UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.

WASHINGTON, DC 20549


FORM 10-Q

(Mark One)

☒

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


☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended JuneSeptember 30, 2022
or 
☐ TRANSITION REPORT PURSUANT TO SECTION 13 2022

OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

☐

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

Commission File Number: 000-23970

FALCONSTOR SOFTWARE, INC.

(Exact Name of Registrant as Specified in its Charter)

FALCONSTOR SOFTWARE, INC.Delaware

77-0216135

(Exact name of registrant as specified in its charter)

Delaware77-0216135
(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

501 Congress Avenue

, Suite 150

Austin

TX78701

Austin, TX

78701

(Address of principal executive offices)

(Zip Code)


(631) 777-5188
Registrant’s telephone number, including area code
code: (
631
(Former name, former address and former fiscal year, if changed since last report)

)
777-5188

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

Title of each class

Trading

Symbol(s)

Name of each exchange on which registered

Common stock, $0.001 Par Value

FALC

OTCQB

Indicate by check mark whether the registrant: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 ýYes ☒ 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 ýYes ☒ 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“emerging growth company"company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer

☐

Accelerated filer

☐

Non-accelerated filer

☒

Smaller reporting company

☒

Emerging growth company

☐


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 ☐ No o☒


Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes


☒

The numberNo ☐

As of October 31, 2022, the registrant had 7,118,609 shares of common stock, outstanding as of July 31, 2022 was 7,111,801.

$0.001 par value per share, outstanding.



FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

Page

43

43

Condensed Consolidated Balance Sheets at JuneSeptember 30, 2022 (unaudited) and December 31, 2021

43

Unaudited Condensed Consolidated Statements of Operations for the three and sixnine months ended JuneSeptember 30, 2022 and 2021

54

Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and sixnine months ended JuneSeptember 30, 2022 and 2021

65

Unaudited Condensed Consolidated Statements of Stockholders' Deficit for the three and sixnine months ended JuneSeptember 30, 2022 and 2021

76

Unaudited Condensed Consolidated Statements of Cash Flows for the sixnine months ended JuneSeptember 30, 2022 and 2021

98

Notes to the Unaudited Condensed Consolidated Financial Statements

109

2826

39

39

40

40

40

40

40

40

4041

4142

4243


3

2


PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 June 30, 2022December 31, 2021
 (unaudited) 
Assets  
Current assets:  
Cash and cash equivalents$1,808,118 $3,181,209 
Accounts receivable, net of allowances1,552,626 2,855,135 
Prepaid expenses and other current assets1,074,029 1,074,972 
Contract assets401,582 209,936 
Inventory— 7,744 
Total current assets4,836,355 7,328,996 
Property and equipment, net110,265 153,904 
Operating lease right-of-use assets, net70,355 112,405 
Deferred tax assets28,110 30,190 
Software development costs, net67,189 42,695 
Other assets98,774 106,023 
Goodwill4,150,339 4,150,339 
Other intangible assets, net35,350 51,362 
Long-term contract assets449,564 692,712 
Total assets$9,846,301 $12,668,626 
Liabilities and Stockholders' Deficit  
Current liabilities:  
Accounts payable$468,427 $297,033 
Accrued expenses1,107,409 1,099,257 
Current portion of lease liabilities70,355 76,940 
Deferred revenue3,576,161 4,557,317 
Total current liabilities5,222,352 6,030,547 
Other long-term liabilities957,462 950,843 
Notes payable, net of debt issuance costs and discounts2,160,225 2,154,098 
Operating lease liabilities, net of current portion— 35,465 
Deferred tax liabilities500,499 500,499 
Deferred revenue, net of current portion1,456,333 1,578,769 
Total liabilities10,296,871 11,250,221 
Commitments and contingencies (Note 11)00
Series A redeemable convertible preferred stock, $0.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $15,129,623 and 14,490,274, respectively15,074,134 14,384,388 
Stockholders' deficit:  
Common stock, $0.001 par value, 30,000,000 shares authorized, 7,111,801 shares and 7,082,276 shares issued and outstanding, respectively7,112 7,082 
Additional paid-in capital111,687,123 112,349,613 
Accumulated deficit(125,503,270)(123,462,638)
Accumulated other comprehensive loss(1,715,669)(1,860,040)
Total stockholders' deficit(15,524,704)(12,965,983)
Total liabilities and stockholders' deficit$9,846,301 $12,668,626 

 

 

September 30, 2022

 

 

December 31, 2021

 

 

 

(unaudited)

 

 

 

 

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,666,054

 

 

$

3,181,209

 

Accounts receivable, net of allowances

 

 

2,288,133

 

 

 

2,855,135

 

Prepaid expenses and other current assets

 

 

885,734

 

 

 

1,074,972

 

Contract assets

 

 

273,945

 

 

 

209,936

 

Inventory

 

 

—

 

 

 

7,744

 

Total current assets

 

 

5,113,866

 

 

 

7,328,996

 

Property and equipment, net

 

 

95,796

 

 

 

153,904

 

Operating lease right-of-use assets, net

 

 

49,626

 

 

 

112,405

 

Deferred tax assets

 

 

26,327

 

 

 

30,190

 

Software development costs, net

 

 

60,123

 

 

 

42,695

 

Other assets

 

 

97,212

 

 

 

106,023

 

Goodwill

 

 

4,150,339

 

 

 

4,150,339

 

Other intangible assets, net

 

 

27,437

 

 

 

51,362

 

Long-term contract assets

 

 

445,017

 

 

 

692,712

 

Total assets

 

$

10,065,743

 

 

$

12,668,626

 

Liabilities and Stockholders' Deficit

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

450,250

 

 

$

297,033

 

Accrued expenses

 

 

1,355,927

 

 

 

1,099,257

 

Current portion of lease liabilities

 

 

49,626

 

 

 

76,940

 

Deferred revenue

 

 

3,504,907

 

 

 

4,557,317

 

Total current liabilities

 

 

5,360,710

 

 

 

6,030,547

 

Other long-term liabilities

 

 

954,213

 

 

 

950,843

 

Notes payable, net of debt issuance costs and discounts

 

 

2,164,251

 

 

 

2,154,098

 

Operating lease liabilities, net of current portion

 

 

—

 

 

 

35,465

 

Deferred tax liabilities

 

 

500,499

 

 

 

500,499

 

Deferred revenue, net of current portion

 

 

1,281,279

 

 

 

1,578,769

 

Total liabilities

 

 

10,260,952

 

 

 

11,250,221

 

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 $15,520,639 and $14,490,274, respectively

 

 

15,505,173

 

 

 

14,384,388

 

Stockholders' deficit:

 

 

 

 

 

 

Common stock, $.001 par value, 30,000,000 shares authorized, 7,111,801 shares and 7,082,276 shares issued and outstanding, respectively

 

 

7,112

 

 

 

7,082

 

Additional paid-in capital

 

 

111,264,069

 

 

 

112,349,613

 

Accumulated deficit

 

 

(125,281,898

)

 

 

(123,462,638

)

Accumulated other comprehensive loss

 

 

(1,689,665

)

 

 

(1,860,040

)

Total stockholders' deficit

 

 

(15,700,382

)

 

 

(12,965,983

)

Total liabilities and stockholders' deficit

 

$

10,065,743

 

 

$

12,668,626

 

See accompanying notes to unaudited condensed consolidated financial statements.

4

3


FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

Three Months Ended June 30,Six Months Ended June 30,
 2022202120222021
Revenue:    
Product revenue$962,898 $1,602,005 $1,557,826 $3,741,734 
Support and services revenue1,431,437 1,656,742 2,885,616 3,345,339 
Total revenue2,394,335 3,258,747 4,443,442 7,087,073 
Cost of revenue:   
Product24,588 34,781 45,307 257,615 
Support and service373,822 405,960 768,371 832,133 
Total cost of revenue398,410 440,741 813,678 1,089,748 
Gross profit1,995,925 2,818,006 3,629,764 5,997,325 
Operating expenses:    
Research and development costs655,524 661,147 1,361,505 1,321,087 
Selling and marketing1,124,498 1,259,735 2,314,344 2,656,375 
General and administrative724,066 658,100 1,574,005 1,495,967 
Restructuring costs— 421,737 744 724,050 
Total operating expenses2,504,088 3,000,719 5,250,598 6,197,479 
Operating income (loss)(508,163)(182,713)(1,620,834)(200,154)
Gain on debt extinguishment— — — 754,000 
Interest and other expense(201,236)(176,928)(319,231)(460,576)
Income (loss) before income taxes(709,399)(359,641)(1,940,065)93,270 
Income tax expense (benefit)221,827 2,659 100,567 47,275 
Net income (loss)$(931,226)$(362,300)$(2,040,632)$45,995 
Less: Accrual of Series A redeemable convertible preferred stock dividends338,428 282,926 639,349 560,096 
Less: Accretion to redemption value of Series A redeemable convertible preferred stock35,582 75,183 50,397 272,297 
Net income (loss) attributable to common stockholders$(1,305,236)$(720,409)$(2,730,378)$(786,398)
Basic net income (loss) per share attributable to common stockholders$(0.18)$(0.12)$(0.39)$(0.13)
Diluted net income (loss) per share attributable to common stockholders$(0.18)$(0.12)$(0.39)$(0.13)
Weighted average basic shares outstanding7,090,885 6,021,483 7,086,605 5,985,672 
Weighted average diluted shares outstanding7,090,885 6,021,483 7,086,605 5,985,672 


 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Product revenue

 

$

1,568,110

 

 

$

1,547,013

 

 

$

3,125,936

 

 

$

5,288,747

 

Support and services revenue

 

 

1,491,031

 

 

 

1,736,456

 

 

 

4,376,647

 

 

 

5,081,795

 

Total revenue

 

 

3,059,141

 

 

 

3,283,469

 

 

 

7,502,583

 

 

 

10,370,542

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

 

19,711

 

 

 

41,351

 

 

 

65,018

 

 

 

298,966

 

Support and service

 

 

360,393

 

 

 

400,934

 

 

 

1,128,764

 

 

 

1,233,067

 

Total cost of revenue

 

 

380,104

 

 

 

442,285

 

 

 

1,193,782

 

 

 

1,532,033

 

Gross profit

 

$

2,679,037

 

 

$

2,841,184

 

 

$

6,308,801

 

 

$

8,838,509

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Research and development costs

 

 

581,941

 

 

 

711,273

 

 

 

1,943,446

 

 

 

2,032,360

 

Selling and marketing

 

 

887,967

 

 

 

1,610,635

 

 

 

3,202,311

 

 

 

4,267,010

 

General and administrative

 

 

826,556

 

 

 

633,954

 

 

 

2,400,561

 

 

 

2,129,921

 

Gain on litigation settlement

 

 

—

 

 

 

(632,600

)

 

 

—

 

 

 

(632,600

)

Restructuring costs

 

 

—

 

 

 

68,704

 

 

 

744

 

 

 

792,754

 

Total operating expenses

 

 

2,296,464

 

 

 

2,391,966

 

 

 

7,547,062

 

 

 

8,589,445

 

Operating income (loss)

 

 

382,573

 

 

 

449,218

 

 

 

(1,238,261

)

 

 

249,064

 

Gain on debt extinguishment

 

 

—

 

 

 

—

 

 

 

—

 

 

 

754,000

 

Interest and other expense

 

 

(111,399

)

 

 

(84,049

)

 

 

(430,630

)

 

 

(544,625

)

Income (loss) before income taxes

 

 

271,174

 

 

 

365,169

 

 

 

(1,668,891

)

 

 

458,439

 

Income tax expense (benefit)

 

 

49,802

 

 

 

16,529

 

 

 

150,369

 

 

 

63,804

 

Net income (loss)

 

$

221,372

 

 

$

348,640

 

 

$

(1,819,260

)

 

$

394,635

 

Less: Accrual of Series A redeemable convertible preferred stock dividends

 

 

391,016

 

 

 

288,802

 

 

 

1,030,365

 

 

 

848,898

 

Less: Accretion to redemption value of Series A redeemable convertible preferred stock

 

 

40,023

 

 

 

13,517

 

 

 

90,420

 

 

 

285,814

 

Net income (loss) attributable to common stockholders

 

$

(209,667

)

 

$

46,321

 

 

$

(2,940,045

)

 

$

(740,077

)

Basic net income (loss) per share attributable to common stockholders

 

$

(0.03

)

 

$

0.01

 

 

$

(0.41

)

 

$

(0.12

)

Diluted net income (loss) per share attributable to common stockholders

 

$

(0.03

)

 

$

0.01

 

 

$

(0.41

)

 

$

(0.12

)

Weighted average basic shares outstanding

 

 

7,111,801

 

 

 

6,990,723

 

 

 

7,095,096

 

 

 

6,324,370

 

Weighted average diluted shares outstanding

 

 

7,111,801

 

 

 

7,039,421

 

 

 

7,095,096

 

 

 

6,324,370

 

See accompanying notes to unaudited condensed consolidated financial statements.


4

5


FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

Three Months Ended June 30,Six Months Ended June 30,
 2022202120222021
Net income (loss)$(931,226)$(362,300)$(2,040,632)$45,995 
Other comprehensive income (loss), net of applicable taxes    
Foreign currency translation110,861 (4,740)144,371 81,658 
Total other comprehensive income (loss), net of applicable taxes:110,861 (4,740)144,371 81,658 
Total comprehensive income (loss)$(820,365)$(367,040)$(1,896,261)$127,653 
Less: Accrual of Series A redeemable convertible preferred stock dividends338,428 282,926 639,349 560,096 
Less: Accretion to redemption value of Series A redeemable convertible preferred stock35,582 75,183 50,397 272,297 
Total comprehensive income (loss) attributable to common stockholders$(1,194,375)$(725,149)$(2,586,007)$(704,740)

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

2022

 

2021

 

2022

 

2021

 

Net income (loss)

$

221,372

 

$

348,640

 

$

(1,819,260

)

$

394,635

 

Other comprehensive income (loss), net of applicable taxes

 

 

 

 

 

 

 

 

Foreign currency translation

 

26,004

 

 

11,144

 

 

170,375

 

 

92,802

 

Total other comprehensive income (loss), net of applicable
   taxes:

 

26,004

 

 

11,144

 

 

170,375

 

 

92,802

 

Total comprehensive income (loss)

$

247,376

 

$

359,784

 

$

(1,648,885

)

$

487,437

 

Less: Accrual of Series A redeemable convertible preferred
   stock dividends

 

391,016

 

 

288,802

 

 

1,030,365

 

 

848,898

 

Less: Accretion to redemption value of Series A redeemable
   convertible preferred stock

 

40,023

 

 

13,517

 

 

90,420

 

 

285,814

 

Total comprehensive income (loss) attributable to common
   stockholders

$

(183,663

)

$

57,465

 

$

(2,769,670

)

$

(647,275

)


See accompanying notes to unaudited condensed consolidated financial statements.


