Form 10-Q FALCONSTOR SOFTWARE INC For: Sep 30
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number:
(Exact Name of Registrant as Specified in its Charter)
( State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
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(Address of principal executive offices) |
(Zip Code) |
Registrant’s telephone number, including area code: (
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
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Trading Symbol(s) |
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Name of each exchange on which registered |
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OTCQB |
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
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).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer |
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☐ |
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Accelerated filer |
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☐ |
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☒ |
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Smaller reporting company |
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Emerging growth company |
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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. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No
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
As of October 31, 2022, the registrant had
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
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Page |
3 |
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3 |
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Condensed Consolidated Balance Sheets at September 30, 2022 (unaudited) and December 31, 2021 |
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5 |
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6 |
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8 |
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Notes to the Unaudited Condensed Consolidated Financial Statements |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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PART II. |
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Item 1. |
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43 |
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
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September 30, 2022 |
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December 31, 2021 |
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(unaudited) |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
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$ |
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Accounts receivable, net of allowances |
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Prepaid expenses and other current assets |
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Contract assets |
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Inventory |
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Total current assets |
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Property and equipment, net |
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Operating lease right-of-use assets, net |
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Deferred tax assets |
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Software development costs, net |
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Other assets |
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Goodwill |
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Other intangible assets, net |
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Long-term contract assets |
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Total assets |
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$ |
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$ |
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Liabilities and Stockholders' Deficit |
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Current liabilities: |
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Accounts payable |
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$ |
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$ |
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Accrued expenses |
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Current portion of lease liabilities |
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Deferred revenue |
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Total current liabilities |
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Other long-term liabilities |
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Notes payable, net of debt issuance costs and discounts |
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Operating lease liabilities, net of current portion |
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Deferred tax liabilities |
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Deferred revenue, net of current portion |
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Total liabilities |
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Series A redeemable convertible preferred stock, $ |
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Stockholders' deficit: |
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Common stock, $ |
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Additional paid-in capital |
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Accumulated deficit |
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( |
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( |
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Accumulated other comprehensive loss |
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( |
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( |
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Total stockholders' deficit |
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( |
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( |
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Total liabilities and stockholders' deficit |
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$ |
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$ |
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See accompanying notes to unaudited condensed consolidated financial statements.
3
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
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Three Months Ended September 30, |
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Nine Months Ended September 30, |
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2022 |
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2021 |
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2022 |
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2021 |
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Revenue: |
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Product revenue |
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$ |
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$ |
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$ |
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$ |
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Support and services revenue |
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Total revenue |
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Cost of revenue: |
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Product |
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Support and service |
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Total cost of revenue |
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Gross profit |
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$ |
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$ |
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$ |
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$ |
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Operating expenses: |
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Research and development costs |
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Selling and marketing |
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General and administrative |
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Gain on litigation settlement |
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( |
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( |
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Restructuring costs |
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Total operating expenses |
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Operating income (loss) |
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Gain on debt extinguishment |
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Interest and other expense |
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( |
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( |
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( |
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( |
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Income (loss) before income taxes |
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( |
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Income tax expense (benefit) |
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Net income (loss) |
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$ |
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$ |
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$ |
( |
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$ |
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Less: Accrual of Series A redeemable convertible preferred stock dividends |
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Less: Accretion to redemption value of Series A redeemable convertible preferred stock |
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Net income (loss) attributable to common stockholders |
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$ |
( |
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$ |
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$ |
( |
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$ |
( |
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Basic net income (loss) per share attributable to common stockholders |
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$ |
( |
) |
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$ |
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$ |
( |
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$ |
( |
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Diluted net income (loss) per share attributable to common stockholders |
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$ |
( |
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$ |
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$ |
( |
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$ |
( |
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Weighted average basic shares outstanding |
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Weighted average diluted shares outstanding |
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See accompanying notes to unaudited condensed consolidated financial statements.
4
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
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Three Months Ended September 30, |
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Nine Months Ended September 30, |
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2022 |
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2021 |
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2022 |
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2021 |
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Net income (loss) |
$ |
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$ |
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$ |
( |
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$ |
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Other comprehensive income (loss), net of applicable taxes |
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Foreign currency translation |
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Total other comprehensive income (loss), net of applicable |
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Total comprehensive income (loss) |
$ |
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$ |
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$ |
( |
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$ |
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Less: Accrual of Series A redeemable convertible preferred |
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Less: Accretion to redemption value of Series A redeemable |
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Total comprehensive income (loss) attributable to common |
$ |
( |
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$ |
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$ |
( |
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$ |
( |
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See accompanying notes to unaudited condensed consolidated financial statements.
