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Form 10-Q FALCONSTOR SOFTWARE INC For: Jun 30

August 3, 2022 5:06 PM
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2022
or 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                                 to                                
Commission File Number:  000-23970
FALCONSTOR SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
Delaware77-0216135
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)
501 Congress AvenueSuite 150AustinTX78701
(Address of principal executive offices)(Zip Code)

(631) 777-5188
Registrant’s telephone number, including area code

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

Securities registered pursuant to Section 12(b) of the Act: None.
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes ý  No ¨
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.  (Check one):
Large accelerated filerAccelerated filer
Non-accelerated filerSmaller reporting company
Emerging growth company

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

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




The number of shares of common stock outstanding as of July 31, 2022 was 7,111,801.



FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
 
  Page
   
   
 
  
 
  
 
  
 
   
 
   
   
   
   
   
   

3


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


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

See accompanying notes to unaudited condensed consolidated financial statements.

5


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

See accompanying notes to unaudited condensed consolidated financial statements.

6


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

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

See accompanying notes to unaudited condensed consolidated financial statements.
8


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


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

The Company’s principal sources of liquidity at June 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 six months ended June 30, 2022, and it reported negative working capital as of June 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 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 June 30, 2022, the Company would have been required to pay the holders of the Series A Preferred Stock $15.1 million.

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

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

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

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

(d) Impact of the COVID-19 Pandemic
We are continuing to monitor the impact of COVID-19, on all aspects of our business. The outbreak of COVID-19 has caused and may continue to cause travel bans or disruptions, and in some cases, prohibitions of non-essential activities, disruption and shutdown of businesses and greater uncertainty in global financial markets. The impact of COVID-19 is fluid and uncertain, but it has caused and may continue to cause various negative effects, including an inability to meet with actual or potential customers, our end customers deciding to delay or abandon their planned purchases or failing to make payments, and delays or disruptions in our or our partners’ supply chains. As a result, we may experience extended sales cycles, our ability to close transactions with new and existing customers and partners may be negatively impacted, our ability to recognize revenue from software transactions we do close may be negatively impacted, our demand generation activities, and the efficiency and effect of those activities, may be negatively affected, and it has been and, until the COVID-19 outbreak is contained, will continue to be more difficult for us to forecast our operating results. These uncertainties have, and may continue to, put pressure on global economic conditions and overall IT spending and may cause our end customers to modify spending priorities or delay or abandon purchasing decisions, thereby lengthening sales cycles and potentially lowering prices for our solutions, and may make it difficult for us to forecast our sales and operating results and to make decisions about future investments, any of which could materially harm our business, operating results and financial condition.
Further, our management team is focused on addressing the impacts of COVID-19 on our business, which has required and will continue to require, a large investment of their time and resources and may distract our management team or disrupt our 2022 operating plans. The extent to which COVID-19 ultimately impacts our results of operations, cash flow and financial position will depend on future developments, which are uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak, its severity, the actions taken by governments and authorities to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of its global economic impact, including as a result of any recession that may occur.

(e)  Principles of Consolidation
 
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
 
(f)  Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include those related to revenue
12


recognition, accounts receivable allowances, valuation of derivatives, valuation of goodwill and income taxes. Actual results could differ from those estimates.
 
The financial market volatility in many countries where the Company operates has impacted and may continue to impact the Company’s business. Such conditions could have a material impact on the Company’s significant accounting estimates discussed above.
 
(g)  Unaudited Interim Financial Information
 
The accompanying unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements.
 
In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly state the financial position of the Company at June 30, 2022, and the results of its operations for the three and six months ended June 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.

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.
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    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 June 30, 2022 and December 31, 2021, accounts receivable, net of allowance for doubtful accounts, was $1.6 million and $2.9 million, respectively. As of June 30, 2022 and December 31, 2021, short and long-term contract assets, net of allowance for doubtful accounts, was $0.9 million and $0.9 million, respectively. As of June 30, 2022 and December 31, 2021, allowance for doubtful accounts was $102,172 and $85,816, respectively.

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

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

    During the three months ended June 30, 2022 and 2021, revenue of $1.3 million and $1.3 million respectively, and the six months ended June 30, 2022 and 2021, revenue of $2.7 million and $2.8 million respectively, was recognized from the deferred revenue balance at the beginning of each period.