5

6


FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT

(UNAUDITED)

Common Stock OutstandingCommon StockAdditional Paid-In CapitalAccumulated DeficitAccumulated Other Comprehensive Loss, NetTotal Stockholders' Deficit
Balance at January 1, 20227,082,276 $7,082 $112,349,613 $(123,462,638)$(1,860,040)$(12,965,983)
Net income (loss)(1,109,406)(1,109,406)
Share-based compensation to employees8,184 8,184 
Accretion of Series A redeemable convertible preferred stock(14,815)(14,815)
Dividends on Series A redeemable convertible preferred stock(300,921)(300,921)
Foreign currency translation33,510 33,510 
Balance at March 31, 20227,082,276 $7,082 $112,042,061 $(124,572,044)$(1,826,530)$(14,349,431)
Net income (loss)(931,226)(931,226)
Share-based compensation to employees19,102 19,102 
Shares issued in connection with vesting of restricted stock29,525 30 (30)— 
Accretion of Series A redeemable convertible preferred stock(35,582)(35,582)
Dividends on Series A redeemable convertible preferred stock(338,428)(338,428)
Foreign currency translation110,861 110,861 
Balance at June 30, 20227,111,801 $7,112 $111,687,123 $(125,503,270)$(1,715,669)$(15,524,704)


 

 

Common
Stock
Outstanding

 

 

Common
Stock

 

 

Additional
Paid-In
Capital

 

 

Accumulated
Deficit

 

 

 

Accumulated
Other
Comprehensive
Loss, Net

 

 

Total
Stockholders'
Deficit

 

Balance at January 1, 2022

 

 

7,082,276

 

 

$

7,082

 

 

$

112,349,613

 

 

$

(123,462,638

)

 

 

$

(1,860,040

)

 

$

(12,965,983

)

Net income (loss)

 

 

 

 

 

 

 

 

 

 

 

(1,109,406

)

 

 

 

 

 

 

(1,109,406

)

Share-based compensation to employees

 

 

 

 

 

 

 

 

8,184

 

 

 

 

 

 

 

 

 

 

8,184

 

Accretion of Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(14,815

)

 

 

 

 

 

 

 

 

 

(14,815

)

Dividends on Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(300,921

)

 

 

 

 

 

 

 

 

 

(300,921

)

Foreign currency translation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

33,510

 

 

 

33,510

 

Balance at March 31, 2022

 

 

7,082,276

 

 

 

7,082

 

 

 

112,042,061

 

 

 

(124,572,044

)

 

 

 

(1,826,530

)

 

 

(14,349,431

)

Net income (loss)

 

 

 

 

 

 

 

 

 

 

 

(931,226

)

 

 

 

 

 

 

(931,226

)

Share-based compensation to employees

 

 

 

 

 

 

 

 

19,102

 

 

 

 

 

 

 

 

 

 

19,102

 

Shares issued in connection with vesting of restricted stock

 

 

29,525

 

 

 

30

 

 

 

(30

)

 

 

 

 

 

 

 

 

 

—

 

Accretion of Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(35,582

)

 

 

 

 

 

 

 

 

 

(35,582

)

Dividends on Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(338,428

)

 

 

 

 

 

 

 

 

 

(338,428

)

Foreign currency translation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

110,861

 

 

 

110,861

 

Balance at June 30, 2022

 

 

7,111,801

 

 

 

7,112

 

 

 

111,687,123

 

 

 

(125,503,270

)

 

 

 

(1,715,669

)

 

 

(15,524,704

)

Net income (loss)

 

 

 

 

 

 

 

 

 

 

 

221,372

 

 

 

 

 

 

 

221,372

 

Share-based compensation to employees

 

 

 

 

 

 

 

 

7,985

 

 

 

 

 

 

 

 

 

 

7,985

 

Accretion of Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(40,023

)

 

 

 

 

 

 

 

 

 

(40,023

)

Dividends on Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(391,016

)

 

 

 

 

 

 

 

 

 

(391,016

)

Foreign currency translation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

26,004

 

 

 

26,004

 

Balance at September 30, 2022

 

 

7,111,801

 

 

 

7,112

 

 

 

111,264,069

 

 

 

(125,281,898

)

 

 

 

(1,689,665

)

 

 

(15,700,382

)

See accompanying notes to unaudited condensed consolidated financial statements.

7

6


FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT

(UNAUDITED)

Common Stock OutstandingCommon StockAdditional Paid-In CapitalAccumulated DeficitAccumulated Other Comprehensive Loss, NetTotal Stockholders' Deficit
Balance at January 1, 20215,949,463 5,949 110,107,170 (123,665,970)(1,987,961)(15,540,812)
Net income (loss)408,295 408,295 
Share-based compensation to employees4,471 4,471 
Shares issued in connection with vesting of restricted stock00— — 
Accretion of Series A redeemable convertible preferred stock(197,114)(197,114)
Dividends on Series A redeemable convertible preferred stock(277,170)(277,170)
Foreign currency translation86,398 86,398 
Balance at March 31, 20215,949,463 $5,949 $109,637,357 $(123,257,675)$(1,901,563)$(15,515,932)
Net income (loss)(362,300)(362,300)
Sale of common stock in public offering, net of underwriting discounts and offering costs811,750 812 2,736,958 2,737,770 
Share-based compensation to employees4,697 4,697 
Shares issued in connection with vesting of restricted stock28,151 28 (28)— 
Accretion of Series A redeemable convertible preferred stock(75,183)(75,183)
Dividends on Series A redeemable convertible preferred stock(282,926)(282,926)
Foreign currency translation(4,740)(4,740)
Balance at June 30, 20216,789,364 $6,789 $112,020,875 $(123,619,975)$(1,906,303)$(13,498,614)


 

 

Common
Stock
Outstanding

 

 

Common
Stock

 

 

Additional
Paid-In
Capital

 

 

Accumulated
Deficit

 

 

 

Accumulated
Other
Comprehensive
Loss, Net

 

 

Total
Stockholders'
Deficit

 

Balance at January 1, 2021

 

 

5,949,463

 

 

$

5,949

 

 

$

110,107,170

 

 

$

(123,665,970

)

 

 

$

(1,987,961

)

 

$

(15,540,812

)

Net income (loss)

 

 

 

 

 

 

 

 

 

 

 

408,295

 

 

 

 

 

 

 

408,295

 

Share-based compensation to employees

 

 

 

 

 

 

 

 

4,471

 

 

 

 

 

 

 

 

 

 

4,471

 

Accretion of Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(197,114

)

 

 

 

 

 

 

 

 

 

(197,114

)

Dividends on Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(277,170

)

 

 

 

 

 

 

 

 

 

(277,170

)

Foreign currency translation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

86,398

 

 

 

86,398

 

Balance at March 31, 2021

 

 

5,949,463

 

 

 

5,949

 

 

 

109,637,357

 

 

 

(123,257,675

)

 

 

 

(1,901,563

)

 

 

(15,515,932

)

Net income (loss)

 

 

 

 

 

 

 

 

 

 

 

(362,300

)

 

 

 

 

 

 

(362,300

)

Sale of common stock in public offering, net of underwriting discounts and offering costs

 

 

811,750

 

 

 

812

 

 

 

2,736,958

 

 

 

 

 

 

 

 

 

 

2,737,770

 

Share-based compensation to employees

 

 

 

 

 

 

 

 

4,697

 

 

 

 

 

 

 

 

 

 

4,697

 

Shares issued in connection with vesting of restricted stock

 

 

28,151

 

 

 

28

 

 

 

(28

)

 

 

 

 

 

 

 

 

 

—

 

Accretion of Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(75,183

)

 

 

 

 

 

 

 

 

 

(75,183

)

Dividends on Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(282,926

)

 

 

 

 

 

 

 

 

 

(282,926

)

Foreign currency translation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(4,740

)

 

 

(4,740

)

Balance at June 30, 2021

 

 

6,789,364

 

 

$

6,789

 

 

$

112,020,875

 

 

$

(123,619,975

)

 

 

$

(1,906,303

)

 

$

(13,498,614

)

Net income (loss)

 

 

 

 

 

 

 

 

 

 

 

348,640

 

 

 

 

 

 

 

348,640

 

Sale of common stock in public offering, net of underwriting discounts and offering costs

 

 

285,000

 

 

 

285

 

 

 

948,281

 

 

 

 

 

 

 

 

 

 

948,566

 

Share-based compensation to employees

 

 

 

 

 

 

 

 

4,916

 

 

 

 

 

 

 

 

 

 

4,916

 

Accretion of Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(13,517

)

 

 

 

 

 

 

 

 

 

(13,517

)

Dividends on Series A redeemable convertible preferred stock

 

 

 

 

 

 

 

 

(288,802

)

 

 

 

 

 

 

 

 

 

(288,802

)

Foreign currency translation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

11,144

 

 

 

11,144

 

Balance at September 30, 2021

 

 

7,074,364

 

 

$

7,074

 

 

$

112,671,753

 

 

$

(123,271,335

)

 

 

$

(1,895,159

)

 

$

(12,487,667

)

See accompanying notes to unaudited condensed consolidated financial statements.

8

7


FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 Six Months Ended June 30,
 20222021
Cash flows from operating activities:  
Net income (loss)$(2,040,632)$45,995 
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:  
Depreciation and amortization68,528 105,982 
Amortization of debt discount on notes payable6,127 159,791 
Amortization of right of use assets42,050 341,384 
Gain on debt extinguishment— (754,000)
Share-based payment compensation27,286 9,168 
Recovery of returns and doubtful accounts(18,740)— 
Deferred income taxes— 7,139 
Changes in operating assets and liabilities:  
Accounts receivable1,309,794 667,748 
Prepaid expenses and other current assets(59,132)302,404 
Contract assets51,502 38,016 
Inventory7,291 — 
Other assets4,925 (269)
Accounts payable301,761 102,950 
Accrued expenses and other long-term liabilities106,945 (521,676)
Operating lease liabilities(42,050)(468,821)
Deferred revenue(1,075,349)(381,096)
Net cash provided by (used in) operating activities(1,309,694)(345,285)
Cash flows from investing activities:  
Purchases of property and equipment— (60,444)
Security deposits— 739,484 
Capitalized software development costs(35,000)— 
Purchase of intangible assets(3,078)(10,436)
Net cash provided by (used in) investing activities(38,078)668,604 
Cash flows from financing activities:  
Proceeds from public offering, net of underwriting discounts paid— 3,095,203 
Payments of offering costs— (265,252)
Payments of short-term debt— (1,334,058)
Net cash provided by (used in) financing activities— 1,495,893 
Effect of exchange rate changes on cash and cash equivalents(25,319)1,732 
Net increase (decrease) in cash and cash equivalents(1,373,091)1,820,944 
Cash and cash equivalents, beginning of period3,181,209 1,920,656 
Cash and cash equivalents, end of period$1,808,118 $3,741,600 
Supplemental disclosures:  
Cash paid for interest$43,224 $86,860 
Non-cash investing and financing activities:  
Accrual of deferred offering costs$— $92,181 
Undistributed Series A redeemable convertible preferred stock dividends$639,349 $560,096 
Accretion of Series A redeemable convertible preferred stock$50,397 $272,297 

 

 

Nine Months Ended September 30,

 

 

 

2022

 

 

2021

 

Cash flows from operating activities:

 

 

 

 

 

 

Net income (loss)

 

$

(1,819,260

)

 

$

394,635

 

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

 

Depreciation and amortization

 

 

94,710

 

 

 

151,468

 

Amortization of debt discount on notes payable

 

 

10,153

 

 

 

163,769

 

Amortization of right of use assets

 

 

62,779

 

 

 

396,034

 

Gain on debt extinguishment

 

 

—

 

 

 

(754,000

)

Gain on litigation settlement

 

 

—

 

 

 

(632,600

)

Share-based payment compensation

 

 

35,271

 

 

 

14,084

 

Recovery of returns and doubtful accounts

 

 

2,217

 

 

 

—

 

Deferred income taxes

 

 

—

 

 

 

12,485

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable

 

 

538,413

 

 

 

541,249

 

Prepaid expenses and other current assets

 

 

106,208

 

 

 

271,443

 

Contract assets

 

 

183,686

 

 

 

236,296

 

Inventory

 

 

7,329

 

 

 

—

 

Other assets

 

 

(2,604

)

 

 

748,457

 

Accounts payable

 

 

340,818

 

 

 

(53,814

)

Accrued expenses and other long-term liabilities

 

 

401,087

 

 

 

(614,491

)

Operating lease liabilities

 

 

(62,779

)

 

 

(524,263

)

Deferred revenue

 

 

(1,315,987

)

 

 

(1,058,641

)

Net cash provided by (used in) operating activities

 

 

(1,417,959

)

 

 

(707,889

)

Cash flows from investing activities:

 

 

 

 

 

 

Purchases of property and equipment

 

 

—

 

 

 

(98,702

)

Capitalized software development costs

 

 

(35,000

)

 

 

(10,226

)

Purchase of intangible assets

 

 

(3,078

)

 

 

—

 

Net cash provided by (used in) investing activities

 

 

(38,078

)

 

 

(108,928

)

Cash flows from financing activities:

 

 

 

 

 

 

Proceeds from public offering, net of underwriting discounts paid

 

 

—

 

 

 

4,181,908

 

Payments of offering costs

 

 

—

 

 

 

(476,143

)

Payments of short-term debt

 

 

—

 

 

 

(1,334,058

)

Net cash provided by (used in) financing activities

 

 

—

 

 

 

2,371,707

 

Effect of exchange rate changes on cash and cash equivalents

 

 

(59,118

)

 

 

(762

)

Net increase (decrease) in cash and cash equivalents

 

 

(1,515,155

)

 

 

1,554,128

 

Cash and cash equivalents, beginning of period

 

 

3,181,209

 

 

 

1,920,656

 

Cash and cash equivalents, end of period

 

$

1,666,054

 

 

$

3,474,784

 

Supplemental disclosures:

 

 

 

 

 

 

Cash paid for interest

 

$

64,842

 

 

$

110,408

 

Non-cash investing and financing activities:

 

 

 

 

 

 

Accrual of deferred offering costs

 

$

—

 

 

$

19,429

 

Undistributed Series A redeemable convertible preferred stock dividends

 

$

1,030,365

 

 

$

848,898

 

Accretion of Series A redeemable convertible preferred stock

 

$

90,420

 

 

$

285,814

 

See accompanying notes to unaudited condensed consolidated financial statements.

9

8


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 ("we", the "Company" or "FalconStor"), is thea trusted data protection leader modernizing disaster recovery and backup for the hybrid cloud world. The Company enables enterprise customers and managed service providers to secure, migrate, and protect their data while reducing data storage and long-term retention costs. More than 1,000 organizations and managed service providers worldwide standardize on FalconStor as the foundation for their cloud first data protection future.


(b) Liquidity


As of JuneSeptember 30, 2022, the Company had a working capital deficiency of $0.4$0.2 million, which is inclusive of current deferred revenue of $3.6$3.5 million, and a stockholders' deficit of $15.5$15.7 million. During the sixnine months ended JuneSeptember 30, 2022, the Company had net loss of $2.0$1.8 million and negative cash flow from operations of $1.3$1.4 million. The Company's total cash balance at JuneSeptember 30, 2022 was $1.8$1.7 million, a decrease of $1.4$1.5 million compared to $3.2$3.2 million on December 31, 2021.


The Company’s principal sources of liquidity at JuneSeptember 30, 2022 consisted of cash and future cash anticipated to be generated from operations. The Company generated negative net income and negative cash flows from operations during the sixnine months ended JuneSeptember 30, 2022, and it reported negative working capital as of JuneSeptember 30, 2022.