5
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(UNAUDITED)
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Common |
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Common |
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Additional |
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Accumulated |
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Accumulated |
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Total |
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Balance at January 1, 2022 |
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$ |
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$ |
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$ |
( |
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$ |
( |
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$ |
( |
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Net income (loss) |
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( |
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( |
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Share-based compensation to employees |
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Accretion of Series A redeemable convertible preferred stock |
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( |
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( |
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Dividends on Series A redeemable convertible preferred stock |
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( |
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( |
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Foreign currency translation |
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Balance at March 31, 2022 |
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( |
) |
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( |
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( |
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Net income (loss) |
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( |
) |
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( |
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Share-based compensation to employees |
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Shares issued in connection with vesting of restricted stock |
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( |
) |
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Accretion of Series A redeemable convertible preferred stock |
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( |
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( |
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Dividends on Series A redeemable convertible preferred stock |
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( |
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( |
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Foreign currency translation |
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Balance at June 30, 2022 |
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( |
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( |
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( |
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Net income (loss) |
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Share-based compensation to employees |
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Accretion of Series A redeemable convertible preferred stock |
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( |
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( |
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Dividends on Series A redeemable convertible preferred stock |
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( |
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( |
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Foreign currency translation |
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Balance at September 30, 2022 |
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( |
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( |
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( |
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See accompanying notes to unaudited condensed consolidated financial statements.
6
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(UNAUDITED)
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Common |
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Common |
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Additional |
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Accumulated |
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Accumulated |
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Total |
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Balance at January 1, 2021 |
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$ |
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$ |
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$ |
( |
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$ |
( |
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$ |
( |
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Net income (loss) |
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Share-based compensation to employees |
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Accretion of Series A redeemable convertible preferred stock |
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( |
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( |
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Dividends on Series A redeemable convertible preferred stock |
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( |
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( |
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Foreign currency translation |
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Balance at March 31, 2021 |
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( |
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( |
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( |
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Net income (loss) |
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( |
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( |
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Sale of common stock in public offering, net of underwriting discounts and offering costs |
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Share-based compensation to employees |
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Shares issued in connection with vesting of restricted stock |
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( |
) |
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Accretion of Series A redeemable convertible preferred stock |
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( |
) |
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( |
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Dividends on Series A redeemable convertible preferred stock |
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( |
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( |
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Foreign currency translation |
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( |
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( |
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Balance at June 30, 2021 |
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$ |
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$ |
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$ |
( |
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$ |
( |
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$ |
( |
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Net income (loss) |
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Sale of common stock in public offering, net of underwriting discounts and offering costs |
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Share-based compensation to employees |
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Accretion of Series A redeemable convertible preferred stock |
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( |
) |
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( |
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Dividends on Series A redeemable convertible preferred stock |
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( |
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( |
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Foreign currency translation |
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Balance at September 30, 2021 |
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|
$ |
|
|
$ |
|
|
$ |
( |
) |
|
|
$ |
( |
) |
|
$ |
( |
) |
|||
See accompanying notes to unaudited condensed consolidated financial statements.
7
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
|
|
Nine Months Ended September 30, |
|
|||||
|
|
2022 |
|
|
2021 |
|
||
Cash flows from operating activities: |
|
|
|
|
|
|
||
Net income (loss) |
|
$ |
( |
) |
|
$ |
|
|
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: |
|
|
|
|
|
|
||
Depreciation and amortization |
|
|
|
|
|
|
||
Amortization of debt discount on notes payable |
|
|
|
|
|
|
||
Amortization of right of use assets |
|
|
|
|
|
|
||
Gain on debt extinguishment |
|
|
|
|
|
( |
) |
|
Gain on litigation settlement |
|
|
|
|
|
( |
) |
|
Share-based payment compensation |
|
|
|
|
|
|
||
Recovery of returns and doubtful accounts |
|
|
|
|
|
|
||
Deferred income taxes |
|
|
|
|
|
|
||
Changes in operating assets and liabilities: |
|
|
|
|
|
|
||
Accounts receivable |
|
|
|
|
|
|
||
Prepaid expenses and other current assets |
|
|
|
|
|
|
||
Contract assets |
|
|
|
|
|
|
||
Inventory |
|
|
|
|
|
|
||
Other assets |
|
|
( |
) |
|
|
|
|
Accounts payable |
|
|
|
|
|
( |
) |
|
Accrued expenses and other long-term liabilities |
|
|
|
|
|
( |
) |
|
Operating lease liabilities |
|
|
( |
) |
|
|
( |
) |
Deferred revenue |
|
|
( |
) |
|
|
( |
) |
Net cash provided by (used in) operating activities |
|
|
( |
) |
|
|
( |
) |
Cash flows from investing activities: |
|
|
|
|
|
|
||
Purchases of property and equipment |
|
|
|
|
|
( |
) |
|
Capitalized software development costs |
|
|
( |
) |
|
|
( |
) |
Purchase of intangible assets |
|
|
( |
) |
|
|
|
|
Net cash provided by (used in) investing activities |
|
|
( |
) |
|
|
( |
) |
Cash flows from financing activities: |
|
|
|
|
|
|
||
Proceeds from public offering, net of underwriting discounts paid |
|
|
|
|
|
|
||
Payments of offering costs |
|
|
|
|
|
( |
) |
|
Payments of short-term debt |
|
|
|
|
|
( |
) |
|
Net cash provided by (used in) financing activities |
|
|
|
|
|
|
||
Effect of exchange rate changes on cash and cash equivalents |
|
|
( |
) |
|
|
( |
) |
Net increase (decrease) in cash and cash equivalents |
|
|
( |
) |
|
|
|
|
Cash and cash equivalents, beginning of period |
|
|
|
|
|
|
||
Cash and cash equivalents, end of period |
|
$ |
|
|
$ |
|
||
Supplemental disclosures: |
|
|
|
|
|
|
||
Cash paid for interest |
|
$ |
|
|
$ |
|
||
Non-cash investing and financing activities: |
|
|
|
|
|
|
||
Accrual of deferred offering costs |
|
$ |
|
|
$ |
|
||
Undistributed Series A redeemable convertible preferred stock dividends |
|
$ |
|
|
$ |
|
||
Accretion of Series A redeemable convertible preferred stock |
|
$ |
|
|
$ |
|
||
See accompanying notes to unaudited condensed consolidated financial statements.