Deferred revenue includes invoiced revenue allocated to remaining performance obligations that has not yet been recognized and will be recognized as revenue in future periods. Deferred revenue was $5.0 million as of June 30, 2022, of which the Company expects to recognize approximately 71% of such amount as revenue over the next 12 months and the remainder thereafter.

    Approximately $1.6 million of revenue is expected to be recognized from remaining performance obligations for unbilled support and services as of June 30, 2022. We expect to recognize revenue on approximately 40% of these remaining performance obligations over the next twelve months, with the balance recognized thereafter.

    Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 90 days. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined its contracts generally do not include a significant financing component. The primary purpose of the Company’s invoicing terms is to provide customers with simplified and predictable ways of purchasing its products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a
14


subscription term with maintenance and support revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with product revenue recognized upon delivery.
Significant Judgments
    The Company’s contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.
    Judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. For products and services aside from maintenance and support, the Company estimates SSP by adjusting the list price by historical discount percentages. SSP for software and hardware maintenance and support fees is based on the stated percentages of the fees charged for the respective products.
    The Company’s perpetual and term software licenses have significant standalone functionality and therefore revenue allocated to these performance obligations are recognized at a point in time upon electronic delivery of the download link and the license keys.
    Product maintenance and support services are satisfied over time as they are stand-ready obligations throughout the support period. As a result, revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract.
    Revenues associated with professional services are recognized at a point in time upon customer acceptance.
Disaggregation of Revenue
    Please refer to the condensed consolidated statements of operations and Note (16) Segment Reporting and Concentrations for discussion on revenue disaggregation by product type and by geography. The Company believes this level of disaggregation sufficiently depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors.

Assets Recognized from Costs to Obtain a Contract with a Customer

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

Leases

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

Right of Use Assets and Liabilities

    We have various operating leases for office facilities that are expected to continue through 2023. Below is a summary of our ROU assets and liabilities as of June 30, 2022.

15


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

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

    During the three months ended June 30, 2022 and 2021, operating cash flows from operating leases were approximately $19,249 and $162,247, respectively. During the six months ended June 30, 2022 and 2021 operating cash flows from operating leases were approximately $38,498 and $517,216, respectively.

Approximate future minimum lease payments for our ROU assets over the remaining lease periods as of June 30, 2022, are as follows:
202238,498 
202338,498 
Total minimum lease payments76,996 
Less interest6,641 
Present value of lease liabilities70,355 

(3) Earnings Per Share

Basic earnings per share ("EPS") is computed based on the weighted average number of shares of common stock outstanding. Diluted EPS is computed based on the weighted average number of common shares outstanding increased by dilutive common stock equivalents, attributable to stock option awards, restricted stock awards, warrants and the Series A Preferred Stock outstanding.

The following represents the common stock equivalents that were excluded from the computation of diluted shares outstanding because their effect would have been anti-dilutive for the three and six months ended June 30, 2022 and 2021:
 Three Months Ended June 30,Six Months Ended June 30,
2022202120222021
Stock options5,690 9,645 5,690 9,645 
Restricted stock34,576 65,461 34,576 65,461 
Series A redeemable convertible preferred stock147,623 135,691 147,623 135,691 
Total anti-dilutive common stock equivalents187,889 210,797 187,889 210,797 

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(4) Property and Equipment

The gross carrying amount and accumulated depreciation of property and equipment as of June 30, 2022 and December 31, 2021 are as follows:
June 30, 2022December 31, 2021
Gross carrying amount$15,510,448 $15,544,212 
Accumulated depreciation(15,400,183)(15,390,308)
Property and Equipment, net$110,265 $153,904 

For the three months ended June 30, 2022 and 2021, depreciation expense was $15,588 and $30,867, respectively. For the six months ended June 30, 2022 and 2021, depreciation expense was $38,932 and $70,632, respectively.

(5) Software Development Costs

The gross carrying amount and accumulated amortization of software development costs as of June 30, 2022 and December 31, 2021 are as follows:
June 30, 2022December 31, 2021
Gross carrying amount$3,015,132 $2,980,132 
Accumulated amortization(2,947,943)(2,937,437)
Software development costs, net$67,189 $42,695 

During the three months ended June 30, 2022 and 2021, the Company recorded $8,867 and $1,645, respectively, of amortization expense related to capitalized software costs. During the six months ended June 30, 2022 and 2021, the Company recorded $10,506 and $3,284, respectively, of amortization expense related to capitalized software costs.