The Company is currently a party to an Amended and Restated Term Loan Credit Agreement, dated as of February 23, 2018, as amended December 27, 2019, by and between the Company and HCP-FVA, LLC (“HCP-FVA”), (the “Amended and Restated Loan Agreement”). In connection with the then-proposed public offering of the Company as described in the Company's Registration Statement on Form S-1, as amended, originally filed on June 3, 2021 (the "June Offering"), we entered into a letter agreement with Hale Capital Partners, LP (“Hale Capital”), dated June 2, 2021 (the “Loan Extension Letter Agreement”), that provided for an extension of the maturity date on Hale Capital’s portion of the outstanding indebtedness owed under the Amended and Restated Loan Agreement to June 30, 2023. The remaining principal amount outstanding, which was owed to other lenders, was repaid in full. On July 19, 2022, we entered into a letter agreement with Hale Capital (the "Second Loan Extension Letter Agreement"), that provided for a subsequent extension of the maturity date on the outstanding indebtedness owed under the Amended and Restated Loan Agreement from June 30, 2023 to December 31, 2023. See Note (9) Notes Payable for more information. Also, as described further in Note (12) Series A Redeemable Convertible Preferred Stock, the effective date of the mandatory redemption right of the Company's Series A Redeemable Convertible Preferred Stock (the “Series A Preferred Stock”) held by HCP-FVA and Hale Capital was extended from July 30, 2021 to July 30, 2023 pursuant to that certain Amendment No. 1 to the Amended and Restated Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock of the Company, dated as of June 24, 2021 (as amended, the “Certificate of Designations”). On July 19, 2022, the Company and Hale Capital entered into a letter agreement pursuant to which Hale Capital agreed not to exercise or to permit the exercise of the mandatory redemption right of the Series A Preferred Stock on or prior to December 31, 2023 unless the redemption is in accordance with Section 8(e)(z) of the Certificate of Designations or in accordance with a Breach Event (as defined in the Certificate of Designations). If such Series A Preferred Stock was redeemed at JuneSeptember 30, 2022, the Company would have been required to pay the holders of the Series A Preferred Stock $15.1$15.5 million.


As discussed in Note (17) Restructuring Costs the Melville, NY office lease which ended on April 30, 2021 with a gross annualized rental cost of $1.5$1.5 million, will not be replaced. FalconStor is primarily a virtual company and is redeploying this savings to more productive uses.


The Company believes its current cash balances together with anticipated cash flows from operating activities will be sufficient to meet its working capital requirements for at least one year from the date the consolidated financial statements were issued.


9

(c) Revision of Previously Issued Financial Statements


Adjustment in Connection with the Adoption of ASC 606, Revenue from Contracts with Customers

During the year ended December 31, 2021, the Company identified an immaterial accounting error related to the beginning balance adjustment to deferred revenue and accumulated deficit in connection with the adoption of ASC 606, Revenue from Contracts with Customers. There was no impact of the correction on the previously issued consolidated statement of operations or on the consolidated statements of cash flows for the year ended December 31, 2020.

10


The Company assessed the materiality of this error on prior period financial statements in accordance with the SEC Staff Accounting Bulletin Number 99, Materiality, and ASC 250-10, Accounting Changes and Error Corrections. The Company determined that this error was not material to the financial statements of any prior annual or interim period.

Embedded Derivative Liability Fair Value Adjustment

During the year ended December 31, 2021, the Company identified an immaterial accounting error related to the fair value adjustments recorded to the embedded derivative liability associated with the Company's Series A Preferred Stock. The redemption feature of the embedded derivative may require cash payment of face value of preferred stock plus the value of accrued but unpaid dividends converted to common stock at a specified conversion rate at the date of occurrence of a specified breach event. The companyCompany recorded the fair value of the liability based on the face value of the preferred stock but not on accrued and unpaid dividends. This error resulted in an understatement of other long-term liabilities and an understatement of interest and other expense in the financial statements included in the Company’s quarterly reports on Form 10-Q and the Company’s annual reports on Form 10-K previously filed with the SEC. The Company assessed the materiality of this error on prior period financial statements in accordance with the SEC Staff Accounting Bulletin Number 99, Materiality, and ASC 250-10, Accounting Changes and Error Corrections. The Company determined that this error was not material to the financial statements of any prior annual or interim period.

To correct the misstatements above, the Company revised its previously issued financial statements as follows:

 

 

For the Three Months Ended September 30, 2021

 

 

For the Nine Months Ended September 30, 2021

 

CONSOLIDATED STATEMENT OF OPERATIONS

 

As Previously Reported

 

 

Adjustments

 

 

As Revised

 

 

As Previously Reported

 

 

Adjustments

 

 

As Revised

 

Interest and other expense

 

$

(58,257

)

 

$

(25,792

)

 

$

(84,049

)

 

$

(489,264

)

 

$

(55,361

)

 

$

(544,625

)

Income (loss) before income taxes

 

$

390,961

 

 

$

(25,792

)

 

$

365,169

 

 

$

513,800

 

 

$

(55,361

)

 

$

458,439

 

Net income (loss)

 

$

374,432

 

 

$

(25,792

)

 

$

348,640

 

 

$

449,996

 

 

$

(55,361

)

 

$

394,635

 

Net income (loss) attributable to common
   stockholders

 

$

72,113

 

 

$

(25,792

)

 

$

46,321

 

 

$

(684,716

)

 

$

(55,361

)

 

$

(740,077

)

Basic net income (loss) per share
   attributable to common stockholders

 

$

0.01

 

 

$

—

 

 

$

0.01

 

 

$

(0.11

)

 

$

(0.01

)

 

$

(0.12

)

Diluted net income (loss) per share
   attributable to common stockholders

 

$

0.01

 

 

$

—

 

 

$

0.01

 

 

$

(0.11

)

 

$

(0.01

)

 

$

(0.12

)

 

 

For the Three Months Ended September 30, 2021

 

 

For the Nine Months Ended September 30, 2021

 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)

 

As Previously Reported

 

 

Adjustments

 

 

As Revised

 

 

As Previously Reported

 

 

Adjustments

 

 

As Revised

 

Net income (loss)

 

$

374,432

 

 

$

(25,792

)

 

$

348,640

 

 

$

449,996

 

 

$

(55,361

)

 

$

394,635

 

Total comprehensive income (loss)

 

$

385,576

 

 

$

(25,792

)

 

$

359,784

 

 

$

542,798

 

 

$

(55,361

)

 

$

487,437

 

Total comprehensive income (loss)
   attributable to common stockholders

 

$

83,257

 

 

$

(25,792

)

 

$

57,465

 

 

$

(591,914

)

 

$

(55,361

)

 

$

(647,275

)

10

 

 

Total Stockholders' Deficit

 

CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT

 

As Previously Reported

 

 

Adjustments

 

 

As Revised

 

Balance at January 1, 2021

 

$

(14,608,186

)

 

$

(932,626

)

 

$

(15,540,812

)

Net income (loss)

 

$

425,248

 

 

$

(16,953

)

 

$

408,295

 

Balance at March 31, 2021

 

$

(14,566,353

)

 

$

(949,579

)

 

$

(15,515,932

)

Net income (loss)

 

$

(349,684

)

 

$

(12,616

)

 

$

(362,300

)

Balance at June 30, 2021

 

$

(12,536,419

)

 

$

(962,195

)

 

$

(13,498,614

)

Net income (loss)

 

$

374,432

 

 

$

(25,792

)

 

$

348,640

 

Balance at September 30, 2021

 

$

(11,499,680

)

 

$

(987,987

)

 

$

(12,487,667

)

 

 

For the Nine Months Ended September 30, 2021

 

CONSOLIDATED STATEMENT OF CASH FLOWS

 

As Previously Reported

 

 

Adjustments

 

 

As Revised

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

449,996

 

 

$

(55,361

)

 

$

394,635

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

Accrued expenses and other long-term liabilities

 

$

(669,852

)

 

$

55,361

 

 

$

(614,491

)

Net cash provided by (used in) operating activities

 

$

(707,889

)

 

$

—

 

 

$

(707,889

)

For the Three Months Ended June 30, 2021For the Six Months Ended June 30, 2021
CONSOLIDATED STATEMENT OF OPERATIONSAs Previously ReportedAdjustmentsAs RevisedAs Previously ReportedAdjustmentsAs Revised
Interest and other expense$(164,312)$(12,616)$(176,928)$(431,007)$(29,569)$(460,576)
Income (loss) before income taxes$(347,025)$(12,616)$(359,641)$122,839 $(29,569)$93,270 
Net income (loss)$(349,684)$(12,616)$(362,300)$75,564 $(29,569)$45,995 
Net income (loss) attributable to common stockholders$(707,793)$(12,616)$(720,409)$(756,829)$(29,569)$(786,398)
Basic net income (loss) per share attributable to common stockholders$(0.12)$— $(0.12)$(0.13)$— $(0.13)
Diluted net income (loss) per share attributable to common stockholders$(0.12)$— $(0.12)$(0.13)$— $(0.13)
For the Three Months Ended June 30, 2021For the Six Months Ended June 30, 2021
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)As Previously ReportedAdjustmentsAs RevisedAs Previously ReportedAdjustmentsAs Revised
Net income (loss)$(349,684)$(12,616)$(362,300)$75,564 $(29,569)$45,995 
Total comprehensive income (loss)$(354,424)$(12,616)$(367,040)$157,222 $(29,569)$127,653 
Total comprehensive income (loss) attributable to common stockholders$(712,533)$(12,616)$(725,149)$(675,171)$(29,569)$(704,740)


11


Total Stockholders' Deficit
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICITAs Previously ReportedAdjustmentsAs Revised
Balance at January 1, 2021$(14,608,186)$(932,626)$(15,540,812)
Net income (loss)$425,248 $(16,953)$408,295 
Balance at March 31, 2021$(14,566,353)$(949,579)$(15,515,932)
Net income (loss)$(349,684)$(12,616)$(362,300)
Balance at June 30, 2021$(12,536,419)$(962,195)$(13,498,614)
For the Six Months Ended June 30, 2021
CONSOLIDATED STATEMENT OF CASH FLOWSAs Previously ReportedAdjustmentsAs Revised
Cash flows from operating activities:
Net income (loss)$75,564 $(29,569)$45,995 
Changes in operating assets and liabilities:
Accrued expenses and other long-term liabilities$(551,245)$29,569 $(521,676)
Net cash provided by (used in) operating activities$(345,285)$— $(345,285)

(d) Impact of the COVID-19 Pandemic

We are continuing to monitor the impact of COVID-19, on all aspects of our business. 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 2022 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.


(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.

11

(f) 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

12

recognition, accounts receivable allowances, valuation of derivatives, valuation of goodwill and income taxes. Actual results could differ from those estimates.

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

(g) 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 fairly state the financial position of the Company at JuneSeptember 30, 2022, and the results of its operations for the three and sixnine months ended JuneSeptember 30, 2022 and 2021. 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, 2021 ("2021 Form 10-K").


(h) Recently Issued Accounting Pronouncements


In August 2020, the Financial Accounting Standards Board, or FASB, issued ASU 2020-06, regarding ASC Topic 470 “Debt” and ASC Topic 815 “Derivatives and Hedging,” which reduces the number of accounting models for convertible instruments and amends the calculation of diluted earnings per share for convertible instruments, among other changes. The guidance is effective for smaller reporting companies as defined by the SEC, for annual reporting periods beginning after December 15, 2023, including interim periods within that reporting period. Early adoption is permitted. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.


In June 2016, the FASB issued ASU 2016-13, "Financial Instruments – Credit Losses (together with all subsequent amendments, ("Topic 326"))", which replaced the previous U.S. GAAP that required an incurred loss methodology for recognizing credit losses and delayed recognition until it was probable a loss had been incurred. Topic 326 replaced the incurred loss methodology with a methodology that reflects expected credit losses and requires consideration of reasonable and supportable information to estimate credit losses. This provision was effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted. In February 2020, the FASB issued ASU 2020-02, "Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842)", which delayed the effective date of Topic 326 for smaller reporting companies until fiscal years beginning after December 15, 2022. We are currently evaluating the impact of the adoption of this standard on our 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 2021 Form 10-K. There have been no significant changes in the Company's significant accounting policies since December 31, 2021. For a description of the Company's significant accounting policies refer to the 2021 Form 10-K.

12


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.
13



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 when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For perpetual licenses with multi-year maintenance agreements, the companyCompany invoices the license and generally one year of maintenance with future maintenance generally invoiced annually. 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 JuneSeptember 30, 2022 and December 31, 2021, accounts receivable, net of allowance for doubtful accounts, was $1.6$2.3 million and $2.9$2.9 million, respectively. As of JuneSeptember 30, 2022 and December 31, 2021, short and long-term contract assets, net of allowance for doubtful accounts, was $0.9$0.7 million and $0.9$0.9 million, respectively. As of JuneSeptember 30, 2022 and December 31, 2021, allowance for doubtful accounts was $102,172$78,859 and $85,816,$85,816, 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:

Nine Months Ended September 30, 2022

 

 

 

Balance at January 1, 2021

 

$

7,070,859

 

   Deferral of revenue

 

 

13,248,342

 

   Recognition of revenue

 

 

(14,180,480

)

   Change in reserves

 

 

(2,635

)

Balance at December 31, 2021

 

$

6,136,086

 

   Deferral of revenue

 

 

6,147,943

 

   Recognition of revenue

 

 

(7,502,583

)

   Change in reserves

 

 

4,740

 

Balance at September 30, 2022

 

$

4,786,186

 

Six Months Ended June 30, 2022

Balance at January 1, 2021$7,070,859 
   Deferral of revenue13,248,342 
   Recognition of revenue(14,180,480)
   Change in reserves(2,635)
Balance at December 31, 2021$6,136,086 
   Deferral of revenue3,338,283 
   Recognition of revenue(4,443,442)
   Change in reserves1,567 
Balance at June 30, 2022$5,032,494 

During the three months ended JuneSeptember 30, 2022 and 2021, revenue of $1.3$1.1 million and $1.3$1.0 million respectively, and the sixnine months ended JuneSeptember 30, 2022, and 2021, revenue of $2.7$3.8 million and $2.8$3.9 million respectively, was recognized from the deferred revenue balance at the beginning of each period.

13


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 $5.0$4.8 million as of JuneSeptember 30, 2022, of which the Company expects to recognize approximately 71%73% of such amount as revenue over the next 12 months and the remainder thereafter.


Approximately $1.6$1.9 million of revenue is expected to be recognized from remaining performance obligations for unbilled support and services as of JuneSeptember 30, 2022. We expect to recognize revenue on approximately 40%28% 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 that 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, and not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a
14

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

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

14

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 are expected to continue through 2023. Below is a summary of our ROU assets and liabilities as of JuneSeptember 30, 2022.