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 a 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 September 30, 2022, the Company had a working capital deficiency of $
The Company’s principal sources of liquidity at September 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 nine months ended September 30, 2022, and it reported negative working capital as of September 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 September 30, 2022, the Company would have been required to pay the holders of the Series A Preferred Stock $
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 $
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.
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 Company 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 |
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
Income (loss) before income taxes |
|
$ |
|
|
$ |
( |
) |
|
$ |
|
|
$ |
|
|
$ |
( |
) |
|
$ |
|
||||
Net income (loss) |
|
$ |
|
|
$ |
( |
) |
|
$ |
|
|
$ |
|
|
$ |
( |
) |
|
$ |
|
||||
Net income (loss) attributable to common |
|
$ |
|
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
||
Basic net income (loss) per share |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|||
Diluted net income (loss) per share |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|||
|
|
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) |
|
$ |
|
|
$ |
( |
) |
|
$ |
|
|
$ |
|
|
$ |
( |
) |
|
$ |
|
||||
Total comprehensive income (loss) |
|
$ |
|
|
$ |
( |
) |
|
$ |
|
|
$ |
|
|
$ |
( |
) |
|
$ |
|
||||
Total comprehensive income (loss) |
|
$ |
|
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
||
10
|
|
Total Stockholders' Deficit |
|
|||||||||
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT |
|
As Previously Reported |
|
|
Adjustments |
|
|
As Revised |
|
|||
Balance at January 1, 2021 |
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
Net income (loss) |
|
$ |
|
|
$ |
( |
) |
|
$ |
|
||
Balance at March 31, 2021 |
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
Net income (loss) |
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
Balance at June 30, 2021 |
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
Net income (loss) |
|
$ |
|
|
$ |
( |
) |
|
$ |
|
||
Balance at September 30, 2021 |
|
$ |
( |
) |
|
$ |
( |
) |
|
$ |
( |
) |
|
|
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) |
|
$ |
|
|
$ |
( |
) |
|
$ |
|
||
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
|
|||
Accrued expenses and other long-term liabilities |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
Net cash provided by (used in) operating activities |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
(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 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 September 30, 2022, and the results of its operations for the three and nine months ended September 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.
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 Company 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 September 30, 2022 and December 31, 2021, accounts receivable, net of allowance for doubtful accounts, was $
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 |
|
$ |
|
|
Deferral of revenue |
|
|
|
|
Recognition of revenue |
|
|
( |
) |
Change in reserves |
|
|
( |
) |
Balance at December 31, 2021 |
|
$ |
|
|
Deferral of revenue |
|
|
|
|
Recognition of revenue |
|
|
( |
) |
Change in reserves |
|
|
|
|
Balance at September 30, 2022 |
|
$ |
|
|
During the three months ended September 30, 2022 and 2021, revenue of $
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 $
Approximately $
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 subscription term with maintenance and support revenue recognized ratably over the contract period, and multi-year, on-premises licenses that are invoiced annually with product revenue recognized upon delivery.
Significant Judgments
The Company’s contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.
Judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. For products and services aside from maintenance and support, the Company estimates SSP by adjusting the list price by historical discount percentages. SSP for software and hardware maintenance and support fees is based on the stated percentages of the fees charged for the respective products.
The Company’s perpetual and term software licenses have significant standalone functionality and therefore revenue allocated to these performance obligations are recognized at a point in time upon electronic delivery of the download link and the license keys.