(6) Goodwill and Other Intangible Assets

The gross carrying amount and accumulated amortization of goodwill and other intangible assets as of June 30, 2022 and December 31, 2021 are as follows: 
June 30, 2022December 31, 2021
Goodwill$4,150,339 $4,150,339 
Other intangible assets:  
Gross carrying amount$4,041,216 $4,038,138 
Accumulated amortization(4,005,866)(3,986,776)
Net carrying amount$35,350 $51,362 

    For the three months ended June 30, 2022 and 2021, amortization expense was $8,554 and $15,984, respectively. For the six months ended June 30, 2022 and 2021, amortization expense was $19,090 and $32,066, respectively.
17


(7) Share-Based Payment Arrangements

On June 22, 2018, the Company's stockholders adopted the FalconStor Software, Inc. 2018 Incentive Stock Plan (the "2018 Plan"). The 2018 Plan is administered by the Compensation Committee (the “Compensation Committee”) of the Company’s Board of Directors (the “Board”) and initially provided for the issuance of up to 1,471,997 shares of the Company's common stock upon the grant of shares with such restrictions as determined by the Compensation Committee to the employees and directors of, and consultants providing services to, the Company or its affiliates. In June 2021, the Company's stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2018 Plan by 220,800 shares to a total of 1,692,797 shares. Exercise prices of the options will be determined by the Compensation Committee, subject to the consent of Hale Capital. The vesting terms will be performance based and determined by the Compensation Committee, subject to the consent of Hale Capital, based on various factors, including (i) the return of capital to the holders of the Series A Preferred Stock and the Company’s common stock in the event of a change of control, (ii) the repayment of the Company’s obligations under its senior secured debt, and (iii) the Company’s free cash flow.

The following table summarizes the 2018 Plan, which was the only plan under which the Company was able to grant equity compensation as of June 30, 2022: 
 SharesShares AvailableShares
Name of PlanAuthorizedfor GrantOutstanding
FalconStor Software, Inc. 2018 Incentive Stock Plan1,692,797241,8991,323,741

The following table summarizes the Company’s equity plans that have terminated or expired but that still have equity awards outstanding as of June 30, 2022: 
Name of PlanShares Available for GrantShares Outstanding
FalconStor Software, Inc., 2016 Incentive Stock Plan2,250
FalconStor Software, Inc., 2006 Incentive Stock Plan3,440
 
A summary of the Company’s restricted stock activity for the six months ended June 30, 2022 is below. Such restricted stock did not bestow any voting or dispositive power and is not deemed outstanding until they vest.

Number of Restricted Stock Awards
Non-Vested at January 1, 20221,513,380 
Granted113,230 
Vested(30,557)
Forfeited(272,312)
Non-Vested at June 30, 20221,323,741 


The following table summarizes the share-based compensation expense for all awards issued under the Company’s stock equity plans in the following line items in the condensed consolidated statements of operations for the three and six months ended June 30, 2022 and 2021:
 Three Months Ended June 30,Six Months Ended June 30,
 2022202120222021
Cost of revenue - Product$165 $229 $392 $456 
Cost of revenue - support and service147 183 328 364 
Research and development costs1,900  3,779  
Selling and marketing9,523 2,883 14,034 5,560 
General and administrative7,367 1,402 8,753 2,788 
 $19,102 $4,697 $27,286 $9,168 
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(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 six months ended June 30, 2022, the Company recorded an income tax provision of $100,567. The effective tax rate for the six months ended June 30, 2022 was (5.2%). The effective tax rate differs from the statutory rate of 21% due to the mix of foreign and domestic earnings, foreign withholding taxes and the application of valuation allowances. As of June 30, 2022, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and therefore, the Company had not recorded any income tax benefit as such amounts are fully offset with a valuation allowance.

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

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

(9) Notes Payable

    The notes payable balance consists of the following:
<
Total notes payable, net at January 1, 2022$2,154,098 
Accretion of discount