Right of use assets

 

$

49,626

 

Lease liability obligations, current

 

 

49,626

 

Lease liability obligations, less current portion

 

 

—

 

Total lease liability obligations

 

$

49,626

 

Weighted-average remaining lease term

 

0.75

 

Weighted-average discount rate

 

 

3.35

%

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Components of lease expense:

 

 

 

 

 

 

 

 

 

 

 

 

Operating lease cost

 

$

38,420

 

 

$

88,593

 

 

$

107,800

 

 

$

712,911

 

Sublease income

 

 

—

 

 

 

—

 

 

 

—

 

 

 

(100,419

)

Net lease cost

 

$

38,420

 

 

$

88,593

 

 

$

107,800

 

 

$

612,492

 


15


Right of use assets$70,355 
Lease liability obligations, current70,355 
Lease liability obligations, less current portion— 
Total lease liability obligations$70,355 
Weighted-average remaining lease term1.00
Weighted-average discount rate3.35 %

Three Months Ended June 30,Six Months Ended June 30,
2022202120222021
Components of lease expense:
   Operating lease cost$37,286 $209,967 $69,380 $624,318 
   Sublease income— (25,105)— (100,419)
Net lease cost$37,286 $184,862 $69,380 $523,899 

During the three months ended JuneSeptember 30, 2022 and 2021, operating cash flows from operating leases were approximately $19,249$19,249 and $162,247,$57,541, respectively. During the sixnine months ended JuneSeptember 30, 2022 and 2021 operating cash flows from operating leases were approximately $38,498$57,747 and $517,216,$574,757, respectively.


Approximate future minimum lease payments for our ROU assets over the remaining lease periods as of JuneSeptember 30, 2022, are as follows:

 2022 (remaining)

 

$

19,249

 

 2023

 

 

38,498

 

Total minimum lease payments

 

$

57,747

 

Less interest

 

 

8,121

 

Present value of lease liabilities

 

$

49,626

 

202238,498 
202338,498 
Total minimum lease payments76,996 
Less interest6,641 
Present value of lease liabilities70,355 


(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 Preferred Stock outstanding.

15


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 sixnine months ended JuneSeptember 30, 2022 and 2021:

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Stock options

 

 

4,965

 

 

 

9,640

 

 

 

4,965

 

 

 

9,640

 

Restricted stock

 

 

32,768

 

 

 

—

 

 

 

32,768

 

 

 

63,207

 

Series A redeemable convertible preferred stock

 

 

151,439

 

 

 

138,509

 

 

 

151,439

 

 

 

138,509

 

Total anti-dilutive common stock equivalents

 

 

189,172

 

 

 

148,149

 

 

 

189,172

 

 

 

211,356

 

 Three Months Ended June 30,Six Months Ended June 30,
2022202120222021
Stock options5,690 9,645 5,690 9,645 
Restricted stock34,576 65,461 34,576 65,461 
Series A redeemable convertible preferred stock147,623 135,691 147,623 135,691 
Total anti-dilutive common stock equivalents187,889 210,797 187,889 210,797 


16

(4) Property and Equipment


The gross carrying amount and accumulated depreciation of property and equipment as of JuneSeptember 30, 2022 and December 31, 2021 are as follows:

 

 

September 30, 2022

 

 

December 31, 2021

 

 

 

 

 

 

 

 

Gross carrying amount

 

$

15,483,291

 

 

$

15,544,212

 

Accumulated depreciation

 

 

(15,387,495

)

 

 

(15,390,308

)

Property and Equipment, net

 

$

95,796

 

 

$

153,904

 

June 30, 2022December 31, 2021
Gross carrying amount$15,510,448 $15,544,212 
Accumulated depreciation(15,400,183)(15,390,308)
Property and Equipment, net$110,265 $153,904 


For the three months ended JuneSeptember 30, 2022 and 2021, depreciation expense was $15,588$11,203 and $30,867,$29,838, respectively. For the sixnine months ended JuneSeptember 30, 2022 and 2021, depreciation expense was $38,932$50,135 and $70,632,$100,470, respectively.


(5) Software Development Costs


The gross carrying amount and accumulated amortization of software development costs as of JuneSeptember 30, 2022 and December 31, 2021 are as follows:

 

 

September 30, 2022

 

 

December 31, 2021

 

 

 

 

 

 

 

 

Gross carrying amount

 

$

3,015,132

 

 

$

2,980,132

 

Accumulated amortization

 

 

(2,955,009

)

 

 

(2,937,437

)

Software development costs, net

 

$

60,123

 

 

$

42,695

 

June 30, 2022December 31, 2021
Gross carrying amount$3,015,132 $2,980,132 
Accumulated amortization(2,947,943)(2,937,437)
Software development costs, net$67,189 $42,695 


During the three months ended JuneSeptember 30, 2022 and 2021, the Company recorded $8,867$7,066 and $1,645,$1,649, respectively, of amortization expense related to capitalized software costs. During the sixnine months ended JuneSeptember 30, 2022 and 2021, the Company recorded $10,506$17,572 and $3,284,$4,933, 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 JuneSeptember 30, 2022 and December 31, 2021 are as follows:

 

 

September 30, 2022

 

 

December 31, 2021

 

Goodwill

 

$

4,150,339

 

 

$

4,150,339

 

Other intangible assets:

 

 

 

 

 

 

Gross carrying amount

 

$

4,041,216

 

 

$

4,038,138

 

Accumulated amortization

 

 

(4,013,779

)

 

 

(3,986,776

)

Net carrying amount

 

$

27,437

 

 

$

51,362

 

June 30, 2022December 31, 2021
Goodwill$4,150,339 $4,150,339 
Other intangible assets:  
Gross carrying amount$4,041,216 $4,038,138 
Accumulated amortization(4,005,866)(3,986,776)
Net carrying amount$35,350 $51,362 


For the three months ended JuneSeptember 30, 2022 and 2021, amortization expense was $8,554$7,913 and $15,984,$13,999, respectively. For the sixnine months ended JuneSeptember 30, 2022 and 2021, amortization expense was $19,090$27,003 and $32,066,$46,065, respectively.

16

17


(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 (the “Compensation Committee”) of the Company’s Board of Directors (the “Board”) and initially provided 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. In June 2021, the Company's stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2018 Plan by 220,800 shares to a total of 1,692,797 shares. Exercise prices of the options will beare determined by the Compensation Committee, subject to the consent of Hale Capital. The vesting terms will beare 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 JuneSeptember 30, 2022:

 

 

Shares

 

 

Shares Available

 

 

Shares

 

Name of Plan

 

Authorized

 

 

for Grant

 

 

Outstanding

 

FalconStor Software, Inc. 2018 Incentive Stock Plan

 

 

1,692,797

 

 

 

241,899

 

 

 

1,316,933

 

 SharesShares AvailableShares
Name of PlanAuthorizedfor GrantOutstanding
FalconStor Software, Inc. 2018 Incentive Stock Plan1,692,797241,8991,323,741


The following table summarizes the Company’s equity plans that have terminated or expired but that still have equity awards outstanding as of JuneSeptember 30, 2022:

Name of Plan

Shares Available for Grant

Shares Outstanding

FalconStor Software, Inc., 2016 Incentive Stock Plan

—

2,250

FalconStor Software, Inc., 2006 Incentive Stock Plan

—

3,440

2,715

A summary of the Company’s restricted stock activity for the sixnine months ended JuneSeptember 30, 2022 is below. Such restricted stock did not bestow any voting or dispositive power and is not deemed outstanding until they vest.


Number of
Restricted Stock
Awards

Non-Vested at January 1, 2022

1,513,380

Granted

113,230

Vested

(30,557)

(37,365

)

Forfeited

(272,312)

(272,312

)

Non-Vested at JuneSeptember 30, 2022

1,323,741 

1,316,933



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 sixnine months ended JuneSeptember 30, 2022 and 2021:

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Cost of revenue - Product

 

$

46

 

 

$

232

 

 

$

438

 

 

$

688

 

Cost of revenue - support and service

 

 

82

 

 

 

185

 

 

 

410

 

 

 

549

 

Research and development costs

 

 

1,830

 

 

 

167

 

 

 

5,609

 

 

 

167

 

Selling and marketing

 

 

3,598

 

 

 

2,915

 

 

 

17,632

 

 

 

8,475

 

General and administrative

 

 

2,429

 

 

 

1,417

 

 

 

11,182

 

 

 

4,205

 

 

 

$

7,985

 

 

$

4,916

 

 

$

35,271

 

 

$

14,084

 

17

 Three Months Ended June 30,Six Months Ended June 30,
 2022202120222021
Cost of revenue - Product$165 $229 $392 $456 
Cost of revenue - support and service147 183 328 364 
Research and development costs1,900 — 3,779 — 
Selling and marketing9,523 2,883 14,034 5,560 
General and administrative7,367 1,402 8,753 2,788 
 $19,102 $4,697 $27,286 $9,168 
18


(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 sixnine months ended JuneSeptember 30, 2022, the Company recorded an income tax provision of $100,567.$150,369. The effective tax rate for the sixnine months ended JuneSeptember 30, 2022 was (5.2%)9.0%. The effective tax rate differs from the statutory rate of 21% due to the mix of foreign and domestic earnings, foreign withholding taxes and the application of valuation allowances.allowances that are applicable with respect to the Company. As of JuneSeptember 30, 2022, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and therefore, the Company had not recorded any income tax benefit as such amounts are fully offset with a valuation allowance.


For the sixnine months ended JuneSeptember 30, 2021, the Company recorded an income tax provision of $47,275.$63,804. The effective tax rate for the sixnine months ended JuneSeptember 30, 2021 was 50.7%.13.9 %. The effective tax rate differsdiffered from the statutory rate of 21% due to the mix of foreign and domestic earnings and the application of valuation allowances. As of JuneSeptember 30, 2021, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and therefore, the Company had not recorded any income tax benefit as such amounts are fully offset with a valuation allowance.


The Company’s total unrecognized tax benefits, excluding interest, as of JuneSeptember 30, 2022 and JuneSeptember 30, 2021 were $70,935$70,935 and $70,260,$70,260, respectively. As of JuneSeptember 30, 2022 and JuneSeptember 30, 2021, the Company had $41,933$42,859 and $36,575,$36,575, respectively, of accrued interest reflected in accrued expenses.


(9) Notes Payable


The notes payable balance consists of the following:

Total notes payable, net at January 1, 2022

 

$

2,154,098

 

Accretion of discount

 

 

2,148

 

Total notes payable, net at March 31, 2022

 

$

2,156,246

 

Accretion of discount

 

 

3,979

 

Total notes payable, net at June 30, 2022

 

$

2,160,225

 

Accretion of discount

 

 

4,026

 

Total notes payable, net at September 30, 2022

 

$

2,164,251

 

Total notes payable, net at January 1, 2022

$2,154,098 
Accretion of discount2,148 
Total notes payable, net at March 31, 2022$2,156,246 
Accretion of discount$3,979 
Total notes payable, net at June 30, 2022$2,160,225 

Senior Secured Debt


The senior secured debt bears interest at prime plus 0.75%0.75% and had an original maturity date of June 30, 2021. In connection with the June Offering, we entered into the Loan Extension Letter Agreement on June 2, 2021 which provided for an extension of the maturity date on Hale Capital’s portion of the outstanding indebtedness owed under the Amended and Restated Loan Agreement to June 30, 2023. The amount extended constituted approximately $2.2$2.2 million of the $3.5$3.5 million principal amount outstanding as of June 2, 2021. The remaining $1.3$1.3 million of the outstanding principal, which was owed to other lenders, was repaid in full on June 30, 2021. On July 19, 2022, we entered into the "Second Loan Extension Letter Agreement" that provided for a subsequent extension of the maturity date on the outstanding indebtedness owed under the Amended and Restated Loan Agreement from June 30, 2023 to December 31, 2023.

The Company concluded the extension resulted in a debt modification under ASC 470-50, Modifications and Extinguishments, and therefore no gain or loss was required to be recognized. The change is accounted for prospectively using the new effective interest rate of the loan
.

As of JuneSeptember 30, 2022, the Company was in compliance with the financial covenants contained in the Amended and Restated Loan Agreement.

18


(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.

19


Fair Value Hierarchy

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

•
Level 1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities. At JuneSeptember 30, 2022, 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 JuneSeptember 30, 2022 and December 31, 2021, 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 JuneSeptember 30, 2022 and December 31, 2021, 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 JuneSeptember 30, 2022 or December 31, 2021.


The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at JuneSeptember 30, 2022:
  Fair Value Measurements at Reporting Date Using
TotalQuoted Prices in Active Markets for Identical Assets
(Level 1)		Significant other Inputs
(Level 2)		Significant Unobservable Inputs
(Level 3)
Derivative liabilities:    
Derivative Instruments796,846 — — 796,846 
Total derivative liabilities796,846 — — 796,846 
Total assets and liabilities measured at fair value$796,846 $— $— $796,846 


 

 

 

 

 

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

 

$

795,708

 

 

$

—

 

 

$

—

 

 

$

795,708

 

Total derivative liabilities

 

 

795,708

 

 

 

—

 

 

 

—

 

 

 

795,708

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets and liabilities measured at fair value

 

$

795,708

 

 

$

—

 

 

$

—

 

 

$

795,708

 

19

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at December 31, 2021:

 

 

 

 

 

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

 

$

776,623

 

 

$

—

 

 

$

—

 

 

$

776,623

 

Total derivative liabilities

 

 

776,623

 

 

 

—

 

 

 

—

 

 

 

776,623

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets and liabilities measured at fair value

 

$

776,623

 

 

$

—

 

 

$

—

 

 

$

776,623

 

  Fair Value Measurements at Reporting Date Using
TotalQuoted Prices in Active Markets for Identical Assets
(Level 1)		Significant other Inputs
(Level 2)		Significant Unobservable Inputs
(Level 3)
Derivative liabilities:
Derivative Instruments776,623 — — 776,623 
Total derivative liabilities776,623 — — 776,623 
Total assets and liabilities measured at fair value$776,623 $— $— $776,623 
20


Measurement of Fair Value

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 derivatives are included in other long-term liabilities on our consolidated balance sheets.


The fair value of the Company's Series A Preferred Stock is based on its future cash flows discounted at a 10%11% yield. The fair value of the Company's note payable is based on its future cash flows discounted at a 5%5% 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 sixnine months ended JuneSeptember 30, 2022 and June 30, 2021:

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Beginning Balance

 

$

796,846

 

 

$

728,063

 

 

$

776,623

 

 

$

703,747

 

Total (gain) loss recognized in earnings

 

 

(1,138

)

 

 

23,166

 

 

 

19,085

 

 

 

47,482

 

Ending Balance

 

$

795,708

 

 

$

751,229

 

 

$

795,708

 

 

$

751,229

 

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:

Three Months Ended June 30,Six Months Ended June 30,
2022202120222021
Beginning Balance$784,325 $718,070 $776,623 $703,747 
Total loss recognized in earnings12,521 9,993 20,223 24,316 
Ending Balance$796,846 $728,063 $796,846 $728,063 

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 %


(11) Commitments and Contingencies

The Company typically provides its customers a warranty on its software products for a period of no more than 90 days.days. Such warranties are accounted for in accordance with the authoritative guidance issued by the FASB on contingencies. For the three and sixnine months ended JuneSeptember 30, 2022, the Company has not incurred any costs related to warranty obligations.

20

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.original equipment manufacturers. The Company is not currently aware of any material claims for indemnification.