Product maintenance and support services are satisfied over time as they are stand-ready obligations throughout the support period. As a result, revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract.
Revenues associated with professional services are recognized at a point in time upon customer acceptance.
Disaggregation of Revenue
Please refer to the condensed consolidated statements of operations and Note (16) Segment Reporting and Concentrations for discussion on revenue disaggregation by product type and by geography. The Company believes this level of disaggregation sufficiently depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors.
Assets Recognized from Costs to Obtain a Contract with a Customer
The Company recognizes an asset for the incremental costs of obtaining a contract with a customer if it expects the benefit of those costs to be longer than one year. The Company has determined that its sales commission program meets the requirements for cost capitalization. Total capitalized costs to obtain a contract were immaterial during the periods presented and are included in other current and long-term assets on our consolidated balance sheets. The Company applies a practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would have been one year or less.
Leases
We have entered into operating leases for our various facilities. We determine if an arrangement is a lease at inception. Operating leases are included in Right-of-Use ("ROU") assets, and lease liability obligations in our condensed consolidated balance sheets. ROU
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 September 30, 2022.
Right of use assets |
|
$ |
|
|
Lease liability obligations, current |
|
|
|
|
Lease liability obligations, less current portion |
|
|
|
|
Total lease liability obligations |
|
$ |
|
|
Weighted-average remaining lease term |
|
|
||
Weighted-average discount rate |
|
|
% |
|
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
||||||||||
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
||||
Components of lease expense: |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Operating lease cost |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
Sublease income |
|
|
|
|
|
|
|
|
|
|
|
( |
) |
|||
Net lease cost |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
During the three months ended September 30, 2022 and 2021, operating cash flows from operating leases were approximately $
Approximate future minimum lease payments for our ROU assets over the remaining lease periods as of September 30, 2022, are as follows:
2022 (remaining) |
|
$ |
|
|
2023 |
|
|
|
|
Total minimum lease payments |
|
$ |
|
|
Less interest |
|
|
|
|
Present value of lease liabilities |
|
$ |
|
(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 nine months ended September 30, 2022 and 2021:
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
||||||||||
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
||||
Stock options |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Restricted stock |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Series A redeemable convertible preferred stock |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Total anti-dilutive common stock equivalents |
|
|
|
|
|
|
|
|
|
|
|
|
||||
(4) Property and Equipment
The gross carrying amount and accumulated depreciation of property and equipment as of September 30, 2022 and December 31, 2021 are as follows:
|
|
September 30, 2022 |
|
|
December 31, 2021 |
|
||
|
|
|
|
|
|
|
||
Gross carrying amount |
|
$ |
|
|
$ |
|
||
Accumulated depreciation |
|
|
( |
) |
|
|
( |
) |
Property and Equipment, net |
|
$ |
|
|
$ |
|
||
For the three months ended September 30, 2022 and 2021, depreciation expense was $
(5) Software Development Costs
The gross carrying amount and accumulated amortization of software development costs as of September 30, 2022 and December 31, 2021 are as follows:
|
|
September 30, 2022 |
|
|
December 31, 2021 |
|
||
|
|
|
|
|
|
|
||
Gross carrying amount |
|
$ |
|
|
$ |
|
||
Accumulated amortization |
|
|
( |
) |
|
|
( |
) |
Software development costs, net |
|
$ |
|
|
$ |
|
||
During the three months ended September 30, 2022 and 2021, the Company recorded $
(6) Goodwill and Other Intangible Assets
The gross carrying amount and accumulated amortization of goodwill and other intangible assets as of September 30, 2022 and December 31, 2021 are as follows:
|
|
September 30, 2022 |
|
|
December 31, 2021 |
|
||
Goodwill |
|
$ |
|
|
$ |
|
||
Other intangible assets: |
|
|
|
|
|
|
||
Gross carrying amount |
|
$ |
|
|
$ |
|
||
Accumulated amortization |
|
|
( |
) |
|
|
( |
) |
Net carrying amount |
|
$ |
|
|
$ |
|
||
For the three months ended September 30, 2022 and 2021, amortization expense was $
16
(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
The following table summarizes the 2018 Plan, which was the only plan under which the Company was able to grant equity compensation as of September 30, 2022:
|
|
Shares |
|
|
Shares Available |
|
|
Shares |
|
|||
Name of Plan |
|
Authorized |
|
|
for Grant |
|
|
Outstanding |
|
|||
FalconStor Software, Inc. 2018 Incentive Stock Plan |
|
|
|
|
|
|
|
|
|
|||
The following table summarizes the Company’s equity plans that have terminated or expired but that still have equity awards outstanding as of September 30, 2022:
Name of Plan |
|
Shares Available for Grant |
|
|
Shares Outstanding |
|
||
|
|
|
|
|
|
|
||
FalconStor Software, Inc., 2016 Incentive Stock Plan |
|
|
|
|
|
|
||
FalconStor Software, Inc., 2006 Incentive Stock Plan |
|
|
|
|
|
|
||
A summary of the Company’s restricted stock activity for the nine months ended September 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 |
|
|
Non-Vested at January 1, 2022 |
|
|
|
|
Granted |
|
|
|
|
Vested |
|
|
( |
) |
Forfeited |
|
|
( |
) |
Non-Vested at September 30, 2022 |
|
|
|
|
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 nine months ended September 30, 2022 and 2021:
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
||||||||||
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
||||
Cost of revenue - Product |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
Cost of revenue - support and service |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Research and development costs |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Selling and marketing |
|
|
|
|
|
|
|
|
|
|
|
|
||||
General and administrative |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
17
(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 nine months ended September 30, 2022, the Company recorded an income tax provision of $
For the nine months ended September 30, 2021, the Company recorded an income tax provision of $
The Company’s total unrecognized tax benefits, excluding interest, as of September 30, 2022 and September 30, 2021 were $
(9) Notes Payable
The notes payable balance consists of the following:
Total notes payable, net at January 1, 2022 |
