)							(285,760		)				(285,760		)							(285,760		)
Foreign currency translation										(13,153		)	(13,153		)										(13,153		)	(13,153		)
Balance at March 31, 2020	5,919,837	$	5,920	$	111,420,547		$	(124,591,693	)	$	(1,906,413	)	$	(15,071,639	)	5,919,837	$	5,920	$	111,420,547		$	(124,591,693	)	$	(1,906,413	)	$	(15,071,639	)

Balance at January 1, 2019	5,872,252	$	5,873	$	113,243,227		$	(122,907,794	)	$	(1,895,102	)	$	(11,553,796	)
Net income							(124,907		)				(124,907		)
Net income (loss)																						$	406,558					$	406,558
Share-based compensation to employees				9,251									9,251						$	3,060								$	3,060
Accretion of Series A redeemable convertible preferred stock				(129,239		)							(129,239		)				$	(165,141	)							$	(165,141	)
Dividends on Series A redeemable convertible preferred stock				(247,027		)							(247,027		)				$	(260,595	)							$	(260,595	)
Foreign currency translation										19,392			19,392												$	(8,087	)	$	(8,087	)
Balance at March 31, 2019	5,872,252	$	5,873	$	112,876,212		$	(123,032,701	)	$	(1,875,710	)	$	(12,026,326	)
Balance at June 30, 2020																5,919,837	$	5,920	$	110,997,871		$	(124,185,135	)	$	(1,914,500	)	$	(15,095,844	)

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT

(UNAUDITED)



	Common Stock Outstanding	Common Stock		Additional Paid-In Capital			Accumulated Deficit			Accumulated Other Comprehensive Loss, Net			Total Stockholders' Deficit
Balance at January 1, 2019	5,872,552	$	5,873	$	113,243,227		$	(122,119,899	)	$	(1,895,102	)	$	(10,765,901	)
Net income (loss)							(124,907		)				(124,907		)
Share-based compensation to employees				9,251									9,251
Accretion of Series A redeemable convertible preferred stock				(129,239		)							(129,239		)
Dividends on Series A redeemable convertible preferred stock				(247,027		)							(247,027		)
Foreign currency translation										19,392			19,392
Balance at March 31, 2019	5,872,552	$	5,873	$	112,876,212		$	(122,244,806	)	$	(1,875,710	)	$	(11,238,431	)
Net income (loss)							$	(1,171,723	)				$	(1,171,723	)
Share-based compensation to employees				$	16,231								$	16,231
Warrants exercised	15,181	$	15	$	(15	)							$	—
Accretion of Series A redeemable convertible preferred stock				$	(134,223	)							$	(134,223	)
Dividends on Series A redeemable convertible preferred stock				$	(256,553	)							$	(256,553	)
Foreign currency translation										$	(49,410	)	$	(49,410	)
Balance at June 30, 2019	5,887,733	$	5,888	$	112,501,652		$	(123,416,529	)	$	(1,925,120	)	$	(12,834,109	)

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)


	Three Months Ended March 31,						Six Months Ended June 30,
	2020			2019			2020			2019
Cash flows from operating activities:
Net loss	$	(719,840	)	$	(124,907	)
Net income (loss)							$	(313,282	)	$	(1,296,630	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	33,563			127,871			97,065			223,783
Amortization of debt discount on notes payable	109,861			57,785			317,843			110,913
Amortization of right of use assets	353,715			398,203			687,226			437,384
Share-based payment compensation	4,510			9,251			7,570			25,482
Provision for (recovery of) returns and doubtful accounts	(81,244		)	(35,649		)	(81,244		)	29,346
Deferred income taxes (benefit)	24,545			—			—			—
Changes in operating assets and liabilities:
Accounts receivable	1,720,163			325,914			1,628,983			1,915,823
Prepaid expenses and other current assets	121,591			170,927			277,525			181,764
Contract assets	229,042			(86,397		)	399,320			92,724
Inventory	15,539			(15,829		)	14,571			(90,045		)
Other assets	(51		)	(467,367		)	(7,160		)	(551,582		)
Accounts payable	(433,791		)	(64,080		)	(605,831		)	527,623
Accrued expenses and other long-term liabilities	(171,461		)	137,972			(298,558		)	(262,193		)
Operating lease liabilities	(403,100		)	(463,781		)	(810,426		)	(568,539		)
Deferred revenue	(1,201,373		)	(74,142		)	(1,988,705		)	(699,893		)
Net cash used in operating activities	(398,331		)	(104,229		)
Net cash provided by (used in) operating activities							(675,103		)	75,960
Cash flows from investing activities:
Purchases of property and equipment	—			(42,586		)	—			(179,048		)
Security deposits	(82,908		)	146			—			(6,398		)
Purchase of intangible assets	(11,360		)	(26,365		)	(35,655		)	(41,736		)
Net cash used in investing activities	(94,268		)	(68,805		)
Net cash provided by (used in) investing activities							(35,655		)	(227,182		)
Cash flows from financing activities:
Proceeds from issuance of PPP loan							754,000			—
Payments of long term-debt	—			(489,321		)	—			(489,321		)
Net cash provided by (used in) financing activities	—			(489,321		)	754,000			(489,321		)
Effect of exchange rate changes on cash and cash equivalents	(6,446		)	(29,173		)	(4,057		)	(18,181		)
Net decrease in cash and cash equivalents	(499,045		)	(691,528		)
Net increase (decrease) in cash and cash equivalents							39,185			(658,724		)
Cash and cash equivalents, beginning of period	1,475,166			3,059,677			1,475,166			3,059,677
Cash and cash equivalents, end of period	$	976,121		$	2,368,149		$	1,514,351		$	2,400,953
Supplemental disclosures:
Cash paid for interest	$	52,546		$	60,833		$	110,708		$	119,040
Non-cash investing and financing activities:
Undistributed Series A redeemable convertible preferred stock dividends	$	285,760		$	247,027		$	546,355		$	503,580
Accretion of Series A redeemable convertible preferred stock	$	26,090		$	129,239		$	191,231		$	263,462

See accompanying notes to unaudited condensed consolidated financial statements.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

(1) Basis of Presentation

(a) The Company and Nature of Operations

FalconStor Software, Inc., a Delaware corporation (the "Company" or "FalconStor"), is a leading storage software company offering a converged data services software platform that is hardware agnostic. The Company develops, manufactures and sells data migration, business continuity, disaster recovery, optimized backup and de-duplication solutions and provides the related maintenance, implementation and engineering services.

(b) Liquidity

As of ~~March 31,~~June 30, 2020, the Company had a working capital deficiency of ~~$3.9~~$3.5 million, which is inclusive of current deferred revenue of ~~$3.5~~$2.9 million, and a stockholders' deficit of $15.1 million. During the ~~three~~six months ended ~~March 31,~~June 30, 2020, the Company had a net loss of ~~$0.7~~$0.3 million and negative cash flow from operations of ~~$0.4~~$0.7 million. The Company's total cash balance at ~~March 31,~~June 30, 2020 was ~~$1.0~~$1.5 million, ~~a decrease~~an increase of ~~$0.5 million~~$39,185 compared to December 31, 2019. On April 28, 2020, the Company entered into a loan with Peapack-Gladstone Bank in an aggregate principal amount of $754,000 (the "Loan"), pursuant to the Paycheck Protection Program (the "PPP") under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act").

The Company's ability to continue as a going concern for the next twelve months, depends on its ability to execute its business plan, increase revenue and billings and reduce expenditures. In the third quarter of 2019, the Company adopted 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 (the "2019 Plan"). In connection with the 2019 Plan, the Company eliminated 23 positions worldwide, implemented tighter expense controls, ceased non-core activities and downsized several facilities. As of ~~March 31,~~June 30, 2020, the 2019 Plan is considered to be substantially completed.

On December 27, 2019, the Company entered into Amendment No. 1 to Amended and Restated Term Loan Credit Agreement (the “Amendment”), by and among the Company, certain of the Company’s affiliates in their capacities as guarantors, HCP-FVA, LLC (“HCP-FVA”) as administrative agent for the lenders party thereto (the “Lenders”), ESW Capital, LLC (“ESW”), as co-agent, and the Lenders, to provide for, among other things, a new $2,500,000 term loan facility to the Company (the “2019 Term Loan”). The Amendment also provides for certain financial covenants. On December 27, 2019, the Company drew down $1,000,000 of the 2019 Term Loan and the Company will pay a fixed amount of interest on such advance equal to 15% of the principal amount advanced.

In connection with the initial advance of the 2019 Term Loan, HCP-FVA funded $620,000, ESW funded $378,439 and Michael Kelly funded $1,561. HCP-FVA is an affiliate of Hale Capital Partners, LP ("Hale Capital"), the Company’s largest stockholder, and an affiliate of a director of the Company, Martin Hale. ESW is a greater than 5% stockholder of the Company and Mr. Kelly is a director of the Company.

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 prepared to keep in place for the remainder of 2020. This plan reduces the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 4 of these positions were reinstated in the second quarter of 2020. We believe the reduced expense level will enable FalconStor to remain profitable during the remainder of 2020, even with continued revenue challenges throughout.

There is no assurance that the Company will be successful in generating sufficient bookings, billings, revenue or continue to reduce operating costs or that the Company will be able to obtain financing or that such financing will be on favorable terms. Any such financing would be dilutive to our shareholders. Failure to generate sufficient revenue, billings, control or further reduce expenditures and/or the inability to obtain financing will result in an inability of the Company to continue as a going concern. Subject to the foregoing, management believes that, based on projected cash flows and additional financing, the Company will have sufficient capital and liquidity to fund its operations for at least one year from the date of issuance of the accompanying interim financial statements.

We believe that our cash flows from operations and existing cash on hand are sufficient to conduct our planned operations and meet our contractual requirements through ~~May 15,~~August 5, 2021.

We are closely monitoring the impact of COVID-19, on all aspects of our business. In March 2020, the World Health Organization characterized COVID-19 as a pandemic and the President of the United States declared the COVID-19 outbreak a national emergency. Since then, the COVID-19 pandemic has rapidly spread across the globe and has already resulted in significant volatility, uncertainty and economic disruption. The outbreak of COVID-19 has caused and may continue to cause travel bans or disruptions, and in some cases, prohibitions of non-essential activities, disruption and shutdown of businesses and greater uncertainty in global financial markets. The impact of COVID-19 is fluid and uncertain, but it has caused and may continue to cause various negative effects, including an inability to meet with actual or potential customers, our end customers deciding to delay or abandon their planned purchases or failing to make payments, and delays or disruptions in our or our partners’ supply chains. As a result, we may experience extended sales cycles, our ability to close transactions with new and existing customers and partners may be negatively impacted, our ability to recognize revenue from software transactions we do close may be negatively impacted, our demand generation activities, and the efficiency and effect of those activities, may be negatively affected, and it has been and, until the COVID-19 outbreak is contained, will continue to be more difficult for us to forecast our operating results. These uncertainties have, and may continue to, put pressure on global economic conditions and overall IT spending and may cause our end customers to modify spending priorities or delay or abandon purchasing decisions, thereby lengthening sales cycles and potentially lowering prices for our solutions, and may make it difficult for us to forecast our sales and operating results and to make decisions about future investments, any of which could materially harm our business, operating results and financial condition.

Further, our management team is focused on addressing the impacts of COVID-19 on our business, which has required and will continue to require, a large investment of their time and resources and may distract our management team or disrupt our 2020 operating plans. The extent to which COVID-19 ultimately impacts our results of operations, cash flow and financial position will depend on future developments, which are uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak, its severity, the actions taken by governments and authorities to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of its global economic impact, including as a result of any recession that may occur.

(d) ~~Stock Split~~

On August 8, 2019, the Company effected a 100-for-1 reverse stock split of its issued and outstanding common stock. In connection with the reverse stock split, the Company also decreased its authorized capital to 32,000,000 shares, consisting of 30,000,000 shares of common stock and 2,000,000 shares of preferred stock. The par value of the Company's common stock was not adjusted as a result of the reverse stock split. All of the share and per share information presented in the accompanying financial statements have been adjusted to reflect, unless otherwise indicated, the reverse common stock split on a retroactive basis for all periods and as of all dates presented.

~~(e)~~ 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.

~~(f)~~(e) Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") 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, valuation of derivatives, capitalizable software development costs, valuation of goodwill and other intangible assets and income taxes. During the first quarter of 2018, the Company also had significant estimates in the determination of the fair value of Series A Preferred Stock, notes payable and warrants issued. 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 on the Company’s significant accounting estimates discussed above.