As described under Note (12) Series A Redeemable Convertible Preferred Stock the holders of the Series A Preferred Stock have redemption rights upon certain triggering events. As of JuneSeptember 30, 2022, 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,$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$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,$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 12 months of his base salary if (i) he has been employed by the Company for at least 12 months at the time of termination or (ii) a change of control has occurred within six months of Mr. Brooks’ employment. Except as set forth in the preceding sentence, Mr. Brooks is entitled to receive severance equal to six months of his base salary if he has been employed by the Company for less than six 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 Mr. Sita’s appointment as Chief Financial Officer, the Board approved an Independent Contractor Services Agreement with Alucria Consulting, Inc. (“Alucria”), an entity owned by Mr. Sita (the “Sita Agreement”), which was

21

executed on February 11, 2022. The Sita Agreement provides that Alucria is entitled to receive a fee of $20,000$20,000 per month. Alucria will also be eligible for an additional payment of up to $60,000$60,000 annually, based upon the achievement of goals determined by the Company, to be paid quarterly in accordance with standard Company policies. The agreement also providesprovided that Mr. Sita will is to receivereceived a grant of shares of the Company’s common stock, to be governed by the Company’s 2018 Stock Incentive Plan and subject to specific vesting conditions.


The term of the Sita Agreement expires on July 1, 2023, unless earlier terminated by either party in accordance with the terms therein.


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


In addition, as of JuneSeptember 30, 2022, the Company's liability for uncertain tax positions totaled $112,869.$113,788. 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 with a par value $0.001$0.001 per share and a stated value of $10$10 per share. Pursuant to the Certificate of Designations, each share of Series A Preferred Stock can be converted into shares of the Company’s common stock, at an initial conversion price of $102.488$102.488 per share, subject to appropriate adjustments for any stock

21

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)(60) consecutive trading days exceeds 250%250% of the conversion price and continues to exceed 225%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%5% (up to a maximum dividend rate of 10%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 Amended and Restated Loan 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 9.99%9.99% 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%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 accrued and unpaid dividends with respect thereto) and the closing price as of the occurrence of the triggering event. On or after December 31, 2023, subject to the approval of HCP-FVA, 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%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 (as defined in the Certificate of Designations) 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 will be redeemed at a per share redemption price equal to the greater of (y) 250%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

22

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%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$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$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

22

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%80% of the Company’s accounts receivable; and the redemption or purchase of any of the capital stock of the Company.

The holders of our outstanding Series A Preferred Stock have a mandatory redemption right that may be exercised only with the approval of Hale Capital and HCP-FVA. In connection with the June Offering, the effective date of such redemption right was extended from July 30, 2021 to July 30, 2023 pursuant to an amendment to the Certificate of Designations, dated as of June 24, 2021. On July 19, 2022, the Company and Hale Capital entered into a letter agreement pursuant to which Hale Capital agreed not to exercise or to permit the exercise of the mandatory redemption right of the Series A Preferred Stock on or prior to December 31, 2023 unless the redemption is in accordance with Section 8(e)(z) of the Certificate of Designations or in accordance with a Breach Event (as defined in the Certificate of Designations).

The Company concluded the extension resulted in a debt modification under ASC 470-50, Modifications and Extinguishments, and therefore no gain or loss was required to be recognized. The change is accounted for prospectively using the new effective interest rate of the preferred stock.

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 JuneSeptember 30, 2022 and December 31, 2021, the fair value of these derivative instruments was $796,846$795,708 and $776,623,$776,623, respectively, and were included in "other long-term liabilities" within the consolidated balance sheets. The (income) loss on the change in fair value of these derivative instruments for the six months ended June 30, 2022 and June 30, 2021 of 12,521 and $9,993, respectively, were included in “interest and other expense, 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 June 30, 2022 and 2021, were as follows:
Three Months Ended June 30,Six Months Ended June 30,
2022202120222021
Beginning Balance$784,325 $718,070 $776,623 $703,747 
Total loss recognized in earnings12,521 9,993 20,223 24,316 
Ending Balance$796,846 $728,063 $796,846 $728,063 
23


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 transaction0.5%
Probability of redemption absent a fundamental sale transaction4.75%
Annual volatility65%

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. In connection with the June Offering, Hale Capital Partners, 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 lossincome (loss) attributable to common stockholders on the statement of operations and in determining lossincome (loss) per share for the three and sixnine months ended JuneSeptember 30, 2022 and 2021, respectively.


The Series A Preferred Stock consists of the following:

Total Series A redeemable convertible preferred stock, net at January 1, 2022

 

$

14,384,388

 

Accrued dividends

 

 

300,921

 

Accretion of preferred stock

 

 

14,815

 

Total Series A redeemable convertible preferred stock, net at March 31, 2022

 

$

14,700,124

 

Accrued dividends

 

 

338,428

 

Accretion of preferred stock

 

 

35,582

 

Total Series A redeemable convertible preferred stock, net at June 30, 2022

 

$

15,074,134

 

Accrued dividends

 

 

391,016

 

Accretion of preferred stock

 

 

40,023

 

Total Series A redeemable convertible preferred stock, net at September 30, 2022

 

$

15,505,173

 

23

Total Series A redeemable convertible preferred stock, net at January 1, 2022

$14,384,388 
Accrued dividends300,921
Accretion of preferred stock14,815
Total Series A redeemable convertible preferred stock, net at March 31, 2022$14,700,124 
Accrued dividends$338,428 
Accretion of preferred stock$35,582 
Total Series A redeemable convertible preferred stock, net at June 30, 2022$15,074,134 

(13) Accumulated Other Comprehensive Loss

The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended JuneSeptember 30, 2022 are as follows:

 Foreign Currency
Translation		Net Minimum
Pension Liability		Total
Accumulated other comprehensive income (loss) at April 1, 2022$(1,847,495)$20,965 $(1,826,530)
Other comprehensive income (loss)   
Other comprehensive income (loss) before reclassifications110,861 0110,861 
Total other comprehensive income (loss)110,861 — 110,861 
Accumulated other comprehensive income (loss) at June 30, 2022$(1,736,634)$20,965 $(1,715,669)

 

 

Foreign Currency
Translation

 

 

Net Minimum
Pension Liability

 

 

Total

 

Accumulated other comprehensive income (loss) at July 1, 2022

 

$

(1,736,634

)

 

$

20,965

 

 

$

(1,715,669

)

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss) before reclassifications

 

 

26,004

 

 

 

-

 

 

 

26,004

 

Total other comprehensive income (loss)

 

 

26,004

 

 

 

-

 

 

 

26,004

 

Accumulated other comprehensive income (loss) at September 30, 2022

 

$

(1,710,630

)

 

$

20,965

 

 

$

(1,689,665

)


24


The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended JuneSeptember 30, 2021 are as follows:
 Foreign Currency
Translation		Net Minimum
Pension Liability		Total
Accumulated other comprehensive income (loss) at April 1, 2021$(1,909,282)$7,719 $(1,901,563)
Other comprehensive income (loss)   
Other comprehensive income (loss) before reclassifications(4,740)— (4,740)
Total other comprehensive income (loss)(4,740)— (4,740)
Accumulated other comprehensive income (loss) at June 30, 2021$(1,914,022)$7,719 $(1,906,303)


 

 

Foreign Currency
Translation

 

 

Net Minimum
Pension Liability

 

 

Total

 

Accumulated other comprehensive income (loss) at July 1, 2021

 

$

(1,914,022

)

 

$

7,719

 

 

$

(1,906,303

)

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss) before reclassifications

 

 

11,144

 

 

 

—

 

 

 

11,144

 

Total other comprehensive income (loss)

 

 

11,144

 

 

 

—

 

 

 

11,144

 

Accumulated other comprehensive income (loss) at September 30, 2021

 

$

(1,902,878

)

 

$

7,719

 

 

$

(1,895,159

)

The changes in Accumulated Other Comprehensive Loss, net of tax, for the sixnine months ended JuneSeptember 30, 2022 are as follows:


Foreign Currency
Translation		Net Minimum
Pension Liability		Total
Accumulated other comprehensive income (loss) at January 1, 2022$(1,881,005)$20,965 $(1,860,040)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications144,371 — 144,371 
Total other comprehensive income (loss)144,371 — 144,371 
Accumulated other comprehensive income (loss) at June 30, 2022$(1,736,634)$20,965 $(1,715,669)

 

 

Foreign Currency
Translation

 

 

Net Minimum
Pension Liability

 

 

Total

 

Accumulated other comprehensive income (loss) at January 1, 2022

 

$

(1,881,005

)

 

$

20,965

 

 

$

(1,860,040

)

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss) before reclassifications

 

 

170,375

 

 

 

-

 

 

 

170,375

 

Total other comprehensive income (loss)

 

 

170,375

 

 

 

-

 

 

 

170,375

 

Accumulated other comprehensive income (loss) at September 30, 2022

 

$

(1,710,630

)

 

$

20,965

 

 

$

(1,689,665

)


The changes in Accumulated Other Comprehensive Loss, net of tax, for the sixnine months ended JuneSeptember 30, 2021 are as follows:

 

 

Foreign Currency
Translation

 

 

Net Minimum
Pension Liability

 

 

Total

 

Accumulated other comprehensive income (loss) at January 1, 2021

 

$

(1,995,680

)

 

$

7,719

 

 

$

(1,987,961

)

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss) before reclassifications

 

 

92,802

 

 

 

—

 

 

 

92,802

 

Total other comprehensive income (loss)

 

 

92,802

 

 

 

—

 

 

 

92,802

 

Accumulated other comprehensive income (loss) at September 30, 2021

 

$

(1,902,878

)

 

$

7,719

 

 

$

(1,895,159

)


Foreign Currency
Translation		Net Minimum
Pension Liability		Total
Accumulated other comprehensive income (loss) at January 1, 2021$(1,995,680)$7,719 $(1,987,961)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications81,658 — 81,658 
Total other comprehensive income (loss)81,658 — 81,658 
Accumulated other comprehensive income (loss) at June 30, 2021$(1,914,022)$7,719 $(1,906,303)

(14) Stockholders' Equity


Stock Repurchase Activity

During the three and sixnine months ended JuneSeptember 30, 2022 and 2021, the Company did notnot repurchase any shares of its common stock. As of JuneSeptember 30, 2022, the Company had the authorization to repurchase 49,078 shares of its common stock based upon its judgment and market conditions.


Common Stock Offerings


On June 23, 2021, the Company issued and sold an aggregate of 811,750 shares of its common stock in a public offering underwritten by Roth, which included $86,750 shares purchased by Roth pursuant to the partial exercise of its over-allotment option. At a price of $4.10 per share, the Company received net proceeds of approximately $2.7 million after deducting the underwriting discount and offering expenses paid by the Company.


On July 27, 2021 the Company issued and sold an aggregate of 285,000 shares of its common stock in a public offering underwritten by Roth Capital Partners, LLC (“Roth”)., which included $86,750 shares purchased by Roth pursuant to the partial exercise

24

of its over-allotment option. At a price of $4.10$4.10 per share, the Company received net proceeds of approximately $0.9$2.7 million after deducting the underwriting discount and offering expenses paid by the Company.

On July 27, 2021 the Company issued and sold an aggregate of 285,000 shares of its common stock in a public offering underwritten by Roth. At a price of $4.10 per share, the Company received net proceeds of approximately $0.9 million after deducting the underwriting discount and estimated offering expenses paid by the Company.

25



(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.


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

(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 sixnine months ended JuneSeptember 30, 2022 and 2021, and the location of long-lived assets as of JuneSeptember 30, 2022 and December 31, 2021, are summarized as follows:

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

 

 

2022

 

 

2021

 

 

2022

 

 

2021

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Americas

 

$

1,411,667

 

 

$

880,010

 

 

$

3,482,258

 

 

$

4,422,598

 

Europe, Middle East, Africa and Other

 

 

896,265

 

 

 

1,265,526

 

 

 

2,454,588

 

 

 

3,817,767

 

Asia Pacific

 

 

751,209

 

 

 

1,137,933

 

 

 

1,565,737

 

 

 

2,130,177

 

Total Revenue

��

$

3,059,141

 

 

$

3,283,469

 

 

$

7,502,583

 

 

$

10,370,542

 

 

 

September 30, 2022

 

 

December 31, 2021

 

Long-lived assets:

 

 

 

 

 

 

Americas

 

$

603,366

 

 

$

858,417

 

Asia Pacific

 

 

158,267

 

 

 

261,148

 

Europe, Middle East, Africa and Other

 

 

12,468

 

 

 

18,364

 

Total long-lived assets

 

$

774,101

 

 

$

1,137,929

 

Three Months Ended June 30,Six Months Ended June 30,
2022202120222021
Revenue:
Americas$1,222,283 $1,834,411 $2,070,591 $3,542,588 
Europe, Middle East, Africa and Other753,329 941,385 1,558,323 2,552,241 
Asia Pacific418,723 482,951 814,528 992,244 
Total Revenue$2,394,335 $3,258,747 $4,443,442 $7,087,073 
June 30, 2022December 31, 2021
Long-lived assets:
Americas$619,629 $858,417 
Europe, Middle East, Africa and Other13,373 18,364 
Asia Pacific191,255 261,148 
Total long-lived assets$824,257 $1,137,929 

25

For the three and sixnine months ended JuneSeptember 30, 2022, the Company had 1one and 1one customers that accounted for 10% or more of total revenue, respectively. For the three and sixnine months ended JuneSeptember 30, 2021, the Company had 2two and 3 customers that accounted for 10% or more of total revenue, respectively.


As of JuneSeptember 30, 2022, the Company had 2two customers that accounted for 10% or more of the gross accounts receivable balance. As of December 31, 2021, the Company had 2two customers that accounted for 10% or more of the gross accounts receivable balance.


26

(17) Restructuring Costs

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 its former Melville, NY office space during the three months ended June 30, 2018. During the six months ended June 30, 2021, the Company incurred lease disposal-related costs for this property of $0.7$0.7 million. The Melville, NY lease which ended on April 30, 2021 with a gross annualized rental cost of $1.5$1.5 million, will not be replaced. The Company expects the remaining accrued severance-related costs of $124,017$116,499 as of JuneSeptember 30, 2022 to be paid once final settlement litigation is completed. Such litigation stems from the termination of three employees in France, one of which has been settled, and the remainder of which are expected to settle by December 31, 2022.