|
$ |
|
|
Accretion of discount |
|
|
|
|
Total notes payable, net at March 31, 2022 |
|
$ |
|
|
Accretion of discount |
|
|
|
|
Total notes payable, net at June 30, 2022 |
|
$ |
|
|
Accretion of discount |
|
|
|
|
Total notes payable, net at September 30, 2022 |
|
$ |
|
Senior Secured Debt
The senior secured debt bears interest at prime plus
As of September 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.
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:
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at September 30, 2022:
|
|
|
|
|
Fair Value Measurements at Reporting Date Using |
|
||||||||||
|
|
Total |
|
|
Quoted Prices in |
|
|
Significant |
|
|
Significant |
|
||||
Derivative liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Derivative Instruments |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
Total derivative liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Total assets and liabilities measured at fair value |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
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 |
|
|
Significant |
|
|
Significant |
|
||||
Derivative liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Derivative Instruments |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
Total derivative liabilities |
|
|
|
|
|
|
|
|
|
|
|
|
||||
|
|
|
|
|
|
|
|
|
|
|
|
|
||||
Total assets and liabilities measured at fair value |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
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
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 nine months ended September 30, 2022 and 2021:
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
||||||||||
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
||||
Beginning Balance |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
Total (gain) loss recognized in earnings |
|
|
( |
) |
|
|
|
|
|
|
|
|
|
|||
Ending Balance |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
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.
Probability of redemption as part of a fundamental sale transaction |
|
|
Probability of redemption absent a fundamental sale transaction |
|
|
Annual volatility |
|
(11) Commitments and Contingencies
The Company typically provides its customers a warranty on its software products for a period of no more than
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 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 September 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 $
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 executed on February 11, 2022. The Sita Agreement provides that Alucria is entitled to receive a fee of $
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 September 30, 2022, the Company's liability for uncertain tax positions totaled $
(12) Series A Redeemable Convertible Preferred Stock
The Company has
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 (
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
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
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)
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
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 September 30, 2022 and December 31, 2021, the fair value of these derivative instruments was $
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 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 income (loss) attributable to common stockholders on the statement of operations and in determining income (loss) per share for the three and nine months ended September 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 |
|
$ |
|
|
Accrued dividends |
|
|
|
|
Accretion of preferred stock |
|
|
|
|
Total Series A redeemable convertible preferred stock, net at March 31, 2022 |
|
$ |
|
|
Accrued dividends |
|
|
|
|
Accretion of preferred stock |
|
|
|
|
Total Series A redeemable convertible preferred stock, net at June 30, 2022 |
|
$ |
|
|
Accrued dividends |
|
|
|
|
Accretion of preferred stock |
|
|
|
|
Total Series A redeemable convertible preferred stock, net at September 30, 2022 |
|
$ |
|
23
(13) Accumulated Other Comprehensive Loss
The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended September 30, 2022 are as follows:
|
|
Foreign Currency |
|
|
Net Minimum |
|
|
Total |
|
|||
Accumulated other comprehensive income (loss) at July 1, 2022 |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
Other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|||
Other comprehensive income (loss) before reclassifications |
|
|
|
|
|
|
|
|
|
|||
Total other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|||
Accumulated other comprehensive income (loss) at September 30, 2022 |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended September 30, 2021 are as follows:
|
|
Foreign Currency |
|
|
Net Minimum |
|
|
Total |
|
|||
Accumulated other comprehensive income (loss) at July 1, 2021 |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
Other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|||
Other comprehensive income (loss) before reclassifications |
|
|
|
|
|
|
|
|
|
|||
Total other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|||
Accumulated other comprehensive income (loss) at September 30, 2021 |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
The changes in Accumulated Other Comprehensive Loss, net of tax, for the nine months ended September 30, 2022 are as follows:
|
|
Foreign Currency |
|
|
Net Minimum |
|
|
Total |
|
|||
Accumulated other comprehensive income (loss) at January 1, 2022 |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
Other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|||
Other comprehensive income (loss) before reclassifications |
|
|
|
|
|
|
|
|
|
|||
Total other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|||
Accumulated other comprehensive income (loss) at September 30, 2022 |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
The changes in Accumulated Other Comprehensive Loss, net of tax, for the nine months ended September 30, 2021 are as follows:
|
|
Foreign Currency |
|
|
Net Minimum |
|
|
Total |
|
|||
Accumulated other comprehensive income (loss) at January 1, 2021 |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
Other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|||
Other comprehensive income (loss) before reclassifications |
|
|
|
|
|
|
|
|
|
|||
Total other comprehensive income (loss) |
|
|
|
|
|
|
|
|
|
|||
Accumulated other comprehensive income (loss) at September 30, 2021 |
|
$ |
( |
) |
|
$ |
|
|
$ |
( |
) |
|
(14) Stockholders' Equity
Stock Repurchase Activity
During the three and nine months ended September 30, 2022 and 2021, the Company did
Common Stock Offerings
On June 23, 2021, the Company issued and sold an aggregate of
24
of its over-allotment option. At a price of $
On July 27, 2021 the Company issued and sold an aggregate of
(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.