~~(g)~~(f) Unaudited Interim Financial Information

The accompanying unaudited interim condensed consolidated financial statements have been prepared 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 GAAP 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 ~~March 31,~~June 30, 2020, and the results of its operations for the three and six months ended ~~March 31,~~June 30, 2020 and 2019. 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. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes set forth in the Company's Annual Report on Form 10-K for the year ended December 31, 2019 ("2019 Form 10-K").

~~(h)~~

(g) Recently Issued Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans. The objective of the guidance is to improve the effectiveness of disclosure requirements on defined benefit pension plans and other postretirement plans. The guidance is effective for fiscal years beginning after December 15, 2020. The Company does not expect adoption of the new standard to have a material impact on its condensed consolidated financial statements.

In December 2019, the FASB released ASU 2019-12, which affects general principles within Topic 740, Income Taxes. The amendments of ASU 2019-12 are meant to simplify and reduce the cost of accounting for income taxes. The amendments in ASU 2019-12 are effective for public business entities for fiscal years beginning after December 15, 2020, including interim periods therein. Early adoption of the standard is permitted, including adoption in interim or annual periods for which financial statements have not yet been issued. The Company does not expect adoption of the new standard to have a material impact on its condensed consolidated financial statements.

(2) Summary of Significant Accounting Policies

The Company's significant accounting policies were described in Note (1) Summary of Significant Accounting Policies of the 2019 Form 10-K. There have been no significant changes in the Company's significant accounting policies since December 31, 2019, other than those noted below. For a description of the Company's other significant accounting policies refer to the 2019 Form 10-K.

Revenue from Contracts with Customers and Associated Balances

Nature of Products and Services

Licenses for on-premises software provide the customer with a right to use the software as it exists when made available to the customer. Customers may purchase perpetual licenses or subscribe to licenses, which provide customers with the same functionality and differ mainly in the duration over which the customer benefits from the software. Revenue from distinct on-premises licenses is recognized upfront at the point in time when the software is made available to the customer. Revenue allocated to software maintenance and support services is recognized ratably over the contractual support period.

Hardware products consist primarily of servers and associated components and function independently of the software products and as such are accounted for as separate performance obligations. Revenue allocated to hardware maintenance and support services is recognized ratably over the contractual support period.

Professional services are primarily related to software implementation services and associated revenue is recognized upon customer acceptance.

Contract Balances

Timing of revenue recognition may differ from the timing of invoicing to customers. The Company records a contract asset or receivable when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For perpetual licenses with multi-year product maintenance agreements, the Company generally invoices customers at

the beginning of the coverage period. For multi-year subscription licenses, the Company generally invoices customers annually at the beginning of each annual coverage period. The Company records a contract asset related to revenue recognized for multi-year on-premises licenses as its right to payment is conditioned upon providing product support and services in future years.

As of ~~March 31,~~June 30, 2020 and December 31, 2019, accounts receivable, net of allowance for doubtful accounts, was ~~$1.8~~$1.9 million and $3.4 million, respectively. As of ~~March 31,~~June 30, 2020 and December 31, 2019, short and long-term contract assets, net of allowance for doubtful accounts, was ~~$0.8~~$0.7 million and $1.1 million, respectively.

Deferred revenue is comprised mainly of unearned revenue related maintenance and technical support on term and perpetual licenses. Maintenance and technical support revenue is recognized ratably over the coverage period. Deferred revenue also includes contracts for professional services to be performed in the future which are recognized as revenue when the Company delivers the related service pursuant to the terms of the customer arrangement.

Changes in deferred revenue were as follows:


Three Months Ended March 31, 2020
Six Months Ended June 30, 2020
Balance at December 31, 2019	$	7,355,270		$	7,355,270
Deferral of revenue	1,967,462			4,686,038
Recognition of revenue	(3,180,187		)	(6,679,799		)
Change in reserves	6,881			6,881
Balance at March 31, 2020	$	6,149,426
Balance at June 30, 2020				$	5,368,390

Deferred revenue includes invoiced revenue allocated to remaining performance obligations that has not yet been recognized and will be recognized as revenue in future periods. Deferred revenue was ~~$6.1~~$5.4 million as of ~~March 31,~~June 30, 2020, of which the Company expects to recognize approximately ~~54%~~55% of such amount as revenue over the next 12 months and the remainder thereafter.

Approximately ~~$2.0~~$2.2 million of revenue is expected to be recognized from remaining performance obligations for unbilled support and services as of ~~March 31,~~June 30, 2020. We expect to recognize revenue on approximately ~~46%~~43% of these remaining performance obligations over the next twelve months, with the balance recognized thereafter.

Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 90 days. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined its contracts generally do not include a significant financing component. The primary purpose of the Company’s invoicing terms is to provide customers with simplified and predictable ways of purchasing its products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with maintenance and support revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with product revenue recognized upon delivery.

Significant Judgments

The Company’s contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.

Judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. For products and services aside from maintenance and support, the Company estimates 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.

The Company’s 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.

Disaggregation of Revenue

Please refer to the condensed consolidated statements of operations and Note (16), Segment Reporting and Concentrations, for discussion on revenue disaggregation by product type and by geography. The Company believes this level of disaggregation sufficiently depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors.

Assets Recognized from Costs to Obtain a Contract with a Customer

The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the benefit of those costs to be longer than one year. The Company has determined that its sales commission program meets the requirements for cost capitalization. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets on our consolidated balance sheets. The Company applies a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less.

Leases

We have entered into operating leases for our various facilities. We determine if an arrangement is a lease at inception. Operating leases are included in Right-of-Use ("ROU") assets, and lease liability obligations in our condensed consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liability obligations represent our obligation to make lease payments arising from the lease. ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. We have lease agreements with lease and non-lease components and account for such components as a single lease component. As most of our leases do not provide an implicit rate, we estimated our incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. We use the implicit rate when readily determinable. The ROU asset also includes any lease payments made and excludes lease incentives and lease direct costs. Our lease terms may include options to extend or terminate the lease. Such extended terms have been considered in determining the ROU assets and lease liability obligations when it is reasonably certain that we will exercise that option. Lease expense is recognized on a straight-line basis over the lease term.

Right of Use Assets and Liabilities

We have various operating leases for office facilities that expire through 2021. Below is a summary of our ROU assets and liabilities as of ~~March 31,~~June 30, 2020.


Right of use assets	$	1,488,539		$	1,155,028
Lease liability obligations, current	1,699,377			1,438,448
Lease liability obligations, less current portion	177,905			31,507
Total lease liability obligations	$	1,877,282		$	1,469,955
Weighted-average remaining lease term	1.13			0.89
Weighted-average discount rate	6.02		%	6.03		%


	Three Months Ended March 31,		Three Months Ended June 30,						Six Months Ended June 30,
	2020	2019	2020			2019			2020			2019
Components of lease expense:
Operating lease cost	354,400	417,765	$	352,688		$	416,508		$	782,402		$	834,273
Sublease income	155,944	155,944	(73,314		)	(155,944		)	(148,628		)	(311,888		)
Net lease cost	510,344	573,709	$	279,374		$	260,564		$	633,774		$	522,385

During the three months ended ~~March 31,~~June 30, 2020 and ~~March 31,~~ 2019, operating cash flows from operating leases was approximately ~~$547,623~~$378,392 and ~~$501,469,~~$494,243, respectively. During the six months ended June 30, 2020 and 2019, operating cash flows from operating leases was approximately $757,926 and $995,712, respectively.

Approximate future minimum lease payments for our ROU assets over the remaining lease periods as of ~~March 31,~~June 30, 2020, are as follows:


Remainder of 2020	1,329,957		850,408
2021	639,526		639,526
Thereafter	—
Total minimum lease payments	1,969,483		1,489,934
Less interest	(92,201	)	(19,979	)
Present value of lease liabilities	1,877,282		1,469,955

(3) Earnings Per Share

Basic earnings per share ("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, warrants and the Series A Redeemable Convertible Preferred Stock ("Series A Preferred Stock") outstanding.

The following represents the common stock equivalents that were excluded from the computation of diluted shares outstanding because their effect would have been anti-dilutive for the three and six months ended ~~March 31,~~June 30, 2020 and 2019:


	Three Months Ended March 31,		Three Months Ended June 30,		Six Months Ended June 30,
	2020	2019	2020	2019	2020	2019
Stock options and restricted stock	1,178,974	11,855	1,200,261	11,855	1,200,261	11,855
Series A redeemable convertible preferred stock	87,815	87,815	87,815	87,815	87,815	87,815
Total anti-dilutive common stock equivalents	1,266,789	99,670	1,288,076	99,670	1,288,076	99,670

(4) Property and Equipment

The gross carrying amount and accumulated depreciation of property and equipment as of ~~March 31,~~June 30, 2020 and December 31, 2019 are as follows:


	March 31, 2020			December 31, 2019			June 30, 2020			December 31, 2019
Gross carrying amount	$	18,722,635		$	18,735,885		$	18,734,145		$	18,735,885
Accumulated depreciation	(18,400,921		)	(18,366,612		)	(18,455,800		)	(18,366,612		)
Property and Equipment, net	$	321,714		$	369,273		$	278,345		$	369,273

For the three months ended ~~March 31,~~June 30, 2020 and 2019, depreciation expense was ~~$45,943~~$44,778 and ~~$72,214,~~$61,612, respectively. For the six months ended June 30, 2020 and 2019, depreciation expense was $90,721 and $133,826, respectively.

(5) Software Development Costs

The gross carrying amount and accumulated amortization of software development costs as of ~~March 31,~~June 30, 2020 and December 31, 2019 are as follows:


	March 31, 2020			December 31, 2019			June 30, 2020			December 31, 2019
Gross carrying amount	$	2,950,132		$	2,950,132		$	2,950,132		$	2,950,132
Accumulated amortization	(2,925,911		)	(2,923,120		)	(2,927,555		)	(2,923,120		)
Software development costs, net	$	24,221		$	27,012		$	22,577		$	27,012

During the three months ended ~~March 31,~~June 30, 2020 and 2019, the Company recorded ~~$2,791~~$1,644 and ~~$31,073,~~$11,560, respectively, of amortization expense related to capitalized software costs. During the six months ended June 30, 2020 and 2019, the Company recorded $4,435 and $42,633, respectively, of amortization expense related to capitalized software costs.

(6) Goodwill and Other Intangible Assets

The gross carrying amount and accumulated amortization of goodwill and other intangible assets as of ~~March 31,~~June 30, 2020 and December 31, 2019 are as follows:


	March 31, 2020			December 31, 2019			June 30, 2020			December 31, 2019
Goodwill	$	4,150,339		$	4,150,339		$	4,150,339		$	4,150,339
Other intangible assets:
Gross carrying amount	$	3,958,462		$	3,947,103		$	3,982,757		$	3,947,103
Accumulated amortization	(3,874,213		)	(3,889,385		)	(3,891,294		)	(3,889,385		)
Net carrying amount	$	84,249		$	57,718		$	91,463		$	57,718

For the three months ended ~~March 31,~~June 30, 2020 and 2019, amortization expense was ~~$(15,171)~~$17,080 and ~~$24,584,~~$22,740, respectively. For the six months ended June 30, 2020 and 2019, amortization expense was $1,909 and $47,324, respectively.

(7) Share-Based Payment Arrangements

On June 22, 2018, the Company's stockholders adopted the FalconStor Software, Inc. 2018 Incentive Stock Plan (the "2018 Plan"). The 2018 Plan is administered by the Compensation Committee and provides for the issuance of up to 1,471,997 shares of the Company's common stock upon the grant of shares with such restrictions as determined by the Compensation Committee to the employees and directors of, and consultants providing services to, the Company or its affiliates. Exercise prices of the options will be determined by the Compensation Committee of the Company's Board of Directors, subject to the consent of Hale Capital. The vesting terms shall be performance based and determined by the Compensation Committee, subject to the consent of Hale Capital, based on various factors, including (i) the return of capital to the holders of the Series A Preferred Stock and the Company’s Common Stock in the event of a Change of Control, (ii) the repayment of the Company’s obligations under its senior secured debt, and (iii) the Company’s free cash flow.