The following table summarizes the activity during 2021 through JuneSeptember 30, 2022 related to restructuring liabilities recorded in connection with the 2017, 2019 and 2020 Plans:

 

 

Severance Related Costs

 

 

Facility and Other Costs

 

 

Total

 

Balance at January 1, 2021

 

$

239,444

 

 

$

75,466

 

 

$

314,910

 

Provisions/Additions

 

 

—

 

 

 

302,313

 

 

 

302,313

 

Translation Adjustment

 

 

(10,393

)

 

 

—

 

 

 

(10,393

)

Utilized/Paid

 

 

—

 

 

 

(357,184

)

 

 

(357,184

)

Balance at March 31, 2021

 

$

229,051

 

 

$

20,595

 

 

$

249,646

 

Provisions/Additions

 

 

—

 

 

 

421,737

 

 

 

421,737

 

Translation Adjustment

 

 

2,734

 

 

 

—

 

 

 

2,734

 

Utilized/Paid

 

 

(90,445

)

 

 

(442,332

)

 

 

(532,777

)

Balance at June 30, 2021

 

$

141,340

 

 

$

—

 

 

$

141,340

 

Translation Adjustment

 

 

(3,429

)

 

 

—

 

 

 

(3,429

)

Balance at September 30, 2021

 

$

137,911

 

 

$

—

 

 

$

137,911

 

Translation Adjustment

 

 

(3,248

)

 

 

—

 

 

 

(3,248

)

Balance at December 31, 2021

 

$

134,663

 

 

$

—

 

 

$

134,663

 

Provisions/Additions

 

 

—

 

 

 

744

 

 

 

744

 

Translation Adjustment

 

 

(2,534

)

 

 

—

 

 

 

(2,534

)

Balance at March 31, 2022

 

$

132,129

 

 

$

744

 

 

$

132,873

 

Provisions/Additions

 

 

—

 

 

 

(744

)

 

 

(744

)

Translation Adjustment

 

 

(8,112

)

 

 

—

 

 

 

(8,112

)

Balance at June 30, 2022

 

$

124,017

 

 

$

—

 

 

$

124,017

 

Translation Adjustment

 

 

(7,518

)

 

 

—

 

 

 

(7,518

)

Balance at September 30, 2022

 

$

116,499

 

 

$

—

 

 

$

116,499

 

Severance Related CostsFacility and Other CostsTotal
Balance at January 1, 2021$239,444 $75,466 $314,910 
Provisions/Additions— 302,313 302,313 
Translation Adjustment(10,393)— (10,393)
Utilized/Paid— (357,184)(357,184)
Balance at March 31, 2021$229,051 $20,595 $249,646 
Provisions/Additions— 421,737 421,737 
Translation Adjustment2,734 — 2,734 
Utilized/Paid(90,445)(442,332)(532,777)
Balance at June 30, 2021$141,340 $— $141,340 
Translation Adjustment(3,429)— (3,429)
Balance at September 30, 2021$137,911 $— $137,911 
Translation Adjustment(3,248)— (3,248)
Balance at December 31, 2021$134,663 $— $134,663 
Provisions/Additions— 744 744 
Translation Adjustment(2,534)— (2,534)
Balance at March 31, 2022$132,129 $744 $132,873 
Provisions/Additions$— $(744)$(744)
Translation Adjustment$(8,112)$— $(8,112)
Balance at June 30, 2022$124,017 $— $124,017 


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


27

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

26

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

OVERVIEW


FalconStor Software, Inc., a Delaware corporation ("we", the "Company" or "FalconStor") is a trusted data protection software leader modernizing disaster recovery and backup operations for the hybrid cloud world. The Company enables enterprise customers and managed service providers to secure, migrate, and protect their data while reducing data storage and long-term retention costs by up to 95%. More than 1,000 organizations and managed service providers worldwide standardize on FalconStor as the foundation for their cloud first data protection future. Our products are offered through and supported by a worldwide network of leading managed service providers (“MSPs”), systems integrators, resellers, and original equipment manufacturers (“OEMs”).


Our products address a demand for enterprise data protection driven by the manner in which consumers and businesses are increasingly interacting in a digital space through multiple devices, networks and platforms. The onset of the coronavirus pandemic accelerated this shift, as ongoing remote work and work from home arrangements introduced novel challenges to maintaining enterprise data security. The adoption of increased employee mobility and flexible remote work arrangements, such as a broader incorporation of cloud technology and the option for employees to use their own devices, has introduced additional vulnerabilities that businesses must monitor and protect through solutions like ours in order to maintain enterprise data integrity.


Our products are utilized by enterprises and MSPs to address two key areas of enterprise data protection: (i) long-term data retention and recovery, and (ii) data replication to preserve business continuity. Our integration with modern cloud-based data storage environments, such as IBM PowerVS Cloud, AWS and Microsoft Azure, enables our enterprise customers to significantly reduce costs and improve the portability, security and accessibility of their enterprise data. We believe this accessibility is key in our modern world, where data must be protected and intelligently leveraged to facilitate learning, improve product design and drive competitive advantage. Our products can be used regardless of the underlying hardware, cloud and source-data, which enables our enterprise customers to leverage their existing hardware and software investments.


Since the beginning of 2020, we have focused our go-to-market efforts on long-term data retention and recovery data protection segment,segments, building on the momentum we generated since 2019. In 2021, we increased our go-to-market investment within our core regions of the Americas, EMEA, Japan, Korea, and Southeast Asia, and released StorSafeTM, the next generation of our Virtual Tape Library (“VTL”) product family built for MSPs.

During the secondthird quarter of 2022, we continued to deliver innovation and to enhance each of our products. Our StorSafeTM solution is a vital backup long-term archive retention tool in enterprise IT departments’ data protection arsenal and for MSPs that provide data protection as a service to enterprise companies. It enables them to modernize their backup and archive environments, leverage efficient hybrid- and public-cloud storage environments, such as those provided by IBM PowerVSCloud, AWS and Microsoft Azure, save operational costs, and improve restore performance for rapid remote disaster recovery.


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


27

Beyond our long-term retention and reinstatement products, our StorGuardTM business continuity driven data replication solution gives our customers the ability to move workloads to the right destination, on-premises or in the cloud, with advanced insight. This solution is designed for MSPs and enterprise organizations with complex, heterogeneous IT environments and the full spectrum of data management use cases, including but not limited to large enterprises, universities, health care entities and governmental institutions. StorGuardTM is a modern, comprehensive and easy-to-use software solution that enables IT professionals to have complete insight into and control over their organization’s data.


28


To provide for greater ease of use for all our products, we also made significant enhancements to our central data management console, now called StorSightTM, to interface with each of our products to provide a holistic view of an enterprise’s entire data protection environment – whether on-premises in data centers, in the public cloud, or a hybrid – as well as the key analytics, reports and dashboards our customers need to continuously optimize their operations.


FalconStor continues to focus on MSPs, enterprise customers, and OEM partners. These markets offer the most significant opportunity and are best suited to realize the value of FalconStor products, and provide an efficient and effective access to broad, worldwide markets. Most of our revenue comes from sales to MSPs and to enterprise customers through resellers.


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


Historically, the majority of our software licenses have been sold on a capacity basis and have included a perpetual right to use the licensed capacity. However, we have shifted our focus to an annual recurring revenue model through subscription or term-based licenses, which gives a customer the right to utilize our solutions over a designated period of time. We expect revenue from subscription-based licensing to increase over the next several years.


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


During the secondthird quarter of 2022, our shift to recurring revenue based revenue took a material step forward as we workedcontinued to secure aexpand our strategic reseller relationship with IBM. Through this strategic reseller relationship, IBM and FalconStor will co-market joint solutions consisting of FalconStor’s VTL/StorSafe software, IBM Cloud Object Storage (“COS”), and IBM Power Virtual Servers (“Power VS”PowerVS”) for efficient application and data migration from on-premises environments to IBM Power VS,PowerVS Cloud, and on-going SaaS-based backup and restore within IBM Power VS.PowerVS Cloud. While we expect this relationship to provide healthy recurring revenue growth in the future as our joint solutions will be sold on a monthly consumption basis (MRR), our accelerated focus in these types of hybrid cloud relationships, and associated realignment of our sales teams, will continue to contribute to total GAAP revenue fluctuations in the short-term. In fact, GAAP total revenue in the secondthird quarter of 2022 declined 26.5%6.8% year-over-year as our accelerated focus on advancing critical hybrid cloud relationships negatively impacted our legacy on-premises revenue.year-over-year. Given the reduction in GAAP Q2Q3 2022 revenues, we incurreddelivered a net lossincome of $0.9 million,$221,372, compared to a net lossincome of $0.4 million$348,640 in the secondthird quarter of 2021, even though we managed operating costs to $2.5 million2,296,464 in the quarter compared to $3.0 million2,391,966 in Q2Q3 2021. Despite our year-over-year GAAP total revenue decline, we believe GAAP total revenue will continue to increase each quarter during 2022. In fact, GAAP total revenue increased to $2.4 million$3,059,141 in the secondthird quarter of 2022 compared to $2.0 million$2,394,335 and $2,049,107 in the second and first quarterquarters of 2022, respectively, and we expect sequential quarter-over-quarter GAAP total revenue to continue increasing throughout the balance of 2022.


28

COVID-19


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.


RESULTS OF OPERATIONS – FOR THE THREE MONTHS ENDED JUNESEPTEMBER 30, 2022 COMPARED WITH THE THREE MONTHS ENDED JUNESEPTEMBER 30, 2021.


29


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 JuneSeptember 30, 2022 and 2021 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 June 30, Change
Period to Period
(amounts in dollars)
20222021
Revenue:
Product revenue$962,898 40 %$1,602,005 49 %$(639,107)(40)%
Support and services revenue1,431,437 60 %1,656,742 51 %(225,305)(14)%
Total revenue2,394,335 100 %3,258,747 100 %(864,412)(27)%
Cost of revenue:
Product24,588 1 %34,781 1 %(10,193)(29)%
Support and service373,822 16 %405,960 12 %(32,138)(8)%
Total cost of revenue398,410 17 %440,741 14 %(42,331)(10)%
Gross profit1,995,925 83 %2,818,006 86 %(822,081)(29)%
Operating expenses:
Research and development costs655,524 27 %661,147 20 %(5,623)(1)%
Selling and marketing1,124,498 47 %1,259,735 39 %(135,237)(11)%
General and administrative724,066 30 %658,100 20 %65,966 10 %
Restructuring costs— — %421,737 13 %(421,737)(100)%
Total operating expenses2,504,088 105 %3,000,719 92 %(496,631)(17)%
Operating income (loss)(508,163)(21)%(182,713)(6)%(325,450)(178)%
Interest and other expense(201,236)(8)%(176,928)(5)%(24,308)(14)%
Income (loss) before income taxes(709,399)(30)%(359,641)(11)%(349,758)(97)%
Income tax expense (benefit)221,827 9 %2,659 — %219,168 8,242 %
Net income (loss)$(931,226)(39)%$(362,300)(11)%$(568,926)(157)%
Less: Accrual of Series A redeemable convertible preferred stock dividends338,428 14 %282,926 9 %55,502 20 %
Less: Accretion to redemption value of Series A redeemable convertible preferred stock35,582 1 %75,183 2 %(39,601)(53)%
Net income (loss) attributable to common stockholders$(1,305,236)(55)%$(720,409)(22)%$(584,827)(81)%


 

Three Months Ended September 30,

 

Change

 

(amounts in dollars)

2022

 

2021

 

Period to Period

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Product revenue

$

1,568,110

 

 

51

%

$

1,547,013

 

 

47

%

$

21,097

 

 

 

1

%

Support and services revenue

 

1,491,031

 

 

49

%

 

1,736,456

 

 

53

%

 

(245,425

)

 

 

(14

)%

Total revenue

 

3,059,141

 

 

100

%

 

3,283,469

 

 

100

%

 

(224,328

)

 

 

(7

)%

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

19,711

 

 

1

%

 

41,351

 

 

1

%

 

(21,640

)

 

 

(52

)%

Support and service

 

360,393

 

 

12

%

 

400,934

 

 

12

%

 

(40,541

)

 

 

(10

)%

Total cost of revenue

 

380,104

 

 

12

%

 

442,285

 

 

13

%

 

(62,181

)

 

 

(14

)%

Gross profit

 

2,679,037

 

 

88

%

 

2,841,184

 

 

87

%

 

(162,147

)

 

 

(6

)%

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development costs

 

581,941

 

 

19

%

 

711,273

 

 

22

%

 

(129,332

)

 

 

(18

)%

Selling and marketing

 

887,967

 

 

29

%

 

1,610,635

 

 

49

%

 

(722,668

)

 

 

(45

)%

General and administrative

 

826,556

 

 

27

%

 

633,954

 

 

19

%

 

192,602

 

 

 

30

%

Gain on litigation settlement

 

—

 

 

—

%

 

(632,600

)

 

(19

)%

 

632,600

 

 

 

(100

)%

Restructuring costs

 

—

 

 

—

%

 

68,704

 

 

2

%

 

(68,704

)

 

 

(100

)%

Total operating expenses

 

2,296,464

 

 

75

%

 

2,391,966

 

 

73

%

 

(95,502

)

 

 

(4

)%

Operating income (loss)

 

382,573

 

 

13

%

 

449,218

 

 

14

%

 

(66,645

)

 

 

(15

)%

Gain on debt extinguishment

 

—

 

 

—

%

 

—

 

 

—

%

 

—

 

 

 

—

%

Interest and other expense

 

(111,399

)

 

(4

)%

 

(84,049

)

 

(3

)%

 

(27,350

)

 

 

(33

)%

Income (loss) before income taxes

 

271,174

 

 

9

%

 

365,169

 

 

11

%

 

(93,995

)

 

 

(26

)%

Income tax expense (benefit)

 

49,802

 

 

2

%

 

16,529

 

 

1

%

 

33,273

 

 

 

201

%

Net income (loss)

$

221,372

 

 

7

%

$

348,640

 

 

11

%

$

(127,268

)

 

 

(37

)%

Less: Accrual of Series A redeemable
   convertible preferred stock dividends

 

391,016

 

 

13

%

 

288,802

 

 

9

%

 

102,214

 

 

 

35

%

Less: Accretion to redemption value of
   Series A redeemable convertible preferred
   stock

 

40,023

 

 

1

%

 

13,517

 

 

0

%

 

26,506

 

 

 

196

%

Net income (loss) attributable to
   common stockholders

$

(209,667

)

 

(7

)%

$

46,321

 

 

1

%

$

(255,988

)

 

 

(553

)%

29

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 JuneSeptember 30, 2022, we recognized revenue of $2.4 million,$3,059,141, compared with $3.3 million$3,283,469 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, on occasion, software integrated with industry standard hardware. We no longer primarily source or sell hardware, rather we facilitate our customers in buying their own hardware. 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.


30


For the three months ended JuneSeptember 30, 2022 and 2021, product revenue represented 40%51% and 49%47% of our total revenue, respectively. Product revenue of $962,898$1,568,110 for the three months ended JuneSeptember 30, 2022 decreased $639,107,increased slightly by $21,097, or 40%1%, from $1,602,005$1,547,013 in the prior year period. The decrease inProduct revenue during the three months ended September 30, 2022 was comparable to product revenue is due to entering into several large multi-year contracts duringfor the secondsame quarter of 2021 that did not repeat in the second quarter of 2022.

prior year period.


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


Support and Services Revenue


Support and services revenue is comprised of revenue from (i) maintenance and technical support services, (ii) professional services primarily related to the implementation of our software, and (iii) engineering services. Revenue derived from maintenance and technical support contracts are deferred and recognized ratably over the contractual maintenance term. Revenues associated with professional and engineering services are recognized at a point in time upon customer acceptance.


Maintenance and technical support services revenue for the three months ended JuneSeptember 30, 2022 decreased by $152,278 to $1.4 million,$1,489,635, compared to $1.6 million$1,641,913 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 maintenance and technical support service revenue from the previous year reflects a decline in new contracts and renewals.