|
|
Three Months Ended September 30, |
|
|
Nine Months Ended September 30, |
|
||||||||||
|
|
2022 |
|
|
2021 |
|
|
2022 |
|
|
2021 |
|
||||
Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Americas |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
Europe, Middle East, Africa and Other |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Asia Pacific |
|
|
|
|
|
|
|
|
|
|
|
|
||||
Total Revenue |
|
$ |
|
|
$ |
|
|
$ |
|
|
$ |
|
||||
|
|
September 30, 2022 |
|
|
December 31, 2021 |
|
||
Long-lived assets: |
|
|
|
|
|
|
||
Americas |
|
$ |
|
|
$ |
|
||
Asia Pacific |
|
|
|
|
|
|
||
Europe, Middle East, Africa and Other |
|
|
|
|
|
|
||
Total long-lived assets |
|
$ |
|
|
$ |
|
||
25
For the three and nine months ended September 30, 2022, the Company had
As of September 30, 2022, the Company had
(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
The following table summarizes the activity during 2021 through September 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 |
|
$ |
|
|
$ |
|
|
$ |
|
|||
Provisions/Additions |
|
|
|
|
|
|
|
|
|
|||
Translation Adjustment |
|
|
( |
) |
|
|
|
|
|
( |
) |
|
Utilized/Paid |
|
|
|
|
|
( |
) |
|
|
( |
) |
|
Balance at March 31, 2021 |
|
$ |
|
|
$ |
|
|
$ |
|
|||
Provisions/Additions |
|
|
|
|
|
|
|
|
|
|||
Translation Adjustment |
|
|
|
|
|
|
|
|
|
|||
Utilized/Paid |
|
|
( |
) |
|
|
( |
) |
|
|
( |
) |
Balance at June 30, 2021 |
|
$ |
|
|
$ |
|
|
$ |
|
|||
Translation Adjustment |
|
|
( |
) |
|
|
|
|
|
( |
) |
|
Balance at September 30, 2021 |
|
$ |
|
|
$ |
|
|
$ |
|
|||
Translation Adjustment |
|
|
( |
) |
|
|
|
|
|
( |
) |
|
Balance at December 31, 2021 |
|
$ |
|
|
$ |
|
|
$ |
|
|||
Provisions/Additions |
|
|
|
|
|
|
|
|
|
|||
Translation Adjustment |
|
|
( |
) |
|
|
|
|
|
( |
) |
|
Balance at March 31, 2022 |
|
$ |
|
|
$ |
|
|
$ |
|
|||
Provisions/Additions |
|
|
|
|
|
( |
) |
|
|
( |
) |
|
Translation Adjustment |
|
|
( |
) |
|
|
|
|
|
( |
) |
|
Balance at June 30, 2022 |
|
$ |
|
|
$ |
|
|
$ |
|
|||
Translation Adjustment |
|
|
( |
) |
|
|
|
|
|
( |
) |
|
Balance at September 30, 2022 |
|
$ |
|
|
$ |
|
|
$ |
|
|||
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.
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 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 third 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 PowerVS Cloud, 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.