The following table summarizes the 2018 Plan, which was the only plan under which the Company was able to grant equity compensation as of ~~March 31,~~June 30, 2020:

Shares Available

Name of Plan

Authorized

for Grant

Outstanding

Authorized

for Grant

Outstanding

FalconStor Software, Inc. 2018 Incentive Stock Plan

1,471,997

281,837

1,190,160

1,471,997

282,941

1,189,056

The following table summarizes the Company’s equity plans that have terminated or expired but that still have equity awards outstanding as of ~~March 31,~~June 30, 2020:



Name of Plan	Shares Available for Grant	Shares Outstanding
FalconStor Software, Inc., 2016 Incentive Stock Plan	—	3,850
FalconStor Software, Inc., 2006 Incentive Stock Plan	—	~~7,445~~7,355

The following table summarizes the 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 ~~March 31,~~June 30, 2020 and 2019:


	Three Months Ended March 31,				Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019		2020		2019
Cost of revenue - support and service	103		1,593		103		449		206		2,042
Research and development costs	428		4,745		428		861		856		5,606
Selling and marketing	184		2,410		184		1,248		368		3,658
General and administrative	3,795		503		2,345		13,673		6,140		14,176
	$	4,510	$	9,251	$	3,060	$	16,231	$	7,570	$	25,482

(8) Income Taxes

The Company’s provision for income taxes consists principally 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 ~~three~~six months ended ~~March 31,~~June 30, 2020, the Company recorded an income tax provision of ~~$70,064.~~$33,437. The effective tax rate for the ~~three~~six months ended ~~March 31,~~June 30, 2020 was ~~(10.8%~~(9.9%). The effective tax rate differs from the statutory rate of 21% due to the mix of foreign and domestic earnings and the application of valuation allowances. As of ~~March 31,~~June 30, 2020, 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 income tax benefit as such amounts are fully offset with a valuation allowance.

For the ~~three~~six months ended ~~March 31,~~June 30, 2019, the Company recorded an income tax provision of ~~$87,586.~~$223,830. The effective tax rate for the ~~three~~six months ended ~~March 31,~~June 30, 2019 was ~~(234.7%~~(20.9%). The effective tax ~~rate~~ differs from the statutory rate of 21% ~~due~~primarily related to the mix of foreign and domestic earnings ~~and the application of valuation allowances.~~as no tax expense or benefit is being recognized on domestic earnings or losses. As of ~~March 31,~~June 30, 2019, 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 income tax expense as such amounts are fully offset with a valuation allowance.

The Company’s total unrecognized tax benefits, excluding interest, at ~~March 31,~~June 30, 2020 and December 31, 2019 were $81,399 and $134,246, respectively. As of ~~March 31,~~June 30, 2020 and December 31, 2019, the Company had ~~$33,827~~$35,499 and ~~$60,578,~~$63,404, respectively, of accrued interest reflected in accrued expenses. The Company expects approximately $7,000 of tax benefits during the next twelve months due to expiring statute of limitations, which will impact the Company's effective tax rate.

(9) Notes Payable and Stock Warrants

The notes payable balance consists of the following:


Notes payable principal balance	$	3,000,000		$	3,000,000
Deferred issuance costs	(254,247		)	(254,247		)
Discount	(288,504		)	(288,504		)
Total notes payable, net at inception on February 23, 2018	2,457,249			2,457,249
Proceeds from issuance of long-term debt	1,000,000			1,000,000
Revaluation of long-term debt	(447,008		)	(447,008		)
Accretion of discount	202,195			202,195
Deferred issuance costs	(87,609		)	(87,609		)
Total notes payable, net at December 31, 2018	$	3,124,827		$	3,124,827
Repayment of long-term debt	(489,321		)	(489,321		)
Proceeds from issuance of long-term debt	1,000,000			1,000,000
Accretion of discount	273,521			273,521
Deferred issuance costs	(55,393		)	(55,393		)
Total notes payable, net at December 31, 2019	$	3,853,634		$	3,853,634
Accretion of discount	163,686			317,843
Total notes payable, net at March 31, 2020	$	4,017,320
Total notes payable, net at June 30, 2020				$	4,171,477

The $4 million senior secured debt bears interest at prime plus 0.75% and matures on June 30, 2021. The $1 million term loan bears interest at 15% and matures on September 27, 2020. As of ~~March 31,~~June 30, 2020, the Company was in compliance with the financial covenants contained in the Amended and Restated Term Loan Credit Agreement.

Loan under the Paycheck Protection Program

On April 28, 2020, the Company entered into the Loan with Peapack-Gladstone Bank in an aggregate principal amount of $754,000, pursuant to the PPP under the CARES Act.

The Loan is evidenced by a promissory note (the “Note”) dated April 28, 2020, which is attached as Exhibit 10.1 to this Form 10-Q. The Loan matures two years from the disbursement date and bears interest at a rate of 1.000% per annum, with the first six months of interest deferred. Principal and interest are payable monthly commencing six months after the disbursement date and may be prepaid by the Company at any time prior to maturity with no prepayment penalties.

Under the terms of the CARES Act, PPP loan recipients can apply for and be granted forgiveness for all or a portion of loans granted under the PPP. The Loan is subject to forgiveness to the extent proceeds are used for payroll costs, including payments required to continue group health care benefits, and certain rent, utility, and mortgage interest expenses (collectively, “Qualifying Expenses”), pursuant to the terms and limitations of the PPP. The Company intends to use a significant majority of the Loan amount for Qualifying Expenses. However, no assurance is provided that the Company will obtain forgiveness of the Loan in whole or in part.

The Loan is included in notes payable, net of debt issuance costs and discounts in the accompanying condensed consolidated balance sheet.

(10) Fair Value Measurements

The Company measures its cash equivalents and derivative instruments 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.

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. At ~~March 31,~~June 30, 2020, the Company did not have any Level 1 category assets included 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. At ~~March 31,~~June 30, 2020 and December 31, 2019, the Company did not have any Level 2 category assets included 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. At ~~March 31,~~June 30, 2020 and December 31, 2019, the Level 3 category included derivatives, which are included within other long-term liabilities in the condensed consolidated balance sheets. The Company did not hold any cash and cash equivalents categorized as Level 3 as of ~~March 31,~~June 30, 2020 or December 31, 2019.

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at ~~March 31,~~June 30, 2020:


			Fair Value Measurements at Reporting Date Using								Fair Value Measurements at Reporting Date Using
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Derivative liabilities:
Derivative Instruments	481,052		—		—		481,052		478,312		—		—		478,312
Total derivative liabilities	481,052		—		—		481,052		478,312		—		—		478,312

Total assets and liabilities measured at fair value	$	481,052	$	—	$	—	$	481,052	$	478,312	$	—	$	—	$	478,312

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at December 31, 2019:



			Fair Value Measurements at Reporting Date Using
	Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Derivative liabilities:
Derivative Instruments	483,804		—		—		483,804
Total derivative liabilities	483,804		—		—		483,804

Total assets and liabilities measured at fair value	$	483,804	$	—	$	—	$	483,804

The fair value of the Company’s derivatives were valued using the Black-Scholes pricing model adjusted for probability assumptions, with all significant inputs, except for the probability and volatility assumptions, derived from or corroborated by observable market data such as stock price and interest rates. The probability and volatility assumptions are both significant to the fair value measurement and unobservable. These embedded derivatives are included in Level 3 of the fair value hierarchy.

The fair value of the Company's Series A Preferred Stock is based on its future cash flows discounted at a 14% yield. The fair value of the Company's note payable is based on its future cash flows discounted at a 17% yield.

The following table presents a reconciliation of the beginning and ending balances of the Company's liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended ~~March 31,~~June 30, 2020 and ~~March 31,~~June 30, 2019:


	Three Months Ended March 31,						Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019			2020			2019
Beginning Balance	$	483,804		$	498,086		$	481,042		$	492,327		$	483,804		$	498,086
Total income recognized in earnings	(2,752		)	(5,759		)	(2,730		)	(2,838		)	(5,492		)	(8,597		)
Ending Balance	$	481,052		$	492,327		$	478,312		$	489,489		$	478,312		$	489,489

(11) Commitments and Contingencies

The Company’s headquarters are located in Austin, Texas. The Company has an operating lease covering its Melville, New York office facility that expires in April 2021. The Company has sublet a portion of this lease. The Company also has several additional operating leases related to offices in foreign countries. The expiration dates for these leases range from 2020 through 2021. The following is a schedule of future minimum lease payments as well as sublease income for all operating leases as of ~~March 31,~~June 30, 2020:


	Payments		Sublease Income			Net Commitments		Payments		Sublease Income			Net Commitments
2020	1,329,957		(467,832		)	862,125		850,408		(473,149		)	377,259
2021	639,526		(207,925		)	431,601		639,526		(207,925		)	431,601
Thereafter	—		—			—
	$	1,969,483	$	(675,757	)	$	1,293,726	$	1,489,934	$	(681,074	)	$	808,860

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. For the three and six months ended ~~March 31,~~June 30, 2020, the Company has not incurred any costs related to warranty obligations.

Under the terms of substantially all of its software license agreements, the Company indemnifies 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 on 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. From time to time, in the ordinary course of business, the Company receives claims for indemnification, typically from OEMs. The Company is not currently aware of any material claims for indemnification.

As described under Note (12), the holders of the Series A Preferred Stock have redemption rights upon certain triggering events. As of ~~March 31,~~June 30, 2020, the Company did not fail any non-financial covenants related to the Company's Series A Preferred Stock.

In connection with the appointment of Todd Brooks as Chief Executive Officer, the Board approved an offer letter to Mr. Brooks (the “Brooks Agreement”), which was executed on August 14, 2017. The Brooks Agreement provides that Mr. Brooks is entitled to receive an annualized base salary of $350,000, payable in regular installments in accordance with the Company’s general payroll practices. Mr. Brooks will also be eligible for a cash bonus of $17,500 for any quarter that is free cash flow positive on an operating basis and additional incentive compensation of an annual bonus of up to $200,000, subject to attainment of performance objectives to be mutually agreed upon and established. Mr. Brooks' employment can be terminated at will. Pursuant to the Brooks Agreement and the 2018 Plan, Mr. Brooks received 735,973 shares of restricted stock. If Mr. Brooks’ employment is terminated by the Company other than for cause he is entitled to receive severance equal to twelve (12) months of his base salary if (i) he has been employed by the Company for at least twelve (12) months at the time of termination or (ii) a change of control has occurred within six (6) months of Mr. Brooks’ employment. Except as set forth in the preceding sentence, Mr. Brooks is entitled to receive severance equal to six (6) months of his base salary if he has been employed by the Company for less than six (6) months and his employment was terminated by the Company without cause. Mr. Brooks is also entitled to vacation and other employee benefits in accordance with the Company’s policies as well as reimbursement for an apartment.

In connection with the appointment of Brad Wolfe as the Company's Chief Financial Officer, the Board approved an offer letter to Mr. Wolfe (the “Wolfe Offer Letter”), which was executed on April 4, 2018. The Wolfe Offer Letter provides that Mr. Wolfe is entitled to receive an annualized base salary of $240,000, payable in regular installments in accordance with the Company’s

general payroll practices. Mr. Wolfe will also be eligible for a cash bonus of $10,000 for any quarter which has net working capital cash ~~in excess of $27,500~~that exceeds the prior quarter and additional incentive compensation of an annual bonus of up to $70,000, subject to attainment of performance objectives to be mutually agreed upon and established.

As described under Note (17), the Company has incurred certain restructuring costs in connection with restructuring plans adopted in ~~2013,~~ 2017 and 2019.

In addition, as of ~~March 31,~~June 30, 2020, the Company's liability for uncertain tax positions totaled ~~$115,227.~~$116,849. At this time, the settlement period for this liability, including related accrued interest, cannot be determined.

(12) Series A Redeemable Convertible Preferred Stock

The Company has 900,000 shares of Series A Preferred Stock outstanding. Pursuant to the Amended and Restated Certificate of Designations, Preferences and Rights for the Series A Preferred Stock (the "Certificate of Designations"), each share of Series A Preferred Stock can be converted into shares of the Company’s common stock, at current conversion price of $102.488 per share, subject to appropriate adjustments for any stock dividend, stock split, stock combination, reclassification or similar transaction, (i) at any time at the option of the holder or (ii) by the Company if, following the first anniversary of the issuance of the Series A Preferred Stock (subject to extension under certain circumstances), the volume weighted average trading price per share of the Company’s common stock for sixty (60) consecutive trading days exceeds 250% of the conversion price and continues to exceed 225% of the conversion price through the conversion date, subject at all times to the satisfaction of, and the limitations imposed by, the equity conditions set forth in the Certificate of Designations (including, without limitation, the volume limitations set forth therein).