There was no

We received $1,396 in professional services revenue for the three months ended JuneSeptember 30, 2022 as compared to $56,486$94,543 in the prior year period. Professional services revenue will vary depending on the number of solutions for which customers elect to purchase engineering or professional services to assist with their implementations or other projects. We expect professional services revenue to continue to vary from period to period based upon the number of customers who elect to utilize our professional services upon purchasing any of our solutions.


Cost of Revenue, Gross Profit and Gross Margin


Total cost of revenue for the three months ended JuneSeptember 30, 2022 decreased 10%14% to $398,410,$380,104, compared with $440,741$442,285 in the prior year period. Total gross profit decreased $0.8 million,$162,147, or 29%6%, to $2.0 million$2,679,037 for the three months ended JuneSeptember 30, 2022, compared with $2.8 million$2,841,184 for the prior year period. Total gross margin decreased to 83%88% for the three months ended JuneSeptember 30, 2022, compared with 86%87% for the prior year period. The decrease in our total gross profit, in absolute dollars, was due to decreased revenue.

30

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 hardware and warranty expenses. Cost of product revenue for the three months ended JuneSeptember 30, 2022 decreased to $24,588,$19,711, compared with $34,781$41,351 in the prior year period. This decrease in cost of product revenue for the three months ended JuneSeptember 30, 2022 was primarily due to a continued 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 revenue 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 JuneSeptember 30, 2022 decreased 8%10% to $373,822,$360,393, compared with $405,960$400,934 in the prior year period. Support and service gross margin decreased slightly to 74%76 % for the three months ended JuneSeptember 30, 2022, compared with 75%77 % for the prior year period. The decrease in the cost of support and service revenue was primarily related to decreased personnel costs as well as lower contractors and consulting fees.


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Operating Expenses


Our operating expenses for the three months ended JuneSeptember 30, 2022 decreased by $0.5 million$95,502 to $2.5 million$2,296,464 from $3.0 million,$2,391,966, 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 slightly by $5,623,$129,332, or 1%18%, to $655,524$581,941 for the three months ended JuneSeptember 30, 2022, from $661,147$711,273 in the prior year period. The decrease in research and development costs was primarily related to a decrease in personnel costs which were partially offset by an increase in professional and consulting fees.

costs.

Selling and Marketing


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. Selling and marketing expenses declined $135,237,$722,668, or 11%45%, to $1.1 million$887,967 for the three months ended JuneSeptember 30, 2022 from $1.3 million$1,610,635 in the prior year period. The decrease in selling and marketing expenses was primarily related to reductions in personnel cost, commissions, and promotional costs, which were partially offset by an increase in consulting, contractors and professional fees.


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 increased slightly by $65,966$192,602 to $724,066$826,556 for the three months ended JuneSeptember 30, 2022, compared to $658,100$0.6 million for the prior year period. The increase in general and administrative expenses was due primarily to an increase in professional fees and contractors which were partially offset by a reduction in personnel costs.


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Gain on Litigation Settlement

During the three months ended September 30, 2021, we recorded a gain of $632,600 million for a legal settlement of a contractual dispute with a marketing/sales firm.

Restructuring

In June 2017, the Board of Directors of the Company (the “Board”) approved a comprehensive 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 its former Melville, NY office space during the three months ended June 30, 2018. As the lease has terminated in April 2021, there are no further restructuring costs associated with this lease.


Restructuring

There was no restructuring expense decreased from $421,737 in the prior year to $0 for the three months ended JuneSeptember 30, 2022.

2022, a decrease of $68,704 from the prior year.


Interest and Other (Loss) Income, Net

Interest and other expense, net, increased $24,308$27,350 to a loss of $201,236$111,399 for the three months ended JuneSeptember 30, 2022, compared with a loss of $176,928$84,049 in the prior year period. The increase in interest and other expense primarily relates to an increase in currency translation loss which has been partially offset by a decrease in interest expense resulting from payments made on outstanding debt.loss. The fluctuation in interest and other expense from quarter to quarter also relates to interest expense, foreign currency gains and losses, interest income, sublease income and the change in fair value of our embedded derivatives. For more information on our derivative instruments, see Note (10) Fair Value Measurements to our unaudited condensed consolidated financial statements.


Income Taxes

Our provision for income taxes consists of state and local, and foreign taxes. For the three months ended JuneSeptember 30, 2022 and 2021, the Company recorded income tax provision of $221,827$49,802 and provision of $2,659,$16,529, respectively, consisting primarily of state and local, and foreign taxes.


32


As of JuneSeptember 30, 2022, our conclusion regarding the realizability of our US deferred tax assets did not change and we have recorded a full valuation allowance against them.


32

RESULTS OF OPERATIONS – FOR THE SIXNINE MONTHS ENDED JUNESEPTEMBER 30, 2022 COMPARED WITH THE SIXNINE MONTHS ENDED JUNESEPTEMBER 30, 2021.


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 sixnine months ended JuneSeptember 30, 2022 and 2021 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)20222021
Revenue:
Product revenue$1,557,826 35 %$3,741,734 53 %$(2,183,908)(58)%
Support and services revenue2,885,616 65 %3,345,339 47 %(459,723)(14)%
Total revenue4,443,442 100 %7,087,073 100 %(2,643,631)(37)%
Cost of revenue:
Product45,307 1 %257,615 4 %(212,308)(82)%
Support and service768,371 17 %832,133 12 %(63,762)(8)%
Total cost of revenue813,678 18 %1,089,748 15 %(276,070)(25)%
Gross profit3,629,764 82 %5,997,325 85 %(2,367,561)(39)%
Operating expenses:
Research and development costs1,361,505 31 %1,321,087 19 %40,418 3 %
Selling and marketing2,314,344 52 %2,656,375 37 %(342,031)(13)%
General and administrative1,574,005 35 %1,495,967 21 %78,038 5 %
Restructuring costs744 — %724,050 10 %(723,306)(100)%
Total operating expenses5,250,598 118 %6,197,479 87 %(946,881)(15)%
Operating income (loss)(1,620,834)(36)%(200,154)(3)%(1,420,680)(710)%
Gain on debt extinguishment— — %754,000 11 %(754,000)(100)%
Interest and other expense(319,231)(7)%(460,576)(6)%141,345 31 %
Income (loss) before income taxes(1,940,065)(44)%93,270 1 %(2,033,335)(2,180)%
Income tax expense (benefit)100,567 2 %47,275 1 %53,292 113 %
Net income (loss)$(2,040,632)(46)%$45,995 1 %$(2,086,627)(4,537)%
Less: Accrual of Series A redeemable convertible preferred stock dividends639,349 14 %560,096 8 %79,253 14 %
Less: Accretion to redemption value of Series A redeemable convertible preferred stock50,397 1 %272,297 4 %(221,900)(81)%
Net income (loss) attributable to common stockholders$(2,730,378)(61)%$(786,398)(11)%$(1,943,980)(247)%

 

Nine Months Ended September 30,

 

Change
Period to Period

 

(amounts in dollars)

2022

 

2021

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Product revenue

$

3,125,936

 

 

42

%

$

5,288,747

 

 

51

%

$

(2,162,811

)

 

(41

)%

Support and services revenue

 

4,376,647

 

 

58

%

 

5,081,795

 

 

49

%

 

(705,148

)

 

(14

)%

Total revenue

 

7,502,583

 

 

100

%

 

10,370,542

 

 

100

%

 

(2,867,959

)

 

(28

)%

Cost of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

65,018

 

 

1

%

 

298,966

 

 

3

%

 

(233,948

)

 

(78

)%

Support and service

 

1,128,764

 

 

15

%

 

1,233,067

 

 

12

%

 

(104,303

)

 

(8

)%

Total cost of revenue

 

1,193,782

 

 

16

%

 

1,532,033

 

 

15

%

 

(338,251

)

 

(22

)%

Gross profit

 

6,308,801

 

 

84

%

 

8,838,509

 

 

85

%

 

(2,529,708

)

 

(29

)%

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Research and development costs

 

1,943,446

 

 

26

%

 

2,032,360

 

 

20

%

 

(88,914

)

 

(4

)%

Selling and marketing

 

3,202,311

 

 

43

%

 

4,267,010

 

 

41

%

 

(1,064,699

)

 

(25

)%

General and administrative

 

2,400,561

 

 

32

%

 

2,129,921

 

 

21

%

 

270,640

 

 

13

%

Gain on litigation settlement

 

—

 

 

—

%

 

(632,600

)

 

(6

)%

 

632,600

 

 

(100

)%

Restructuring costs

 

744

 

 

0

%

 

792,754

 

 

8

%

 

(792,010

)

 

(100

)%

Total operating expenses

 

7,547,062

 

 

101

%

 

8,589,445

 

 

83

%

 

(1,042,383

)

 

(12

)%

Operating income (loss)

 

(1,238,261

)

 

(17

)%

 

249,064

 

 

2

%

 

(1,487,325

)

 

(597

)%

Gain on debt extinguishment

 

—

 

 

—

%

 

754,000

 

 

7

%

 

(754,000

)

 

(100

)%

Interest and other expense

 

(430,630

)

 

(6

)%

 

(544,625

)

 

(5

)%

 

113,995

 

 

21

%

Income (loss) before income taxes

 

(1,668,891

)

 

(22

)%

 

458,439

 

 

4

%

 

(2,127,330

)

 

(464

)%

Income tax expense (benefit)

 

150,369

 

 

2

%

 

63,804

 

 

1

%

 

86,565

 

 

136

%

Net income (loss)

$

(1,819,260

)

 

(24

)%

$

394,635

 

 

4

%

$

(2,213,895

)

 

(561

)%

Less: Accrual of Series A redeemable
   convertible preferred stock dividends

 

1,030,365

 

 

14

%

 

848,898

 

 

8

%

 

181,467

 

 

21

%

Less: Accretion to redemption value of Series
   A redeemable convertible preferred stock

 

90,420

 

 

1

%

 

285,814

 

 

3

%

 

(195,394

)

 

(68

)%

Net income (loss) attributable to common
   stockholders

$

(2,940,045

)

 

(39

)%

$

(740,077

)

 

(7

)%

$

(2,199,968

)

 

(297

)%


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 sixnine months ended JuneSeptember 30, 2022, we recognized revenue of $4.4$7.5 million, compared with $7.1$10.4 million in the prior year period.

33


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, on occasion, software integrated with industry standard hardware. We no longer primarily source or sell hardware, rather we facilitate our customers in buying their own hardware. 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.


33

For the sixnine months ended JuneSeptember 30, 2022 and 2021, product revenue represented 35%42% and 53%51% of our total revenue, respectively. Product revenue of $1,557,826$3,125,936 for the sixnine months ended JuneSeptember 30, 2022 decreased $2,183,908,$2,162,811, or 58%41%, from $3,741,734$5,288,747 in the prior year period. The decrease in product revenue is due to order delays as well as entering into several large multi-year contracts in the first halfnine months of 2021 that did not repeat in the first half of 2022.


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


Support and Services Revenue


Support and services revenue is comprised of revenue from (i) maintenance and technical support services, (ii) professional services primarily related to the implementation of our software, and (iii) engineering services. Revenue derived from maintenance and technical support contracts are deferred and recognized ratably over the contractual maintenance term. Revenues associated with professional and engineering services are recognized at a point in time upon customer acceptance.


Maintenance and technical support services revenue for the sixnine months ended JuneSeptember 30, 2022 decreased $456,857 to $2.9 million,$4,369,416, compared to $3.2 million$4,826,273 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 maintenance and technical support service revenue from the previous year reflects a decline in new contracts and renewals.

Professional services revenue for the sixnine months ended JuneSeptember 30, 2022 decreased to $5,835,$7,231, compared to $160,979$255,522 in the prior year period. Professional services revenue will vary depending on the number of solutions for which customers elect to purchase engineering or professional services to assist with their implementations or other projects. We expect professional services revenue to continue to vary from period to period based upon the number of customers who elect to utilize our professional services upon purchasing any of our solutions.


Cost of Revenue, Gross Profit and Gross Margin


Total cost of revenue for the sixnine months ended JuneSeptember 30, 2022 decreased 25%22% to $813,678,$1,193,782, compared with $1,089,748$1,532,033 in the prior year period. Total gross profit decreased $2.4$2.5 million, or 39%28.6%, to $3.6$6.3 million for the sixnine months ended JuneSeptember 30, 2022, compared with $6.0$8.8 million for the prior year period. Total gross margin decreased slightly to 82%84% for the sixnine months ended JuneSeptember 30, 2021,2022, compared with 85% for the prior year period. The decrease in our total gross profit was due to decreased revenue. 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 hardware and warranty expenses. Cost of product revenue for the sixnine months ended JuneSeptember 30, 2022 decreased to $45,307,$65,018, compared with $257,615$298,966 in the prior year period. Product gross margin for the sixnine months ended JuneSeptember 30, 2022 increased, year over year, to 97%98 % from 93%94 % for the same period in 2021. This decrease in cost of product revenue for the sixnine months ended JuneSeptember 30, 2022 was primarily due to a continued intentional shift away from hardware sales in the current period, compared to the prior year period.

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


Cost of support and service revenue consists primarily of personnel and other costs associated with providing software implementations, technical support under maintenance contracts and training. Cost of support and service revenue for the sixnine months ended JuneSeptember 30, 2022 decreased 8% to $768,371,$1,128,764, compared with $832,133$1,233,067 in the prior year period. Support and service gross

34

margin decreased slightly to 73%74% for the sixnine months ended JuneSeptember 30, 2022, compared with 75%76% for the prior year period. The decrease in the cost of support and service revenue, in absolute dollars, was primarily related to decreased personnel cost and employee bonuses.


Operating Expenses


Our operating expenses for the sixnine months ended JuneSeptember 30, 2022 decreased by $0.9$1.0 million to $5.3$7.5 million from $6.2$8.6 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 increased $40,418,decreased $88,914, or 3%4%, to $1,361,505$1,943,446 for the sixnine months ended JuneSeptember 30, 2022, from $1,321,087$2,032,360 in the prior year period. The increasedecrease in research and development costs was primarily related to an increasea decrease in personnel costs and professional fees which were slightly offset by a decrease in bonus.

bonuses.

Selling and Marketing


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. Selling and marketing expenses declined $0.3$1.1 million, or 13%25%, to $2.3$3.2 million for the sixnine months ended JuneSeptember 30, 2022 from $2.7$4.3 million in the prior year period. The decrease in selling and marketing expenses was primarily related to reductions in commissions, personnel costs, and employee bonuses which were partially offset by an increase in consulting, contractor and professional fees.

promotional costs.


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 increased slightly by $78,038$270,640 to $1,574,005$2,400,561 for the sixnine months ended JuneSeptember 30, 2022, compared to $1,495,967$2,129,921 for the prior year period. The increase in general and administrative expenses was due primarily to an increase in professional servicesfees and contractors fees which were partially offset by a reduction in personnel costs and employee bonuses.

costs.


Gain on Litigation Settlement

During the nine months ended September 30, 2021, we recorded a gain of $632,600 million for a legal settlement of a contractual dispute with a marketing/sales firm.

Restructuring

In June 2017, the Board of Directors of the Company (the “Board”) approved a comprehensive 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 its former Melville, NY office space during the three months ended June 30, 2018. As the lease has terminated in April 2021, there are no further restructuring costs associated with this lease.