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 third quarter of 2022, our shift to recurring revenue based revenue took a material step forward as we continued to expand our strategic reseller relationship with IBM. Through this strategic reseller relationship, IBM and FalconStor co-market joint solutions consisting of FalconStor’s VTL/StorSafe software, IBM Cloud Object Storage (“COS”), and IBM Power Virtual Servers (“PowerVS”) for efficient application and data migration from on-premises environments to IBM PowerVS Cloud, and on-going SaaS-based backup and restore within IBM 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 third quarter of 2022 declined 6.8% year-over-year. Given the reduction in GAAP Q3 2022 revenues, we delivered a net income of $221,372, compared to a net income of $348,640 in the third quarter of 2021, even though we managed operating costs to $2,296,464 in the quarter compared to $2,391,966 in Q3 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 $3,059,141 in the third quarter of 2022 compared to $2,394,335 and $2,049,107 in the second and first quarters 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 SEPTEMBER 30, 2022 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 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 three months ended September 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 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 |
|
391,016 |
|
|
13 |
% |
|
288,802 |
|
|
9 |
% |
|
102,214 |
|
|
|
35 |
% |
Less: Accretion to redemption value of |
|
40,023 |
|
|
1 |
% |
|
13,517 |
|
|
0 |
% |
|
26,506 |
|
|
|
196 |
% |
Net income (loss) attributable to |
$ |
(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 September 30, 2022, we recognized revenue of $3,059,141, compared with $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.
For the three months ended September 30, 2022 and 2021, product revenue represented 51% and 47% of our total revenue, respectively. Product revenue of $1,568,110 for the three months ended September 30, 2022 increased slightly by $21,097, or 1%, from $1,547,013 in the prior year period. Product revenue during the three months ended September 30, 2022 was comparable to product revenue for the same quarter in the 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 September 30, 2022 decreased by $152,278 to $1,489,635, compared to $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.
We received $1,396 in professional services revenue for the three months ended September 30, 2022 as compared to $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 September 30, 2022 decreased 14% to $380,104, compared with $442,285 in the prior year period. Total gross profit decreased $162,147, or 6%, to $2,679,037 for the three months ended September 30, 2022, compared with $2,841,184 for the prior year period. Total gross margin decreased to 88% for the three months ended September 30, 2022, compared with 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 September 30, 2022 decreased to $19,711, compared with $41,351 in the prior year period. This decrease in cost of product revenue for the three months ended September 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 September 30, 2022 decreased 10% to $360,393, compared with $400,934 in the prior year period. Support and service gross margin decreased slightly to 76 % for the three months ended September 30, 2022, compared with 77 % for the prior year period. The decrease in the cost of support and service revenue was primarily related to decreased contractors and consulting fees.
Operating Expenses
Our operating expenses for the three months ended September 30, 2022 decreased by $95,502 to $2,296,464 from $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 by $129,332, or 18%, to $581,941 for the three months ended September 30, 2022, from $711,273 in the prior year period. The decrease in research and development costs was primarily related to a decrease in personnel 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 $722,668, or 45%, to $887,967 for the three months ended September 30, 2022 from $1,610,635 in the prior year period. The decrease in selling and marketing expenses was primarily related to reductions in personnel cost, commissions, promotional costs, 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 $192,602 to $826,556 for the three months ended September 30, 2022, compared to $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.
31
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.
There was no restructuring expense in the three months ended September 30, 2022, a decrease of $68,704 from the prior year.
Interest and Other (Loss) Income, Net
Interest and other expense, net, increased $27,350 to a loss of $111,399 for the three months ended September 30, 2022, compared with a loss of $84,049 in the prior year period. The increase in interest and other expense primarily relates to 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 three months ended September 30, 2022 and 2021, the Company recorded income tax provision of $49,802 and provision of $16,529, respectively, consisting primarily of state and local, and foreign taxes.
As of September 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 NINE MONTHS ENDED SEPTEMBER 30, 2022 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 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 nine months ended September 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.
|
Nine Months Ended September 30, |
|
Change |
|
||||||||||||||
(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 |
|
1,030,365 |
|
|
14 |
% |
|
848,898 |
|
|
8 |
% |
|
181,467 |
|
|
21 |
% |
Less: Accretion to redemption value of Series |
|
90,420 |
|
|
1 |
% |
|
285,814 |
|
|
3 |
% |
|
(195,394 |
) |
|
(68 |
)% |
Net income (loss) attributable to common |
$ |
(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 nine months ended September 30, 2022, we recognized revenue of $7.5 million, compared with $10.4 million in the prior year period.