Pursuant to the Certificate of Designations, the holders of the Series A Preferred Stock are entitled to receive quarterly dividends at the prime rate (provided in the Wall Street Journal Eastern Edition) plus 5% (up to a maximum dividend rate of 10%), payable in cash or in kind (i.e., through the issuance of additional shares of Series A Preferred Stock), except that the Company is not permitted to pay such dividends in cash while any indebtedness under the Company’s Amended and Restated Term Loan Credit Agreement remains outstanding without the consent of the holders of the Series A Preferred Stock. In addition, the declaration and payment of dividends is subject to compliance with applicable law and unpaid dividends will accrue. A holder’s right to convert its shares of Series A Preferred Stock and receive dividends in the form of common stock is subject to certain limitations including, among other things, that the shares of common stock issuable upon conversion or as dividends will not, prior to receipt of stockholder approval, result in any holder beneficially owning greater than 19.99% of the Company’s currently outstanding shares of common stock.

The Series A Preferred Stock dividends shall accrue whether or not the declaration or payment of such Series A Preferred Stock dividends are prohibited by applicable law, whether or not the Company has earnings, whether or not there are funds legally available for the payment of such dividends and whether or not such dividends are authorized or declared.

Upon certain triggering events, such as bankruptcy, insolvency or a material adverse effect or failure of the Company to issue shares of common stock upon conversion of the Series A Preferred Stock in accordance with its obligations, the holders may require the Company to redeem all or some of the Series A Preferred Stock at a price per share equal to the greater of (i) the sum of 100% of the stated value of a share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto, and (ii) the product of the number of shares of common stock underlying a share of Series A Preferred Stock and the closing price as of the occurrence of the triggering event. On or after July 30, 2021, each holder of Series A Preferred Stock can also require the Company to redeem its Series A Preferred Stock in cash at a per share price equal to 100% of the stated value of a share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto. Notwithstanding the forgoing, no holder of Series A Preferred Stock is permitted to exercise any rights or remedies upon a Breach Event or to exercise any redemption rights under the Certificate of Designations, unless approved by the holders of a majority of the then outstanding shares of Series A Preferred Stock.

Upon consummation of a fundamental sale transaction, the Series A Preferred Stock shall be redeemed at a per share redemption price equal to the greater of (y) 250% of the per share purchase price of the Series A Preferred Stock and (z) the price payable in respect of such share of Series A Preferred Stock if such share of Series A Preferred Stock had been converted into such number of shares of common stock in accordance with the Certificate of Designations (but without giving effect to any limitations or restrictions contained therein) immediately prior to such fundamental sale transaction; provided however that the 250% threshold

is changed to 100% if the fundamental sale transaction is approved by the two Series A Directors (as defined in the Certificate of Designations). In addition, if the Company consummates an equity or debt financing that results in more than $5.0 million of net proceeds to the Company and/or its subsidiaries, the holders of Series A Preferred Stock will have the right, but not the obligation, to require the Company to use the net proceeds in excess of $5.0 million to repurchase all or a portion of the Series A Preferred

Stock at a per share price equal to the greater of (i) the sum of 100% of the stated value of such share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto, and (ii) the number of shares of common stock into which such share of Series A Preferred Stock is then convertible multiplied by the greater of (y) the closing price of the common stock on the date of announcement of such financing or (z) the closing price of the Common Stock on the date of consummation of such financing.

Each holder of Series A Preferred Stock has a vote equal to the number of shares of common stock into which its Series A Preferred Stock would be convertible as of the record date. In addition, the holders of a majority of the Series A Preferred Stock must approve certain actions, including approving any amendments to the Company’s Restated Certificate of Incorporation as amended or Amended and Restated Bylaws that adversely affects the voting powers, preferences or other rights of the Series A Preferred Stock; payment of dividends or distributions; any liquidation, capitalization, reorganization or any other fundamental transaction of the Company; issuance of any equity security senior to or on parity with the Series A Preferred Stock as to dividend rights, redemption rights, liquidation preference and other rights; issuances of equity below the conversion price; any liens or borrowings other than non-convertible indebtedness from standard commercial lenders which does not exceed 80% of the Company’s accounts receivable; and the redemption or purchase of any of the capital stock of the Company.

The Company has classified the Series A Preferred Stock as temporary equity in the financial statements as it is subject to redemption at the option of the holder under certain circumstances. As a result of the Company’s analysis of all the embedded conversion and put features within the Series A Preferred Stock, the contingent redemption put options in the Series A Preferred Stock were determined to not be clearly and closely related to the debt-type host and also did not meet any other scope exceptions for derivative accounting. Therefore, the contingent redemption put options are being accounted for as derivative instruments and the fair value of these derivative instruments was bifurcated from the Series A Preferred Stock and recorded as a liability.

As of ~~March 31,~~June 30, 2020 and December 31, 2019, the fair value of these derivative instruments was ~~$481,052~~$478,312 and $483,804, respectively, and were included in "other long-term liabilities" within the consolidated balance sheets. The loss on the change in fair value of these derivative instruments for the ~~three~~six months ended ~~March 31,~~June 30, 2020 and ~~March 31,~~June 30, 2019 of ~~$(2,752)~~$5,492 and ~~$(5,759),~~8,597, respectively, were included in “interest and other loss, net” within the consolidated statement of operations.

The fair value of these derivative instruments and the loss recorded on the change in the fair value of these derivative instruments, which was included in “Interest and other income, net” within the condensed consolidated statement of operations, for the three and six months ended ~~March 31,~~June 30, 2020 and 2019, were as follows:


	Three Months Ended March 31,						Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019			2020			2019
Beginning Balance	$	483,804		$	498,086		$	481,042		$	492,327		$	483,804		$	498,086
Total income recognized in earnings	(2,752		)	(5,759		)	(2,730		)	(2,838		)	(5,492		)	(8,597		)
Ending Balance	$	481,052		$	492,327		$	478,312		$	489,489		$	478,312		$	489,489

The Company’s derivatives were valued using the Black-Scholes pricing model adjusted for probability assumptions, with all significant inputs, except for the probability and volatility assumptions, derived from or corroborated by observable market data such as stock price and interest rates. The probability and volatility assumptions are as follows:



Probability of redemption as part of a fundamental sale transaction	0.5%
Probability of redemption absent a fundamental sale transaction	4.75%
Annual volatility	65%

At the time of issuance, the Company recorded transaction costs, a beneficial conversion feature and the fair value allocated to the embedded derivatives as discounts to the Series A Preferred Stock. These costs were being accreted to the Series A Preferred Stock using the effective interest method through the stated redemption date of August 5, 2017, which represents the earliest redemption date of the instrument. This accretion was accelerated as of December 31, 2016 due to the failure of the financial covenants and the redemption right of the holders at that time. Hale Capital, which was the sole holder of the Series A Preferred Stock agreed to the Series A mandatory extension of the mandatory redemption right and waived prior breaches of the terms of the Series A Preferred Stock. The Company included deductions for accretion, deemed and accrued dividends on the Series A Preferred Stock as adjustments to net loss attributable to common stockholders on the statement of operations and in determining ~~loss~~income (loss) per share for the three and six months ended ~~March 31,~~June 30, 2020 and 2019, respectively. The following represents a reconciliation of net loss attributable to common stockholders for the three and six months ended ~~March 31,~~June 30, 2020 and 2019, respectively:


	Three Months Ended March 31,						Three Months Ended June 30,						Six Months Ended June 30,
	2020			2019			2020			2019			2020			2019
Net loss	$	(719,840	)	$	(124,907	)
Net income (loss)							$	406,558		$	(1,171,723	)	$	(313,282	)	$	(1,296,630	)
Effects of Series A redeemable convertible preferred stock:
Less: Accrual of Series A redeemable convertible preferred stock dividends	285,760			247,027			260,595			256,553			546,355			503,580
Less: Accretion to redemption value of Series A redeemable convertible preferred stock	26,090			129,239			165,141			134,223			191,231			263,462
Net loss attributable to common stockholders	$	(1,031,690	)	$	(501,173	)
Net income (loss) attributable to common stockholders							$	(19,178	)	$	(1,562,499	)	$	(1,050,868	)	$	(2,063,672	)

The Series A Preferred Stock consists of the following:


Series A redeemable convertible preferred stock principal balance	$	9,000,000		$	9,000,000
Accrued dividends	1,312,112			1,312,112
Discount	(1,602,428		)	(1,602,428		)
Total Series A redeemable convertible preferred stock, net at inception on February 23, 2018	8,709,684			8,709,684
Accrued dividends	683,742			683,742
Accretion of preferred stock	363,280			363,280
Total Series A redeemable convertible preferred stock, net at December 31, 2018	$	9,756,706		$	9,756,706
Accrued dividends	1,157,762			1,157,762
Accretion of preferred stock	389,811			389,811
Total Series A redeemable convertible preferred stock, net at December 31, 2019	$	11,304,279		$	11,304,279
Accrued dividends	285,760			546,355
Accretion of preferred stock	26,090			191,231
Total Series A redeemable convertible preferred stock, net at March 31, 2020	$	11,616,129
Total Series A redeemable convertible preferred stock, net at June 30, 2020				$	12,041,865

(13) Accumulated Other Comprehensive Loss

The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended ~~March 31,~~June 30, 2020 are as follows:

Foreign Currency
Translation Net Minimum
Pension Liability Total
Accumulated other comprehensive income (loss) at December 31, 2019 $ (1,926,826 ) $ 33,566
$ (1,893,260 )
Other comprehensive loss

Other comprehensive loss before reclassifications (13,153 ) —
(13,153 )
Total other comprehensive loss (13,153 ) —
(13,153 )
Accumulated other comprehensive income (loss) at March 31, 2020 $ (1,939,979 ) $ 33,566
$ (1,906,413 )



	Foreign Currency Translation			Net Minimum Pension Liability		Total
Accumulated other comprehensive income (loss) at March 31, 2020	$	(1,939,979	)	$	33,566	$	(1,906,413	)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications	(8,087		)	—		(8,087		)
Total other comprehensive income (loss)	(8,087		)	—		(8,087		)
Accumulated other comprehensive income (loss) at June 30, 2020	$	(1,948,066	)	$	33,566	$	(1,914,500	)

The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended ~~March 31,~~June 30, 2019 are as follows:

Foreign Currency
Translation Net Minimum
Pension Liability Total
Accumulated other comprehensive income (loss) at December 31, 2018 $ (1,921,905 ) $ 26,803
$ (1,895,102 )
Other comprehensive income

Other comprehensive income before reclassifications 19,392
—
19,392
Total other comprehensive income 19,392
—
19,392
Accumulated other comprehensive income (loss) at March 31, 2019 $ (1,902,513 ) $ 26,803
$ (1,875,710 )



	Foreign Currency Translation			Net Minimum Pension Liability		Total
Accumulated other comprehensive income (loss) at March 31, 2019	$	(1,902,513	)	$	26,803	$	(1,875,710	)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications	(49,410		)	—		(49,410		)
Total other comprehensive income (loss)	(49,410		)	—		(49,410		)
Accumulated other comprehensive income (loss) at June 30, 2019	$	(1,951,923	)	$	26,803	$	(1,925,120	)

The changes in Accumulated Other Comprehensive Loss, net of tax, for the six months ended June 30, 2020 are as follows:



	Foreign Currency Translation			Net Minimum Pension Liability		Total
Accumulated other comprehensive income (loss) at December 31, 2019	$	(1,926,826	)	$	33,566	$	(1,893,260	)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications	(21,240		)	—		(21,240		)
Total other comprehensive income (loss)	(21,240		)	—		(21,240		)
Accumulated other comprehensive income (loss) at June 30, 2020	$	(1,948,066	)	$	33,566	$	(1,914,500	)

The changes in Accumulated Other Comprehensive Loss, net of tax, for the six months ended June 30, 2019 are as follows:



	Foreign Currency Translation			Net Minimum Pension Liability		Total
Accumulated other comprehensive income (loss) at December 31, 2018	$	(1,921,905	)	$	26,803	$	(1,895,102	)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications	(30,018		)	—		(30,018		)
Total other comprehensive income (loss)	(30,018		)	—		(30,018		)
Accumulated other comprehensive income (loss) at June 30, 2019	$	(1,951,923	)	$	26,803	$	(1,925,120	)

(14) Stockholders' Equity

~~Amendments to Articles of Incorporation~~

On August 8, 2019, following stockholder approval, the Company filed a certificate of amendment to the Company’s Restated Certificate of Incorporation, as amended, with the Delaware Secretary of State to reduce the authorized shares of common stock, $.001 par value per share, to 30,000,000. In connection with this event, the Company effected a 100-for-1 reverse stock split of its issued and outstanding common stock. The par value of common stock was not adjusted as a result of the reverse stock split. Unless otherwise indicated, all of the share and per share information presented in the accompanying financial statements have been adjusted to reflect the reverse common stock split on a retroactive basis for all periods and as of all dates presented.