Restructuring expense decreased $723,306$792,010 for the sixnine months ended JuneSeptember 30, 2022 to $744, compared to a restructuring expense of $724,050$792,754 in the prior year period.


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Gain on Debt Extinguishment


Gain on debt extinguishment decreased $754,000 for the sixnine months ended JuneSeptember 30, 2022, from $754,000 for the sixnine months ended JuneSeptember 30, 2021. The debt extinguishment during such sixnine months ended JuneSeptember 30, 2021 reflected the forgiveness of the Company’s PPP Paycheck Protection Program loan, which was issued by Peapack Gladstone Bank in an aggregate principal amount of $754,000, and forgiven in full on March 30, 2021.

35



Interest and Other (Loss) Income, Net

Interest and other expense, net, decreased $141,345$113,995 to a loss of $319,231$430,630 for the sixnine months ended JuneSeptember 30, 2022, compared with a loss of $460,576$544,625 in the prior year period. The decreased interest and other expense primarily relates to a decrease interest expense as a result of payments made on outstanding debt, which has been partially offset by an increase in currency translation loss. The fluctuation in interest and other expense from quarter to quarter also relates to interest expense, foreign currency gains and losses, interest income, sublease income and the change in fair value of our embedded derivatives. For more information on our derivative instruments, see Note (10) Fair Value Measurements to our unaudited condensed consolidated financial statements.


Income Taxes

Our provision for income taxes consists of state and local, and foreign taxes. For the sixnine months ended JuneSeptember 30, 2022 and 2021, the Company recorded income tax provision of $100,567$150,369 and $47,275,$63,804, respectively, consisting primarily of state and local, and foreign taxes.


As of JuneSeptember 30, 2022, our conclusion regarding the realizability of our US deferred tax assets did not change and we have recorded a full valuation allowance against them.



LIQUIDITY AND CAPITAL RESOURCES


Principal Sources of Liquidity and Company Obligations


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 JuneSeptember 30, 2022 and December 31, 2021 totaled $1.8$1.7 million and $3.2 million, respectively.


We are currently a party to the Amended and Restated Term Loan Credit Agreement, dated as of February 23, 2018, as amended December 27, 2019, by and between the Company and HCP-FVA, LLC (“HCP-FVA”), (the “Amended and Restated Loan Agreement”). In connection with the then-proposed public offering of the Company as described in the Company's Registration Statement on Form S-1, as amended, originally filed on June 3, 2021, we entered into the Loan Extension Letter Agreement, which provided for an extension of the maturity date on the portion of the outstanding indebtedness owed to Hale Capital Partners, LP (“Hale Capital”) under the Amended and Restated Loan Agreement to June 30, 2023. The remaining principal amount outstanding, which was owed to other lenders, was repaid in full. On July 19, 2022, we entered into a letter agreement with Hale Capital (the "Second Loan Extension Letter Agreement"), that provided for a subsequent extension of the maturity date on the outstanding indebtedness owed under the Amended and Restated Loan Agreement from June 30, 2023 to December 31, 2023. See Note (9) Notes Payable to our unaudited condensed consolidated financial statements for more information. Also, as described further in Note (12) Series A Redeemable Convertible Preferred Stock to our unaudited condensed consolidated financial statements, the effective date of the mandatory redemption right of the Company’s Series A Redeemable Convertible Preferred Stock (the “Series A Preferred Stock”) held by HCP-FVA and Hale Capital was extended from July 30, 2021 to July 30, 2023 pursuant to that certain Amendment No. 1 to the Company’s Amended and Restated Certificate of Designations, Preferences and Rights of the Series A Preferred Stock,, dated as of June 24, 2021 (as(as amended, the “Certificate of Designations”). On July 19, 2022, the Company and Hale Capital entered into a letter agreement pursuant to which Hale Capital agreed not to exercise or to permit the exercise of the mandatory redemption right of the Series A Preferred Stock on or prior to December 31, 2023 unless the redemption is in accordance with Section 8(e)(z) of the Certificate of Designations or in accordance with

36

a Breach Event (as defined in the Certificate of Designations). If such Series A Preferred Stock was redeemed at JuneSeptember 30, 2022, the Company would have been required to pay the holders of the Series A Preferred Stock $15.1$15.5 million.


The Amended and Restated Loan Agreement has customary representations, warranties and affirmative and negative covenants. The negative covenants include financial covenants relating to in-force annual contract value. The Amended and Restated Loan Agreement also contains customary events of default, including but not limited to payment defaults, cross defaults with certain other indebtedness, breaches of covenants, bankruptcy events and a change of control. In the case of an event of default, as administrative agent under the Amended and Restated Loan Agreement, HCP-FVA, 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 Loan Agreement, and seek other available remedies.


36

As discussed in Note (17) Restructuring Costs to our unaudited condensed consolidated financial statements, the Melville, NY lease which ended on April 30, 2021 with a gross annualized rental cost of $1.5 million, will not be replaced. FalconStor is primarily a virtual company and expects to redeploy this savings to more productive uses.


Liquidity


As of JuneSeptember 30, 2022, we had a working capital deficiency of $0.4$0.2 million, which is inclusive of current deferred revenue of $3.6$3.5 million, and a stockholders' deficit of $15.5$15.7 million. During the sixnine months ended JuneSeptember 30, 2022, the Company had a net loss of $2.0$1.8 million and negative cash flow from operations of $1.3$1.4 million. The Company's total cash balance at JuneSeptember 30, 2022 was $1.8$1.7 million, a decrease of $1.4$1.5 million compared to December 31, 2021. On June 30, 2021, the Company repaid in full $1.3 million of the $3.5 million principal amount that was outstanding as of June 2, 2021 under the Amended and Restated Loan Agreement.


Based

Although there can be no assurance, based on its projected cash flows from operations, recently completed financing activities, cost cutting measures in place and existing cash on hand, the Company is projecting to have sufficient liquidity and to be cash flow positive through August 3, 2023.

the next 12 months.


Cash Flow Analysis


Cash flow information is as follows:

 Six Months Ended June 30,
 20222021
Cash provided by (used in):  
Operating activities$(1,309,694)$(345,285)
Investing activities(38,078)668,604 
Financing activities— 1,495,893 
Effect of exchange rate changes(25,319)1,732 
Net increase (decrease) in cash and cash equivalents$(1,373,091)$1,820,944 


 

 

Nine Months Ended September 30,

 

 

 

2022

 

 

2021

 

Cash provided by (used in):

 

 

 

 

 

 

Operating activities

 

$

(1,417,959

)

 

$

(707,889

)

Investing activities

 

 

(38,078

)

 

 

(108,928

)

Financing activities

 

 

—

 

 

 

2,371,707

 

Effect of exchange rate changes

 

 

(59,118

)

 

 

(762

)

Net increase (decrease) in cash and cash equivalents

 

$

(1,515,155

)

 

$

1,554,128

 

Net cash used in operating activities totaled $1.3$1.4 million for the sixnine months ended JuneSeptember 30, 2022, compared with $0.3$0.7 million of net cash used in operating activities in the prior year period. The change in net cash used in operating activities for the sixnine months ended JuneSeptember 30, 2022 versus the prior year was primarily due to our net loss, a larger decrease in deferred revenue, partially offset with a gain on debt extinguishment and a larger decrease in accounts receivable.


Net cash used in investing activities totaled $38,078 for the sixnine months ended JuneSeptember 30, 2022, compared with $668,604$108,928 of net cash provided byused in investing activities in the prior year period. The change in net cash used in investing activities versus the prior year was primarily due to a decrease in security deposits refunds.


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There was no cash used in or provided by financing activities for the sixnine months ended JuneSeptember 30, 2022, compared with net cash provided by financing activities of $1,495,893$2,371,707 in the prior year period. The net cash provided by financing activities in the prior year period included net proceeds from a public offering of our common stock, less offering costs, and payments on our long-term debt.


Total cash and cash equivalents decreased $1.4$1.5 million to $1.8$1.7 million at JuneSeptember 30, 2022 compared to December 31, 2021.


Contractual Obligations


As of JuneSeptember 30, 2022, our significant commitments are related to (i) the Amended and Restated Loan 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 JuneSeptember 30, 2022:

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Operating LeasesNote Payable (a)Interest Payments (a)Long-Term Income Tax Payable (b)Series A Preferred Stock Mandatory Redemption (c)Dividends on Series A Preferred Stock (d)
2022$38,498 $— $43,532 $— $— $— 
202338,498 2,176,621 43,532 — — — 
Other— — — 112,869 9,000,000 7,807,964 
Total contractual obligations$76,996 $2,176,621 $87,064 $112,869 $9,000,000 $7,807,964 

 

 

Operating Leases

 

 

Note Payable (a)

 

 

Interest Payments (a)

 

 

Long-Term Income Tax Payable (b)

 

 

Series A Preferred Stock Mandatory Redemption (c)

 

 

Dividends on Series A Preferred Stock (d)

 

2022

 

$

19,249

 

 

$

—

 

 

$

21,766

 

 

$

—

 

 

$

—

 

 

$

—

 

2023

 

 

38,498

 

 

 

2,176,621

 

 

 

87,065

 

 

 

—

 

 

 

—

 

 

 

—

 

Other

 

 

—

 

 

 

—

 

 

 

—

 

 

 

113,788

 

 

 

9,000,000

 

 

 

8,852,447

 

Total contractual obligations

 

$

57,747

 

 

$

2,176,621

 

 

$

108,831

 

 

$

113,788

 

 

$

9,000,000

 

 

$

8,852,447

 


(a) See Note (9) Notes Payable 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.


(c) Represents our potential liability if the holders of our Series A Preferred Stock redeem their shares for cash. The earliest date in which a redemption could occur as of JuneSeptember 30, 2022 was July 30, 2023. However, on July 19, 2022, the Company and Hale Capital entered into a letter agreement pursuant to which Hale Capital agreed not to exercise or to permit the exercise of the mandatory redemption right of the Series A Preferred Stock on or prior to December 31, 2023 unless the redemption is in accordance with Section 8(e)(z) of the Certificate of Designations or in accordance with a Breach Event (as defined in the Certificate of Designations). For further information, see Note (12) Series A Redeemable Convertible Preferred Stock to our unaudited condensed consolidated financial statements.


(d) Our agreements with the holders of the Series A Preferred Stock provide that such holders will receive quarterly dividends on the Series A Preferred Stock at prime rate plus 5%, subject to a maximum dividend rate of 10%. We also have the ability to accrue and roll over dividends. Due to the lack of sufficient surplus to pay dividends as required by the Delaware General Corporation Law, the Company was not permitted to pay the fourth quarter 2016 dividend in cash or common stock and has been accruing its quarterly dividends since then. This amount represents our potential liability to pay preferred stock dividends in cash on July 30, 2023, which was the earliest date in which the holders of our Series A Preferred Stock could redeem their shares for cash as of JuneSeptember 30, 2022. However, on July 19, 2022, the Company and Hale Capital entered into a letter agreement pursuant to which Hale Capital agreed not to exercise or to permit the exercise of the mandatory redemption right of the Series A Preferred Stock on or prior to December 31, 2023 unless the redemption is in accordance with Section 8(e)(z) of the Certificate of Designations or in accordance with a Breach Event (as defined in the Certificate of Designations). For further information, see Note (12) Series A Redeemable Convertible Preferred Stock to our unaudited condensed consolidated financial statements.


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Critical Accounting Policies and Estimates

We describe our significant accounting policies in Note (1) Summary of Significant Accounting Policies of our 2021 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 2021 Form 10-K. There have been no significant changes in our significant accounting policies or critical accounting estimates since December 31, 2021.


Impact of Recently Issued Accounting Pronouncements


See Note (1) Basis of Presentation to our unaudited condensed consolidated financial statements.

Off-Balance Sheet Arrangements

As of JuneSeptember 30, 2022 and December 31, 2021, we had no off-balance sheet arrangements.


Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are not required to provide the information required by this item as we are considered a smaller reporting company, as defined in Section 229.10(f)(1) of Regulation S-K.

Item 4. Controls and Procedures

Disclosure Controls and Procedures


The Company maintains “disclosure controls and procedures,” as such term is defined in Rules 13a-15e and 15d-15e of the Exchange Act, that are designed to ensure that information required to be disclosed in its reports, pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding the required disclosures. In designing and evaluating the disclosure controls and procedures, management has recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.

The Company’s Chief Executive Officer (its principal executive officer) and Chief Financial Officer (its principal financial officer and principal accounting officer) have evaluated the effectiveness of its “disclosure controls and procedures” and concluded that such disclosure controls and procedures were effective as of the end of the period covered this report.


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, as amended. 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”).

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The Company’s management has assessed the effectiveness of the Company’s internal control over financial reporting as of JuneSeptember 30, 2022, using the COSO framework (2013). The Company’s management has determined that the Company’s internal control over financial reporting is effective as of that date.


The Principal Executive Officer and the Principal Financial Officer believe that the 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.


Changes in Internal Control over Financial Reporting


There was no change in our internal control over financial reporting that occurred during the period covered by our Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

39


PART II. OTHER INFORMATION

Item 1. Legal Proceedings


From time to time we are party to legal proceedings that we believe to be ordinary, routine litigation incidental to the business of present or former operations. 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.

Item 1A. Risk Factors

We are affected by risks specific to us as well as factors that affect all businesses operating in a global market. The significant factors known to us that could materially adversely affect our business, financial condition, or operating results are set forth in Item 1A to our 2021 Form 10-K.


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 2. Unregistered Sales of Equity Securities and use of Proceeds


None.


Item 3. Defaults Upon Senior Securities


None.


Item 4. Mine Safety Disclosures


Not Applicable.


40

Item 5. Other Information


None.


40

41




Item 6. Exhibits

4.1

Letter Agreement, dated July 19, 2022, by and among FalconStor Software, Inc., Hale Capital Partners, LP, and HCP-FVA, LLC, regarding redemption of Series A Convertible Preferred Stock

10.1

Letter Agreement, dated July 19, 2022, by and among FalconStor Software, Inc., Hale Capital Partners, LP, and HCP-FVA, LLC, regarding extension of the Hale Capital term loan.

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 JuneSeptember 30, 2022, formatted in XBRL (eXtensible Business Reporting Language):

(i)

unaudited Condensed Consolidated Balance Sheets – JuneSeptember 30, 2022 and December 31, 2021.

(ii)

unaudited Condensed Consolidated Statement of Operations – Three and SixNine Months Ended JuneSeptember 30, 2022 and 2021.

(iii)

unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) – Three and SixNine Months Ended JuneSeptember 30, 2022 and 2021.

(iv)

unaudited Condensed Consolidated Statements of Stockholder's Deficit - Three and SixNine Months Ended JuneSeptember 30, 2022 and 2021.

(v)

unaudited Condensed Consolidated Statement of Cash Flows – Three and SixNine Months Ended JuneSeptember 30, 2022 and 2021.

(vi)

Notes to unaudited Condensed Consolidated Financial Statements – JuneSeptember 30, 2022.

104.0

Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101).

.

41

42


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/ Vincent Sita

Vincent Sita

Chief Financial Officer and Treasurer

(principal financial and accounting officer)

/s/ Todd Brooks

Todd Brooks

President & Chief Executive Officer

August 3,November 9, 2022

(principal executive officer)


42

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