Product Revenue
Product revenue is comprised of sales of both licenses for our software solutions and sales of the platforms on which the software is installed. This includes stand-alone software applications and, 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 nine months ended September 30, 2022 and 2021, product revenue represented 42% and 51% of our total revenue, respectively. Product revenue of $3,125,936 for the nine months ended September 30, 2022 decreased $2,162,811, or 41%, from $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 nine 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 nine months ended September 30, 2022 decreased $456,857 to $4,369,416, compared to $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 nine months ended September 30, 2022 decreased to $7,231, compared to $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 nine months ended September 30, 2022 decreased 22% to $1,193,782, compared with $1,532,033 in the prior year period. Total gross profit decreased $2.5 million, or 28.6%, to $6.3 million for the nine months ended September 30, 2022, compared with $8.8 million for the prior year period. Total gross margin decreased slightly to 84% for the nine months ended September 30, 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 nine months ended September 30, 2022 decreased to $65,018, compared with $298,966 in the prior year period. Product gross margin for the nine months ended September 30, 2022 increased, year over year, to 98 % from 94 % for the same period in 2021. This decrease in cost of product revenue for the nine months ended September 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 nine months ended September 30, 2022 decreased 8% to $1,128,764, compared with $1,233,067 in the prior year period. Support and service gross
34
margin decreased slightly to 74% for the nine months ended September 30, 2022, compared with 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 nine months ended September 30, 2022 decreased by $1.0 million to $7.5 million from $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 decreased $88,914, or 4%, to $1,943,446 for the nine months ended September 30, 2022, from $2,032,360 in the prior year period. The decrease in research and development costs was primarily related to a decrease in personnel costs and 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 $1.1 million, or 25%, to $3.2 million for the nine months ended September 30, 2022 from $4.3 million in the prior year period. The decrease in selling and marketing expenses was primarily related to reductions in commissions, personnel costs, employee bonuses and 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 by $270,640 to $2,400,561 for the nine months ended September 30, 2022, compared to $2,129,921 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.
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 $792,010 for the nine months ended September 30, 2022 to $744, compared to a restructuring expense of $792,754 in the prior year period.
35
Gain on Debt Extinguishment
Gain on debt extinguishment decreased $754,000 for the nine months ended September 30, 2022, from $754,000 for the nine months ended September 30, 2021. The debt extinguishment during such nine months ended September 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.
Interest and Other (Loss) Income, Net
Interest and other expense, net, decreased $113,995 to a loss of $430,630 for the nine months ended September 30, 2022, compared with a loss of $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 nine months ended September 30, 2022 and 2021, the Company recorded income tax provision of $150,369 and $63,804, respectively, consisting primarily of state and local, and foreign taxes.
As of September 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 September 30, 2022 and December 31, 2021 totaled $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 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 September 30, 2022, the Company would have been required to pay the holders of the Series A Preferred Stock $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.
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 September 30, 2022, we had a working capital deficiency of $0.2 million, which is inclusive of current deferred revenue of $3.5 million, and a stockholders' deficit of $15.7 million. During the nine months ended September 30, 2022, the Company had a net loss of $1.8 million and negative cash flow from operations of $1.4 million. The Company's total cash balance at September 30, 2022 was $1.7 million, a decrease of $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.
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 the next 12 months.
Cash Flow Analysis
Cash flow information is as follows:
|
|
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 $1.4 million for the nine months ended September 30, 2022, compared with $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 nine months ended September 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 nine months ended September 30, 2022, compared with $108,928 of net cash used 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.
37
There was no cash used in or provided by financing activities for the nine months ended September 30, 2022, compared with net cash provided by financing activities of $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 $1.5 million to $1.7 million at September 30, 2022 compared to December 31, 2021.
Contractual Obligations
As of September 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 September 30, 2022:
|
|
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 September 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 September 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.
38
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 September 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”).
39
The Company’s management has assessed the effectiveness of the Company’s internal control over financial reporting as of September 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.
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.
41
Item 6. Exhibits
4.1 |
|
|
|
10.1 |
|
|
|
31.1 |
|
|
|
31.2 |
|
|
|
32.1 |
|
|
|
32.2 |
|
|
|
101.1 |
The following financial statements from FalconStor Software, Inc’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2022, formatted in XBRL (eXtensible Business Reporting Language): |
|
(i) |
unaudited Condensed Consolidated Balance Sheets – September 30, 2022 and December 31, 2021. |
|
|
|
|
(ii) |
unaudited Condensed Consolidated Statement of Operations – Three and Nine Months Ended September 30, 2022 and 2021. |
|
|
|
|
(iii) |
unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) – Three and Nine Months Ended September 30, 2022 and 2021. |
|
|
|
|
(iv) |
unaudited Condensed Consolidated Statements of Stockholder's Deficit - Three and Nine Months Ended September 30, 2022 and 2021. |
|
|
|
|
(v) |
unaudited Condensed Consolidated Statement of Cash Flows – Three and Nine Months Ended September 30, 2022 and 2021. |
|
|
|
|
(vi) |
Notes to unaudited Condensed Consolidated Financial Statements – September 30, 2022. |
104.0 |
Cover Page Interactive Data File (formatted as inline XBRL with applicable taxonomy extension information contained in Exhibits 101). |
.
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 |
November 9, 2022 |
(principal executive officer) |
43
ATTACHMENTS / EXHIBITS
XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT
XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT
XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE DOCUMENT
XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT
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