Stock Repurchase Activity

During the three and six months ended ~~March 31,~~June 30, 2020 and 2019, the Company did not repurchase any shares of its common stock. As of ~~March 31,~~June 30, 2020, the Company had the authorization under previous Board approved stock repurchase plans to repurchase 49,078 shares of its common stock based upon its judgment and market conditions.

(15) 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 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.

(16) Segment Reporting and Concentrations

The Company is organized in a single operating segment for purposes of making operating decisions and assessing performance. Revenue from the United States to customers in the following geographical areas for the three and six months ended ~~March 31,~~June 30, 2020 and 2019, and the location of long-lived assets as of ~~March 31,~~June 30, 2020 and December 31, 2019, are summarized as follows:


	Three Months Ended March 31,				Three Months Ended June 30,				Six Months Ended June 30,
	2020		2019		2020		2019		2020		2019
Revenue:
Americas	$	1,094,904	$	2,073,314	$	1,156,589	$	1,496,988	$	2,251,493	$	2,497,805
Asia Pacific	983,795		1,000,817		978,474		194,074		1,962,269		2,267,388
Europe, Middle East, Africa and Other	1,101,488		1,418,847		1,364,549		2,308,327		2,466,037		3,727,174
Total Revenue	$	3,180,187	$	4,492,978	$	3,499,612	$	3,999,389	$	6,679,799	$	8,492,367


	March 31, 2020		December 31, 2019		June 30, 2020		December 31, 2019
Long-lived assets:
Americas	$	6,537,094	$	6,811,578	$	6,236,429	$	6,811,578
Asia Pacific	786,340		860,023		745,328		860,023
Europe, Middle East, Africa and Other	170,458		190,928		152,652		190,928
Total long-lived assets	$	7,493,892	$	7,862,529	$	7,134,409	$	7,862,529

For the three and six months ended ~~March 31,~~June 30, 2020, the Company had ~~two customers~~one customer that accounted for 10% or more of total revenue, respectively. For the three and six months ended ~~March 31,~~June 30, 2019, the Company had two customers and one customer that accounted for 10% ~~ore~~or more of total ~~revenue.~~revenue, respectively.

As of ~~March 31,~~June 30, 2020, the Company had two customers that accounted for 10% or more of the gross accounts receivable balance. As of December 31, 2019, the Company had one customer that accounted for 10% or more of the gross accounts receivable balance.

(17) Restructuring Costs

In the third quarter of 2013, the Company adopted 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 (the "2013 Plan"). In connection with the 2013 Plan, the Company eliminated over 100 positions worldwide, implemented tighter expense controls, ceased non-core activities and closed or downsized several facilities. The 2013 Plan was substantially completed by December 31, 2014; however, we expect the majority of the remaining severance related costs to be paid once final settlement litigation is completed, which can be at various times over the next twelve months.

In June 2017, the Board approved a comprehensive plan to increase operating performance (the “2017 Plan”). The 2017 Plan was substantially completed by the end of the Company’s fiscal year ended December 31, 2017, and when combined with previous workforce reductions in the second quarter of fiscal 2017 reduced the Company’s workforce to approximately 86 employees at December 31, 2018. In making these changes, the Company prioritized customer support and development while consolidating operations and streamlining direct sales resources, allowing the Company to focus on the install base and develop alternate channels to the market. As part of this consolidation effort the Company vacated a portion of the Mellville, 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. During the ~~three~~six months ended ~~March 31,~~June 30, 2020, the Company incurred lease disposal-related costs for this property of ~~$0.2~~$0.4 million.

In the third quarter of 2019, the Company adopted the 2019 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. In connection with the 2019 Plan, the Company eliminated 23 positions worldwide, implemented tighter expense controls, ceased non-core activities and downsized several facilities. During the three months ended March 31, 2020, the Company incurred $0.1 million in severance expense as a result of this action. The 2019 Plan was substantially completed as 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 prepared to keep in place for the remainder of 2020 (the "2020 Plan"). This plan reduces the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 4 of these positions were reinstated in the second quarter of 2020. During the three months ended June 30, 2020, the Company has not yet incurred severance expense as a result of this action. We believe the reduced expense level will enable FalconStor to remain profitable during the remainder of 2020, even with continued revenue challenges throughout.

The following table summarizes the activity during 2019 and 2020 related to restructuring liabilities recorded in connection with the ~~2013,~~ 2017, 2019 and ~~2019~~2020 Plans:


	Severance Related Costs			Facility and Other Costs			Total			Severance Related Costs			Facility and Other Costs			Total
Balance at December 31, 2018	$	461,362		$	453,446		$	914,808		$	461,362		$	453,446		$	914,808
Additions (Reductions)	—			157,693			157,693			—			157,693			157,693
Utilized/Paid	—			(187,833		)	(187,833		)	—			(187,833		)	(187,833		)
Balance at March 31, 2019	$	461,362		$	423,306		$	884,668		$	461,362		$	423,306		$	884,668
Additions (Reductions)	—			202,679			202,679			—			202,679			202,679
Utilized/Paid	—			(238,090		)	(238,090		)	—			(238,090		)	(238,090		)
Balance at June 30, 2019	$	461,362		$	387,895		$	849,257		$	461,362		$	387,895		$	849,257
Additions (Reductions)	214,050			170,779			384,829			214,050			170,779			384,829
Utilized/Paid	(214,050		)	(257,453		)	(471,503		)	(214,050		)	(257,453		)	(471,503		)
Balance at September 30, 2019	$	461,362		$	301,221		$	762,583		$	461,362		$	301,221		$	762,583
Additions (Reductions)	31,860			327,257			359,117			31,860			327,257			359,117
Utilized/Paid	(199,423		)	(390,985		)	(590,408		)	(199,423		)	(390,985		)	(590,408		)
Balance at December 31, 2019	$	293,799		$	237,493		$	531,292		$	293,799		$	237,493		$	531,292
Additions (Reductions)	76,708			210,752			287,460			76,708			210,752			287,460
Utilized/Paid	(156,415		)	(225,835		)	(382,250		)	(156,415		)	(225,835		)	(382,250		)
Balance at March 31, 2020	$	214,092		$	222,410		$	436,502		$	214,092		$	222,410		$	436,502
Additions (Reductions)										—			153,685			153,685
Translation Adjustment										4,674			—			4,674
Utilized/Paid										—			(201,211		)	(201,211		)
Balance at June 30, 2020										$	218,766		$	174,884		$	393,650

The severance and facility related liabilities are included within “accrued expenses” in the accompanying condensed consolidated balance sheets. The expenses under the ~~2013,~~ 2017 and 2019 Plans are included within “restructuring costs” in the accompanying condensed consolidated statements of operations.

~~(18) Subsequent Events~~

~~Loan under the Paycheck Protection Program~~

On April 28, 2020, the Company entered into a loan with Peapack-Gladstone Bank. in an aggregate principal amount of $754,000 (the “Loan”), pursuant to the Paycheck Protection Program (the “PPP”) under the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”).

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.

On August 6, 2019, following stockholder approval, the Company filed a certificate of amendment (which was effective August 8, 2019) to the Company’s Restated Certificate of Incorporation, as amended, with the Delaware Secretary of State to reduce the authorized shares of common stock, $.001 par value per share, to 30,000,000. In connection with this event, the Company effected a 100-for-1 reverse stock split of its issued and outstanding common stock. The par value of common stock was not adjusted as a result of the reverse stock split. Unless otherwise indicated, all of the share and per share information presented in the accompanying financial statements have been adjusted to reflect the reverse common stock split on a retroactive basis for all periods and as of all dates presented.

OVERVIEW

FalconStor Software, Inc. is a technology company whose mission is to deliver technical innovation that creates investment protection, flexibility, and leverage of modern cloud-based technologies for our enterprise customers. We provide software and cloud services that enable our enterprise customers to better manage, protect, secure, and make use of their valuable data. Our customers achieve lower costs, simpler operations, greater data security, higher confidence in their business continuity, and greater ability to effectively use their data assets to drive innovation.

Our products are utilized by enterprises and managed service providers across the globe and address two key areas of enterprise data protection; long-term archive retention and reinstatement, and business continuity driven data replication. Our products are software-defined, which means that our technology allows our solutions to be hardware, cloud, and source-data agnostic, giving our customers maximum leverage of existing hardware and software investments. Our innovative integration into modern cloud-based technologies enables our customers to ~~dramatically~~ improve the portability, security, and accessibility of their enterprise data. This accessibility is 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.

During 2020, our commercial strategy ishas been to build on the sales momentum generated in 2019 ~~continue our increased~~while increasing profitability. This plan has been anchored on a continued focus on our long-term archive retention and reinstatement products, FalconStor Virtual Tape Library (“VTL”) and ~~StorSafeTM, and~~StorSafe^TM, an increase in go-to-market investment within our core regions of the Americas, EMEA, Japan, Korea, and Southeast ~~Asia. While this core strategy remains, our progress during Q1 of 2020 has been significantly disrupted~~Asia, and on carefully managing operating expenses.

During Q2, we delivered 11.5% year-over-year total bookings growth despite the economic turmoil caused by the global COVID-19 ~~pandemic,~~pandemic. While uncertainties continue to exist as a result of COVID-19, we have seen our ~~existing~~ customers and ~~new~~prospects continue to invest in the business ~~prospects are dealing with~~critical area of data production in which we sell our solutions. The strongest performance came from our Americas region, where bookings increased 72% year-over-year. In addition, bookings in our EMEA region increased by 7%. Total bookings increases in both regions were exclusively driven by increased adoption of our long-term data retention and reinstatement products, VTL and StorSafe^TM. Across the ~~disruptions created.~~globe, bookings from first-time FalconStor customers grew by 251% year-over-year.

Despite our strong year-over-year sales growth and new customer acquisition, resulting GAAP revenue decreased by $500 thousand during the quarter, compared to Q2 2019. This reduction was primarily due to reduced in-period recurring legacy contract renewals, from our non-core markets, including China.

~~While~~Strong Q2 sales, combined with the ~~spread~~proactive expense management plan we implemented at the end of COVID-19 began in late January and early February 2020, the World Health Organization characterized COVID-19 as a pandemic in March 2020, and the President of the United States declared the COVID-19 outbreak a national emergency. The COVID-19 pandemic has resulted in significant volatility, uncertainty and economic disruption. As a result, we may experience extended sales cycles, our ability to close transactions with new and existing customers and partners may be negatively impacted, our ability to recognize revenue from software transactions we do close may be negatively impacted, our demand generation activities, and the efficiency and effect of those activities, may be negatively affected, and it has been and, until the COVID-19 outbreak is contained, will continue to be more difficult forQ1, allowed us to forecast our operating results. These uncertainties have, and may continue to, put pressure on global economic conditions and overall IT spending and may cause our end customers to modify spending priorities or delay or abandon purchasing decisions, thereby lengthening sales cycles and potentially lowering prices for our solutions, and may make it difficult for us to forecast our sales and operating results and to make decisions about future investments, anydeliver $407 thousand of ~~which could materially harm our business, operating results and financial condition.~~

Despite the unprecedented uncertainties, our management team is focused on proactively addressing the impacts of COVID-19 on our business, while continuing to make progress against our 2020 strategic plan.

During the three months ended March 31, 2020, we recognized revenue of $3.2 million, compared with $4.5 million in the prior year period. Revenue recognition on sales is driven by several factors. First, the volume of new product licenses and maintenance sales, both for expansion of our existing installed base and the acquisition of new customers. Second, customer retention, which sustains maintenance renewal revenue over long term sales arrangements. Insight into Q1 sales opportunities that were delayednet income in the quarter, ~~point~~compared to the Q1 revenue reduction as being a COVID-19 initiated delay in renewals and new deal closings, as opposed to a fundamental shift in the demand for the company’s products. As further evidence, April 2020 sales have returned to a normal level, including the closing of several Q1 renewals that were delayed into Q2, and several VTL wins with new FalconStor customers. However, despite our April 2020 sales results, we are assuming the next six months will continue to produce revenue challenges as enterprises around the globe continue to deal with their own commercial impacts. As we move forward through the balance of the year, our energy will be concentrated on capital preservation, strategic growth and continued product innovation.

~~During the three months ended March 31, 2020, we recorded~~ a net loss of ~~$0.7~~$1.2 million ~~compared with~~in Q2 of 2019. Our dramatically improved profitability has allowed us to make additional targeted investments, primarily related to Sales, R&D, and Support personnel, while maintaining a ~~net loss of $0.1 million for the same period of the previous year. Deferred revenue as of March 31, 2020 totaled $6.1 million, compared with $7.4 million as of December 31, 2019.~~profitable expense base.

Total cost of revenue for the three months ended ~~March 31,~~June 30, 2020 decreased ~~15%~~69% to ~~$0.5~~$0.4 million, compared with ~~$0.6~~$1.3 million in the prior year period. Total gross profit ~~decreased $1.2~~increased $0.4 million, or ~~32%~~15%, to ~~$2.6~~$3.1 million for the three months ended ~~March 31,~~June 30, 2020, compared with ~~$3.8~~$2.7 million for the prior year period. Total gross margin ~~decreased~~increased to ~~83%~~89% for the three months ended ~~March 31,~~June 30, 2020, compared with ~~86%~~68% for the prior year period. The ~~decrease~~increase in our total gross margin, and total gross profit in absolute dollars, was primarily due to ~~a decline~~an intentional reduction in ~~revenue, and product mix.~~hardware sales. Generally, our total gross profits and total gross margins 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.

Overall, our total GAAP operating expenses for the three months ended ~~March 31,~~June 30, 2020 decreased ~~$0.6~~$1.1 million, or ~~16%~~30%, to ~~$3.0~~$2.6 million, compared to ~~$3.6~~$3.7 million for the same period of the previous year.

RESULTS OF OPERATIONS – FOR THE THREE MONTHS ENDED ~~MARCH 31,~~JUNE 30, 2020 COMPARED WITH THE THREE MONTHS ENDED ~~MARCH 31,~~JUNE 30, 2019.

The following table presents revenue and expense line items reported in our condensed consolidated statements of operations and their corresponding percentage of total revenue for the three months ended ~~March 31,~~June 30, 2020 and 2019 and the period-over-period dollar and percentage changes for those line items. Our results of operations are reported as one business segment, represented by our single operating segment.


	Three Months Ended March 31,										Change Period to Period					Three Months Ended June 30,										Change Period to Period
	2020					2019					Change Period to Period					2020					2019					Change Period to Period
Revenue:
Product revenue	$	1,048,963		33	%	$	1,745,784		39	%	$	(696,821	)	(40	)%	$	1,632,055		47	%	$	1,470,430		37	%	$	161,625		11	%
Support and services revenue	2,131,224			67	%	2,747,194			61	%	(615,970		)	(22	)%	1,867,557			53	%	2,528,959			63	%	(661,402		)	(26	)%
Total revenue	3,180,187			100	%	4,492,978			100	%	(1,312,791		)	(29	)%	3,499,612			100	%	3,999,389			100	%	(499,777		)	(12	)%
Cost of revenue:
Product	139,460			4	%	79,669			2	%	59,791			75	%	61,830			2	%	755,796			19	%	(693,966		)	(92	)%
Support and service	407,920			13	%	563,745			13	%	(155,825		)	(28	)%	334,396			10	%	537,105			13	%	(202,709		)	(38	)%
Total cost of revenue	547,380			17	%	643,414			14	%	(96,034		)	(15	)%	396,226			11	%	1,292,901			32	%	(896,675		)	(69	)%
Gross profit	2,632,807			83	%	3,849,564			86	%	(1,216,757		)	(32	)%	3,103,386			89	%	2,706,488			68	%	396,898			15	%
Operating expenses:
Research and development costs	674,924			21	%	947,384			21	%	(272,460		)	(29	)%	534,000			15	%	764,276			19	%	(230,276		)	(30	)%
Selling and marketing	981,191			31	%	1,040,289			23	%	(59,098		)	(6	)%	1,019,940			29	%	1,296,909			32	%	(276,969		)	(21	)%
General and administrative	1,093,169			34	%	1,476,296			33	%	(383,127		)	(26	)%	845,581			24	%	1,397,886			35	%	(552,305		)	(40	)%
Restructuring costs	287,460			9	%	157,693			4	%	129,767			82	%	153,685			4	%	202,679			5	%	(48,994		)	(24	)%
Total operating expenses	3,036,744			95	%	3,621,662			81	%	(584,918		)	(16	)%	2,553,206			73	%	3,661,750			92	%	(1,108,544		)	(30	)%
Operating income (loss)	(403,937		)	(13	)%	227,902			5	%	(631,839		)	(277	)%	550,180			16	%	(955,262		)	(24	)%	1,505,442			(158	)%
Interest and other loss	(245,839		)	(8	)%	(265,223		)	(6	)%	19,384			(7	)%	(180,249		)	(5	)%	(80,217		)	(2	)%	(100,032		)	125	%
Loss before income taxes	(649,776		)	(20	)%	(37,321		)	(1	)%	(612,455		)	1,641	%
Income tax expense	70,064			2	%	87,586			2	%	(17,522		)	(20	)%
Net loss	$	(719,840	)	(23	)%	$	(124,907	)	(3	)%	$	(594,933	)	476	%
Income (loss) before income taxes																369,931			11	%	(1,035,479		)	(26	)%	1,405,410			(136	)%
Income tax expense (benefit)																(36,627		)	(1	)%	136,244			3	%	(172,871		)	(127	)%
Net income (loss)																$	406,558		12	%	$	(1,171,723	)	(29	)%	$	1,578,281		(135	)%
Less: Accrual of Series A redeemable convertible preferred stock dividends	285,760			9	%	247,027			5	%	38,733			16	%	260,595			7	%	256,553			6	%	4,042			2	%
Less: Accretion to redemption value of Series A redeemable convertible preferred stock	26,090			1	%	129,239			3	%	(103,149		)	(80	)%	165,141			5	%	134,223			3	%	30,918			23	%
Net loss attributable to common stockholders	$	(1,031,690	)	(32	)%	$	(501,173	)	(11	)%	$	(530,517	)	106	%
Net income (loss) attributable to common stockholders																$	(19,178	)	(1	)%	$	(1,562,499	)	(39	)%	$	1,543,321		(99	)%

Revenue

Our primary sales focus is on selling software solutions and platforms which includes stand-alone software applications, software integrated with industry standard hardware and sold as one complete integrated solution or sold on a subscription or consumption basis. As a result, our revenue is classified as either: (i) product revenue, or (ii) support and services revenue. During the three months ended ~~March 31,~~June 30, 2020, we recognized revenue of ~~$3.2~~$3.5 million, compared with ~~$4.5~~$4.0 million in the prior year period.

Product revenue

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 software integrated with industry standard hardware, sold as one complete integrated solution or sold on a subscription or consumption basis. Our products are sold through (i) value-added resellers, (ii) distributors, and/or (iii) directly to end-users. These revenues are recognized when all the applicable criteria under accounting principles generally accepted in the United States are met.

For the three months ended ~~March 31,~~June 30, 2020 and 2019, product revenue represented ~~33%~~47% and ~~39%~~37% of our total revenue, respectively. Product revenue of ~~$1.0~~$1.6 million for the three months ended ~~March 31,~~June 30, 2020 ~~decreased $0.7~~increased $0.2 million, or ~~40%~~11%, from ~~$1.7~~$1.5 million in the prior year period.

We continue to invest in our product portfolio by refreshing 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

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. Professional services revenue is recognized in the period that the related services are performed. Engineering services are recognized upon customer acceptance.

Maintenance and technical support services revenue for the three months ended ~~March 31,~~June 30, 2020 decreased to ~~$2.0~~$1.9 million, compared to ~~$2.6~~$2.4 million in the prior year period. Our maintenance and technical support service revenue results 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. The decrease in revenue over the previous year reflects a decline in maintenance renewal revenue, as a result of customer attrition, a smaller volume of new customers, and a decline in new product license and maintenance sales.

For the three months ended ~~March 31,~~June 30, 2020 and 2019, we recognized ~~$0.1 million in~~negligible professional services revenue. 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.

Cost of Revenue, Gross Profit and Gross Margin

Total cost of revenue for the three months ended ~~March 31,~~June 30, 2020 decreased ~~15%~~69% to ~~$0.5~~$0.4 million, compared with ~~$0.6~~$1.3 million in the prior year period. Total gross profit ~~decreased $1.2~~increased $0.4 million, or ~~32%~~15%, to ~~$2.6~~$3.1 million for the three months ended ~~March 31,~~June 30, 2020, compared with ~~$3.8~~$2.7 million for the prior year period. Total gross margin ~~decreased~~increased to ~~83%~~89% for the three months ended ~~March 31,~~June 30, 2020, compared with ~~86%~~68% for the prior year period. The ~~decrease~~increase in our total gross margin and total gross profit, in absolute dollars, was primarily due to product mix, as a result of ~~higher than anticipated~~an intentional shift away from selling hardware, ~~and appliance sales during the current period,~~ which ~~yield significant less~~yields significantly lower profit margins, compared to our key proprietary software license offerings. Generally, our total gross profits and total gross margins 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.

Cost of Product Revenue, 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 and amortization of capitalized software ~~and shipping and logistics~~ costs. Cost of product revenue for the three months ended ~~March 31,~~June 30, 2020 ~~increased~~decreased to ~~$139,460,~~$61,830, compared with ~~$79,669~~$755,796 in the prior year period. Product gross margin for the three months ended ~~March 31,~~June 30, 2020 ~~declined,~~increased, year over year, to ~~87%~~96% from ~~95%~~49% for the same period in 2019. The ~~increase~~decrease in cost of product revenue and ~~decline~~increase in product gross margin for the current year was primarily due to ~~product mix, as the volume of our appliance and~~an intentional shift away from hardware sales ~~which deliver a lower margin, increased significantly,~~in the current period, compared to the prior year period.

Cost of Support and Service Revenue, Gross Profit and Gross Margin

Cost of support and service consists primarily of personnel and other costs associated with providing software implementations, technical support under maintenance contracts and training. Cost of support and service revenue for the three months ended ~~March 31,~~June 30, 2020 decreased ~~28%~~38% to ~~$0.4~~$0.3 million, compared with ~~$0.6~~$0.5 million in the prior year period. Support and service gross margin increased to ~~81%~~82% for the three months ended ~~March 31,~~June 30, 2020, compared with 79% for the prior year period, primarily attributable to a reduction in maintenance and support services revenue that was less in proportion to the reduction in costs, year over year.

Operating Expenses

Our operating expenses for the three months ended ~~March 31,~~June 30, 2020 decreased ~~$0.6~~$1.1 million to ~~$3.0~~$2.6 million from ~~$3.6~~$3.7 million, for the previous year period.

Research and Development Costs

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 ~~$0.3~~$0.2 million, or ~~29%~~30%, to ~~$0.7~~$0.5 million for the three months ended ~~March 31,~~June 30, 2020, from $0.8 million in the prior year period. The decrease was primarily related to a decrease in personnel related costs resulting from our realignment and reduction in workforce and continued efforts to allocate the appropriate level of resources based upon the product development roadmap schedule. 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.

Selling and Marketing

Selling and marketing expenses declined $0.3 million, or 21%, to $1.0 million for the three months ended June 30, 2020 from $1.3 million in the prior year period. Selling and marketing expenses consist primarily of sales and marketing personnel and related costs, travel, public relations expense, marketing literature and promotions, commissions, trade show expenses, and the costs associated with our foreign sales offices.

General and Administrative

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 declined $0.6 million to $0.8 million for the three months ended June 30, 2020, compared to $1.4 million for the prior year period.

Restructuring

In June 2017, the Board approved the 2017 Plan to increase operating performance (the “2017 Plan”). 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 the 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. During the three months ended June 30, 2020, the Company incurred lease disposal-related costs for this property of $0.2 million.

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 prepared to keep in place for the remainder of 2020 (the "2020 Plan"). This plan reduces the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 4 of these positions were reinstated in the second quarter of 2020. We believe the reduced expense level will enable FalconStor to remain profitable during the remainder of 2020, even with continued revenue challenges throughout. During the three months ended June 30, 2020, the Company has not yet incurred severance expense as a result of this action.

Restructuring expense decreased $48,994 for the three months ended June 30, 2020 to $153,685, compared to a restructuring expense of $202,679 in the prior year period. For further information, refer to Note (17) Restructuring Costs, to our unaudited condensed consolidated financial statements.

Interest and other (loss) income, net

Interest and other income (loss), net, decreased $100,032 to a loss of $0.2 million for the three months ended June 30, 2020, compared with a loss of $0.1 million in the prior year period. The fluctuation in interest and other income (loss) from quarter to quarter relates to interest expense, foreign currency gains and losses, interest income, sublease income and the change in fair value of our embedded derivatives.

Income Taxes

Our provision for income taxes consists of state and local, and foreign taxes. For the three months ended June 30, 2020 and 2019, the Company recorded an income tax benefit of $36,627 and expense of $136,244, respectively, consisting primarily of state and local, and foreign taxes.

As of June 30, 2020, our conclusion regarding the realizability of our US deferred tax assets did not change and we have recorded a full valuation allowance against them.

COVID-19

While our Q2 2020 results were strong, we are closely monitoring the impact of the 2019 novel coronavirus, or COVID-19, on all aspects of our business. In March 2020, the World Health Organization characterized COVID-19 as a pandemic and the President of the United States declared the COVID-19 outbreak a national emergency. Since then, the COVID-19 pandemic has rapidly spread across the globe and has already resulted in significant volatility, uncertainty and economic disruption. The outbreak of COVID-19 has caused and may continue to cause travel bans or disruptions, and in some cases, prohibitions of non-essential activities, disruption and shutdown of businesses and greater uncertainty in global financial markets. The impact of COVID-19 is fluid and uncertain, but it has caused and may continue to cause various negative effects, including an inability to meet with actual or potential customers, our end customers deciding to delay or abandon their planned purchases or failing to make payments, and delays or disruptions in our or our partners’ supply chains. Please see “Risk Factors-Our results of operations may be negatively impacted by the coronavirus outbreak” for further information.

RESULTS OF OPERATIONS – FOR THE SIX MONTHS ENDED JUNE 30, 2020 COMPARED WITH THE SIX MONTHS ENDED JUNE 30, 2019.

The following table presents revenue and expense line items reported in our condensed consolidated statements of operations and their corresponding percentage of total revenue for the six months ended June 30, 2020 and 2019 and the period-over-period dollar and percentage changes for those line items. Our results of operations are reported as one business segment, represented by our single operating segment.



	Six Months Ended June 30,										Change Period to Period
(amounts in dollars)	2020					2019					Change Period to Period
Revenue:
Product revenue	$	2,681,018		40	%	$	3,216,214		38	%	$	(535,196	)	(17	)%
Support and services revenue	3,998,781			60	%	5,276,153			62	%	(1,277,372		)	(24	)%
Total revenue	6,679,799			100	%	8,492,367			100	%	(1,812,568		)	(21	)%
Cost of revenue:
Product	201,290			3	%	835,470			10	%	(634,180		)	(76	)%
Support and service	742,316			11	%	1,107,590			13	%	(365,274		)	(33	)%
Total cost of revenue	943,606			14	%	1,943,060			23	%	(999,454		)	(51	)%
Gross profit	5,736,193			86	%	6,549,307			77	%	(813,114		)	(12	)%
Operating expenses:														9	%
Research and development costs	1,208,924			18	%	1,720,847			20	%	(511,923		)	(30	)%
Selling and marketing	2,001,131			30	%	2,369,347			28	%	(368,216		)	(16	)%
General and administrative	1,938,750			29	%	2,826,085			33	%	(887,335		)	(31	)%
Investigation, litigation, and settlement related costs	—			—	%	—			—	%	—			—	%
Restructuring costs	441,145			7	%	360,372			4	%	80,773			22	%
Total operating expenses	5,589,950			84	%	7,276,651			86	%	(1,686,701		)	(23	)%
Operating income (loss)	146,243			2	%	(727,344		)	(9	)%	873,587			(120	)%
Interest and other expense	(426,088		)	(6	)%	(345,456		)	(4	)%	(80,632		)	23	%
Income (loss) before income taxes	(279,845		)	(4	)%	(1,072,800		)	(13	)%	792,955			(74	)%
Income tax expense (benefit)	33,437			1	%	223,830			3	%	(190,393		)	(85	)%
Net income (loss)	$	(313,282	)	(5	)%	$	(1,296,630	)	(15	)%	$	983,348		(76	)%
Less: Accrual of Series A redeemable convertible preferred stock dividends	546,355			8	%	503,580			6	%	42,775			8	%
Less: Deemed dividend on Series A redeemable convertible preferred stock	—			—	%	—			—	%	—			—	%
Less: Accretion to redemption value of Series A redeemable convertible preferred stock	191,231			3	%	263,462			3	%	(72,231		)	(27	)%
Net income (loss) attributable to common stockholders	$	(1,050,868	)	(16	)%	$	(2,063,672	)	(24	)%	$	1,012,804		(49	)%

Revenue

Our primary sales focus is on selling software solutions and platforms which includes stand-alone software applications, software integrated with industry standard hardware and sold as one complete integrated solution or sold on a subscription or consumption basis. As a result, our revenue is classified as either: (i) product revenue, or (ii) support and services revenue. During the six months ended June 30, 2020, we recognized revenue of $6.7 million, compared with $8.5 million in the prior year period.

Product revenue

For the six months ended June 30, 2020 and 2019, product revenue represented 40% and 38% of our total revenue, respectively. Product revenue of $2.7 million for the six months ended June 30, 2020 decreased $0.5 million, or 17%, from $3.2 million in the prior year period.

Support and services revenue

Maintenance and technical support services revenue for the six months ended June 30, 2020 decreased to $3.8 million, compared to $5.0 million in the prior year period. Our maintenance and technical support service revenue results 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. The decrease in revenue over the previous year reflects a decline in maintenance renewal revenue, as a result of customer attrition, a smaller volume of new customers, and a decline in new product license and maintenance sales.

Professional services revenue for the six months ended June 30, 2020 decreased to $0.2 million, compared to $0.3 million in the prior year period. 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.

Cost of Revenue, Gross Profit and Gross Margin

Total cost of revenue for the six months ended June 30, 2020 decreased 51% to $0.9 million, compared with $1.9 million in the prior year period. Total gross profit decreased $0.8 million, or 12%, to $5.7 million for the six months ended June 30, 2020, compared with $6.5 million for the prior year period. Total gross margin increased to 86% for the six months ended June 30, 2020, compared with 77% for the prior year period. The increase in our total gross margin and decrease in our total gross profit, in absolute dollars, was primarily due to product mix, and as a result of an intentional shift away from selling hardware, which yields significantly lower profit margins, compared to our key proprietary software license offerings. Generally, our total gross profits and total gross margins 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.

Cost of Product Revenue, Gross Profit and Gross Margin

Cost of product revenue consists primarily of personnel costs and amortization of capitalized software. Cost of product revenue for the six months ended June 30, 2020 decreased to $201,290, compared with $835,470 in the prior year period. Product gross margin for the six months ended June 30, 2020 increased, year over year, to 92% from 74% for the same period in 2019. The decrease in cost of product revenue and increase in 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.

Cost of Support and Service Revenue, Gross Profit and Gross Margin

Cost of support and service consists primarily of personnel and other costs associated with providing software implementations, technical support under maintenance contracts and training. Cost of support and service revenue for the six months ended June 30, 2020 decreased 33% to $0.7 million, compared with $1.1 million in the prior year period. Support and service gross margin increased to 81% for the six months ended June 30, 2020, compared with 79% for the prior year period, primarily attributable to a reduction in maintenance and support services revenue, year over year.

Operating Expenses

Our operating expenses for the six months ended June 30, 2020 decreased $1.7 million to $5.6 million from $7.3 million, for the previous year period.

Research and Development Costs

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 $0.5 million, or 30%, to $1.2 million for the six months ended June 30, 2020, from $1.7 million in the prior year period. The decrease was primarily related to a decrease in personnel related costs resulting from our realignment and reduction in workforce and continued efforts to allocate the appropriate level of resources based upon the product development roadmap schedule. 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.

Selling and Marketing

Selling and marketing expenses declined ~~$59,098,~~$0.4 million, or 6%16%, to ~~$981,191~~$2.0 million for the ~~three~~six months ended ~~March 31,~~June 30, 2020 from ~~$1,040,289~~$2.4 million in the prior year period. Selling and marketing expenses consist primarily of sales and marketing personnel and related costs, travel, public relations expense, marketing literature and promotions, commissions, trade show expenses, and the costs associated with our foreign sales offices.

General and Administrative

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 declined ~~$0.4~~$0.9 million to ~~$1.1~~$1.9 million for the ~~three~~six months ended ~~March 31,~~June 30, 2020, compared to ~~$1.5~~$2.8 million for the prior year period.

Restructuring

In June 2017, the Board approved ~~a comprehensive plan~~the 2017 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 the ~~Mellville,~~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. During the ~~three~~six months ended ~~March 31,~~June 30, 2020, the Company incurred lease disposal-related costs for this property of ~~$0.3~~$0.4 million.

During the three months ended September 30, 2019, the Company adopted 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 (the "2019 Plan"), implemented tighter expense controls, ceased non-core activities and downsized several facilities. During the ~~three~~six months ended ~~March 31,~~June 30, 2020, the Company incurred ~~$0.1 million~~76,708 in severance expense as a result of this action. The 2019 Plan was substantially completed as of March 31, 2020.

In March 2020, given the commercial uncertainty caused by the novel coronavirus pandemic, or COVID-19, the Company developed and implemented the 2020 Plan, which is an even more aggressive expense control plan, that it is prepared to keep in place for the remainder of 2020. This plan reduces the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 4 of these positions were reinstated in the second quarter of 2020. We believe the reduced expense level will enable FalconStor to remain profitable during the remainder of 2020, even with continued revenue challenges throughout. During the six months ended June 30, 2020, the Company has not yet incurred severance expense as a result of this action.

Restructuring expense increased ~~$0.1 million~~$80,773 for the ~~three~~six months ended ~~March 31,~~June 30, 2020 to ~~$0.3 million,~~$441,145, compared to a restructuring expense of ~~$0.2 million~~$360,372 in the prior year period. For further information, refer to Note (17) Restructuring Costs, to our unaudited condensed consolidated financial statements.

Interest and other (loss) income, net

Interest and other income (loss), net, ~~decreased $19,384~~increased $80,632 to a loss of ~~$0.2 million~~$426,088 for the ~~three~~six months ended ~~March 31,~~June 30, 2020, compared with a loss of ~~$0.3 million~~$345,456 in the prior year period. The fluctuation in interest and other income (loss) from quarter to quarter relates to interest expense, foreign currency gains and losses, interest income, sublease income and the change in fair value of our embedded derivatives.

Income Taxes

Our provision for income taxes consists of state and local, and foreign taxes. For the ~~three~~six months ended ~~March 31,~~June 30, 2020 and 2019, the Company recorded income tax expense of ~~$70,064~~$33,437 and ~~$87,586,~~$0.2 million, respectively, consisting primarily of state and local, and foreign taxes.

As of ~~March 31,~~June 30, 2020, our conclusion regarding the realizability of our US deferred tax assets did not change and we have recorded a full valuation allowance against them.

WeCOVID-19

LIQUIDITY AND CAPITAL RESOURCES

Principal Sources of Liquidity

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 ~~March 31,~~June 30, 2020 and December 31, 2019 totaled ~~$1.0~~$1.5 million and $1.5 million, respectively.

On December 27, 2019, the Company entered into the Amendment, by and among the Company, certain of the Company’s affiliates in their capacities as guarantors, HCP-FVA, as administrative agent for the Lenders party thereto, ESW, as co-agent, and the Lenders, to provide for, among other things, a new $2,500,000 term loan facility to the Company. The Amendment also provides for certain financial covenants. On December 27, 2019, the Company drew down $1,000,000 of the 2019 Term Loan and the Company will pay a fixed amount of interest on such advance equal to 15% of the principal amount advanced. Pursuant to the Amendment, we are required to repay such $1,000,000 advance by September 27, 2020 (as may be extended pursuant to the terms of Amendment).

In connection with the initial advance of the 2019 Term Loan, HCP-FVA funded $620,000, ESW funded $378,439 and Michael Kelly funded $1,561. HCP-FVA is an affiliate of Hale Capital, the Company’s largest stockholder, and an affiliate of a director of the Company, Martin Hale. ESW is a greater than 5% stockholder of the Company and Mr. Kelly is a director of 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 of at least at $300,000 until the 2019 Term Loan is repaid, and other financial covenants relating to In-Force annual contract value, retention rate and churn rate. 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,

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 described in Part I, Item 1, Note ~~(18) "Subsequent Events"~~(9) "Notes Payable and Stock Warrants", to help ensure adequate liquidity during this period and in light of uncertainties posed by the COVID-19 pandemic, the Company entered into a loan with Peapack-Gladstone Bank on April 28, 2020 (the “Loan”), pursuant to the Paycheck Protection Program (the “PPP”) under the Coronavirus Aid, Relief, and Economic Security Act. The Loan has an aggregate principal amount of $754,000. Subject to the terms and limitations of the PPP, the Loan may be forgiven in whole or in part. Our intent is that the entire loan amount will be used to fund our payroll, rent and utilities.

Liquidity

As of ~~March 31,~~June 30, 2020, we had a working capital deficiency of ~~$3.9~~$3.5 million, which is inclusive of current deferred revenue of ~~$3.5~~$2.9 million, and a stockholders' deficit of $15.1 million. During the ~~three~~six months ended ~~March 31,~~June 30, 2020, the Company had a net loss of ~~$0.7~~$0.3 million and negative cash flow from operations of ~~$0.4~~$0.7 million. The Company's total cash balance at ~~March 31,~~June 30, 2020 was ~~$1.0~~$1.5 million, ~~a decrease~~an increase of ~~$0.5 million~~$39,185 compared to December 31, 2019. On April 28, 2020, the company entered into the Loan with Peapack-Gladstone Bank in an aggregate principal amount of $754,000, pursuant to the PPP under the CARES act.

The Company's ability to continue as a going concern, depends on its ability to execute its business plan, increase revenue and billings and reduce expenditures. In the ~~third~~second quarter of ~~2019,~~2020, the Company ~~adopted~~approved the ~~2019~~2020 Plan which included actions to ~~better align~~reduce its cost structure. The 2020 Plan addresses weakened global economic conditions stemming from the ~~Company’s cost structure~~COVID-19 pandemic and related pace of recovery in a few of it's markets along with further opportunities to optimize the ~~skills and resources required to more effectively execute the Company’s~~Company's long-term growth ~~strategy~~strategy. The Company has furloughed 21 positions worldwide, and ~~to support revenue levels~~4 of these positions were reinstated in the second quarter of 2020. During the three months ended June 30, 2020, the Company ~~expected to achieve on~~has not yet incurred severance expense as a ~~go forward basis. In connection with the 2019 Plan,~~result of this action.

A primary focus for the Company ~~eliminated 23 positions worldwide, implemented tighter expense controls, ceased non-core activities~~in 2020 will be to maintain appropriate balance sheet flexibility, including cash on hand, due to the uncertain nature and ~~downsized several facilities. As~~unpredictable timing of ~~March 31, 2020,~~ the ~~2019 Plan is considered to be substantially completed.~~

COVID-19 pandemic.

We believe that our cash flows from operations and existing cash on hand are sufficient to conduct our planned operations and meet our contractual requirements through at least ~~May 15,~~August 5, 2021.

Cash Flow Analysis

Cash flow information is as follows:


	Three Months Ended March 31,						Six Months Ended June 30,
	2020			2019			2020			2019
Cash used in:
Cash provided by (used in):
Operating activities	(398,331		)	(104,229		)	(675,103		)	75,960
Investing activities	(94,268		)	(68,805		)	(35,655		)	(227,182		)
Financing activities	—			(489,321		)	754,000			(489,321		)
Effect of exchange rate changes	(6,446		)	(29,173		)	(4,057		)	(18,181		)
Net decrease in cash and cash equivalents	$	(499,045	)	$	(691,528	)
Net increase (decrease) in cash and cash equivalents							$	39,185		$	(658,724	)

Net cash used in operating activities totaled ~~$0.4~~$0.7 million for the ~~three~~six months ended ~~March 31,~~June 30, 2020, compared with $0.1 million of net cash ~~used in~~provided by operating activities in the prior year period. The changes in net cash used in operating activities for the ~~three~~six months ended ~~March 31,~~June 30, 2020, was primarily due to our net income (loss) and adjustments for net changes in operating assets and liabilities, primarily changes in our accounts receivable, deferred revenue, prepaid expenses, inventory, other assets, accounts payable, accrued expenses and other long-term liabilities contributed to the decrease.

Net cash used in investing activities totaled ~~$94,268~~$35,655 for the ~~three~~six months ended ~~March 31,~~June 30, 2020, compared with net cash used in investing activities of ~~$68,805~~$227,182 in the prior year period. Included in investing activities are purchases of property and equipment, ~~capitalized software development costs,~~ cash ~~received from~~paid for security deposits and purchases of intangible assets.

Net cash ~~used in~~provided by financing activities totaled ~~$0.0~~$0.8 million for the ~~three~~six months ended ~~March 31,~~June 30, 2020, compared with net cash used in financing activities of ~~$(0.5)~~$0.5 million in the prior year period. The ~~three~~six months ended ~~March 31,~~June 30, 2020 reflects the $0.8 million in proceeds from the PPP loan. The six months ended June 30, 2019 reflects the partial repayment of $0.5 million of principal under our Term Loan in January 2019.

Total cash and cash equivalents ~~decreased $0.5 million~~increased $39,185 to ~~$1.0~~$1.5 million at ~~March 31,~~June 30, 2020 compared to December 31, 2019.

Contractual Obligations

As of ~~March 31,~~June 30, 2020, 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.

The following is a schedule summarizing our significant obligations to make future payments under contractual obligations as of ~~March 31,~~June 30, 2020:


	Operating Leases			Note Payable (a)		Interest Payments (a)		Long-Term Income Tax Payable (b)		Series A Preferred Stock Mandatory Redemption		Dividends on Series A Preferred Stock		Operating Leases			Note Payable (a)		Interest Payments (a)		Long-Term Income Tax Payable (b)		Series A Preferred Stock Mandatory Redemption		Dividends on Series A Preferred Stock
2020	$	1,329,957		$	1,000,000	$	227,878	$	—	$	—	$	—	$	850,408		$	1,000,000	$	112,225	$	—	$	—	$	—
2021	639,526			3,510,679		70,274		—		—		—		639,526			3,510,679		70,274		—		—		—
2022	—			—		—		—		—		—		—			754,000		—		—		—		—
Other	—			—		—		115,227		9,000,000		4,906,673		—			—		—		116,849		9,000,000		4,906,673
Total contractual obligations	$	1,969,483		$	4,510,679	$	298,152	$	115,227	$	9,000,000	$	4,906,673	$	1,489,934		$	5,264,679	$	182,499	$	116,849	$	9,000,000	$	4,906,673
Sublease income	$	(675,757	)	$	—	$	—	$	—	$	—	$	—	$	(681,074	)	$	—	$	—	$	—	$	—	$	—
Net contractual obligations	$	1,293,726		$	4,510,679	$	298,152	$	115,227	$	9,000,000	$	4,906,673	$	808,860		$	5,264,679	$	182,499	$	116,849	$	9,000,000	$	4,906,673

(a) See Note (9) Notes Payable and Stock Warrants to our unaudited condensed consolidated financial statements for further information and for a detailed description of the Amended and Restated Term Loan Credit Agreement.

(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.

Critical Accounting Policies and Estimates

We describe our significant accounting policies in Note (1), "Summary of Significant Accounting Policies" of our 2019 Form 10-K. We discuss our critical accounting estimates in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our 2019 Form 10-K. There have been no significant changes in our significant accounting policies or critical accounting estimates since December 31, 2019, other than those noted below.

Revenue Recognition

Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.

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.

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

Impact of Recently Issued Accounting Pronouncements

See Item 1 of Part 1, Condensed Consolidated Financial Statements – Note (1) Basis of Presentation.

Off-Balance Sheet Arrangements

As of ~~March 31,~~June 30, 2020 and December 31, 2019, we had no off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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 ~~three~~six months ended ~~March 31,~~June 30, 2020 and 2019, approximately 66% and ~~78%~~77%, respectively, 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 and the British Pound. 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 ~~March 31,~~June 30, 2020, the effect on our results before taxes from foreign currency fluctuations on our balance sheet would be approximately ~~$1.6~~$1.7 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

Disclosure Controls and Procedures

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 (the "Exchange Act"), is recorded, processed, summarized and reported, within the time periods specified in the SEC'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.

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 not effective as of the end of the period covered by this report. We describe this deficiency and the steps we have taken to remedy such deficiency in our discussion of internal control over financial reporting below.

Internal Control Over Financial Reporting

Management’s Report on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company; as such term is defined in Rules 13a-15(f) under the Exchange Act of 1934. To evaluate the effectiveness

of the Company’s internal control over financial reporting, the Company’s management uses the Integrated Framework (2013) adopted by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

The Company’s management has assessed the effectiveness of the Company’s internal control over financial reporting as of ~~March 31,~~June 30, 2020, using the COSO framework (2013). The Company’s management has determined that the Company’s internal control over financial reporting is not effective as of that date because of the following material weakness:

During the three months ended ~~March 31,~~June 30, 2020, the Company did not fully document all the COSO framework (2013) mandated system controls in place nor did the Company have an independent party complete testing of the controls as of ~~March 31,~~June 30, 2020. The Company has implemented certain mitigating controls such as secondary reviews by senior management, variance analysis reporting and cash-flow monitoring, which insured that both internal and external financial reporting included all the information and disclosures required by generally accepted accounting principles in the United States of America.

Notwithstanding the above, the Principal Executive Officer and the Principal Financial Officer believe that the condensed consolidated financial statements and other information contained in this Quarterly Report on Form 10Q present fairly, in all material respects, our business, financial condition and results of operations.

Remediation

The Company is implementing the appropriate system controls mandated by the COSO framework (2013) and plans to conduct independent audit testing of these controls which are implemented.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

See the discussion of the Company’s material litigation in Note (15) Litigation, to the unaudited condensed consolidated financial statements, which is incorporated by reference in 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 below and in Item 1A to our 2019 Form 10-K.

Our results of operations may be negatively impacted by the coronavirus outbreak.

We are closely monitoring the impact of the 2019 novel coronavirus, or COVID-19, on all aspects of our business. In March 2020, the World Health Organization characterized COVID-19 as a pandemic and the President of the United States declared the COVID-19 outbreak a national emergency. Since then, the COVID-19 pandemic has rapidly spread across the globe and has already resulted in significant volatility, uncertainty and economic disruption. The outbreak of COVID-19 has caused and may continue to cause travel bans or disruptions, and in some cases, prohibitions of non-essential activities, disruption and shutdown of businesses and greater uncertainty in global financial markets. The impact of COVID-19 is fluid and uncertain, but it has caused and may continue to cause various negative effects, including an inability to meet with actual or potential customers, our end customers deciding to delay or abandon their planned purchases or failing to make payments, and delays or disruptions in our or our partners’ supply chains. As a result, we may experience extended sales cycles, our ability to close transactions with new and existing customers and partners may be negatively impacted, our ability to recognize revenue from software transactions we do close may be negatively impacted, our demand generation activities, and the efficiency and effect of those activities, may be negatively affected, and it has been and, until the COVID-19 outbreak is contained, will continue to be more difficult for us to forecast our operating results. These uncertainties have, and may continue to, put pressure on global economic conditions and overall IT spending and may cause our end customers to modify spending priorities or delay or abandon purchasing decisions, thereby lengthening sales cycles and potentially lowering prices for our solutions, and may make it difficult for us to forecast our sales and operating results and to make decisions about future investments, any of which could materially harm our business, operating results and financial condition.

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 6. Exhibits



10.1	Promissory Note between the Company and Peapack-Gladstone Bank, dated April 28, 2020, incorporated herein by reference to Exhibit 10.1 to the Registrant's quarterly report on Form 10-Q for the period ended March 31, 2020 filed on May 7, 2020.

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)

101.1	The following financial statements from FalconStor Software, Inc’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2020, formatted in XBRL (eXtensible Business Reporting Language):



	(i)	unaudited Condensed Consolidated Balance Sheets – ~~March 31,~~June 30, 2020 and December 31, 2019.

	(ii)	unaudited Condensed Consolidated Statement of Operations – Three and Six Months Ended ~~March 31,~~June 30, 2020 and 2019.

	(iii)	unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) – Three and Six Months Ended ~~March 31,~~June 30, 2020 and 2019.

	(iv)	unaudited Condensed Consolidated Statements of Stockholder's Deficit - Three and Six Months Ended ~~March 31,~~June 30, 2020 and 2019.

	(v)	unaudited Condensed Consolidated Statement of Cash Flows – Three and Six Months Ended ~~March 31,~~June 30, 2020 and 2019.

	(vi)	Notes to unaudited Condensed Consolidated Financial Statements – ~~March 31,~~June 30, 2020.

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/ Brad Wolfe
	Brad Wolfe
	Executive Vice President, Chief Financial Officer and Treasurer
	(principal financial and accounting officer)



	/s/ Todd Brooks
	Todd Brooks
	President & Chief Executive Officer
~~May 7,~~August 5, 2020	(principal executive officer)

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