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 ~~September 30, 2020~~March 31, 2021

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

For the transition period from to

Commission File Number: 000-23970

FALCONSTOR SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

Delaware

77-0216135

(State or other jurisdiction of incorporation or organization)

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

701 Brazos Street

Suite 400

Austin

78701

(Address of principal executive offices)

(Zip Code)

(631) 777-5188

Registrant’s telephone number, including area code

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

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ý No o

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


Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
Emerging growth company	☐

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

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

The number of shares of common stock outstanding as of ~~October 31, 2020~~April 30, 2021 was ~~5,919,837.~~5,949,463.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX


		Page
PART I.	Financial Information	4

Item 1.	Financial Statements	4

	Condensed Consolidated Balance Sheets at ~~September 30, 2020~~March 31, 2021 (unaudited) and December 31, ~~2019~~2020	4

	Unaudited Condensed Consolidated Statements of Operations for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020 ~~and 2019~~	5

	Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020 ~~and 2019~~	6

	Unaudited Condensed Consolidated Statements of Stockholders' Deficit for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020 ~~and 2019~~	7

	Unaudited Condensed Consolidated Statements of Cash Flows for the ~~nine~~three months ended ~~September 30,~~March 31, 2021 and 2020 ~~and 2019~~	9

	Notes to the Unaudited Condensed Consolidated Financial Statements	10

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	2826

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	3934

Item 4.	Controls and Procedures	3934

PART II.	Other Information	4136

Item 1.	Legal Proceedings	4136

Item 1A.	Risk Factors	4136

Item 6.	Exhibits	4237

SIGNATURES		4338

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS


		September 30, 2020		December 31, 2019			March 31, 2021		December 31, 2020
		(unaudited)					(unaudited)
Assets	Assets					Assets
Current assets:	Current assets:					Current assets:
Cash and cash equivalents	Cash and cash equivalents	$	871,281	$	1,475,166	Cash and cash equivalents	$	2,020,989	$	1,920,656

Accounts receivable, net of allowances	Accounts receivable, net of allowances	3,476,930		3,406,550		Accounts receivable, net of allowances	2,954,033		2,836,571
Prepaid expenses and other current assets	Prepaid expenses and other current assets	1,930,671		2,252,372		Prepaid expenses and other current assets	2,063,111		1,837,596
Contract assets	Contract assets	419,940		749,515		Contract assets	380,119		254,483
Inventory	Inventory	14,809		30,014		Inventory	15,061		15,275

Total current assets	Total current assets	6,713,631		7,913,617		Total current assets	7,433,313		6,864,581
Property and equipment, net of accumulated depreciation and amortization	Property and equipment, net of accumulated depreciation and amortization	236,442		369,273		Property and equipment, net of accumulated depreciation and amortization	196,630		197,020
Operating lease right-of-use assets, net	Operating lease right-of-use assets, net	854,712		1,842,254		Operating lease right-of-use assets, net	202,495		536,272
Deferred tax assets, net	Deferred tax assets, net	259,209		258,841		Deferred tax assets, net	312,342		330,552
Software development costs, net	Software development costs, net	20,928		27,012		Software development costs, net	17,639		19,278
Other assets	Other assets	926,928		829,335		Other assets	862,515		863,964
Goodwill	Goodwill	4,150,339		4,150,339		Goodwill	4,150,339		4,150,339
Other intangible assets, net	Other intangible assets, net	100,358		57,718		Other intangible assets, net	84,052		100,134
Long-term contract assets	Long-term contract assets	225,128		327,757		Long-term contract assets	188,119		343,934
Total assets	Total assets	$	13,487,675	$	15,776,146	Total assets	$	13,447,444	$	13,406,074
Liabilities and Stockholders' Deficit	Liabilities and Stockholders' Deficit					Liabilities and Stockholders' Deficit
Current liabilities:	Current liabilities:					Current liabilities:
Accounts payable	Accounts payable	$	764,371	$	1,302,290	Accounts payable	$	917,570	$	453,791
Accrued expenses	Accrued expenses	2,046,399		2,533,824		Accrued expenses	2,374,705		2,293,765
Current portion of lease liabilities	Current portion of lease liabilities	1,074,032		1,655,522		Current portion of lease liabilities	235,962		665,074
Short-term loan, net of debt issuance costs and discounts	Short-term loan, net of debt issuance costs and discounts	3,968,827		947,501		Short-term loan, net of debt issuance costs and discounts	3,396,568		3,320,863

Deferred revenue	Deferred revenue	4,010,383		5,270,190		Deferred revenue	4,151,083		4,603,270
Total current liabilities	Total current liabilities	11,864,012		11,709,327		Total current liabilities	11,075,888		11,336,763
Other long-term liabilities	Other long-term liabilities	679,644		745,254		Other long-term liabilities	698,323		703,889
Notes payable, net of debt issuance costs and discounts	Notes payable, net of debt issuance costs and discounts	0		2,906,133		Notes payable, net of debt issuance costs and discounts	0		754,000

Operating lease liabilities, net of current portion		2,194		624,859

Deferred tax liabilities	Deferred tax liabilities	427,030		432,520		Deferred tax liabilities	520,905		513,027
Deferred revenue, net of current portion	Deferred revenue, net of current portion	2,042,978		2,085,080		Deferred revenue, net of current portion	2,303,675		1,765,859
Total liabilities	Total liabilities	15,015,858		18,503,173		Total liabilities	14,598,791		15,073,538
Commitments and contingencies (Note 11)	Commitments and contingencies (Note 11)					Commitments and contingencies (Note 11)	0		0
Series A redeemable convertible preferred stock, $0.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $13,075,046 and $12,262,685, respectively		12,483,206		11,304,279
Series A redeemable convertible preferred stock, $0.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $13,623,747 and $13,346,577, respectively						Series A redeemable convertible preferred stock, $0.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $13,623,747 and $13,346,577, respectively	13,415,006		12,940,722
Stockholders' deficit:	Stockholders' deficit:					Stockholders' deficit:
Common stock - $0.001 par value, 30,000,000 shares authorized, 5,919,837 shares and 5,918,733 shares issued and outstanding, respectively		5,920		5,919
Common stock - $0.001 par value, 30,000,000 shares authorized, 5,949,463 shares and 5,949,463 shares issued and outstanding, respectively						Common stock - $0.001 par value, 30,000,000 shares authorized, 5,949,463 shares and 5,949,463 shares issued and outstanding, respectively	5,949		5,949
Additional paid-in capital	Additional paid-in capital	110,560,351		111,727,888		Additional paid-in capital	109,637,357		110,107,170
Accumulated deficit	Accumulated deficit	(122,638,926)		(123,871,853)		Accumulated deficit	(122,308,096)		(122,733,344)
Accumulated other comprehensive loss, net	Accumulated other comprehensive loss, net	(1,938,734)		(1,893,260)		Accumulated other comprehensive loss, net	(1,901,563)		(1,987,961)
Total stockholders' deficit	Total stockholders' deficit	(14,011,389)		(14,031,306)		Total stockholders' deficit	(14,566,353)		(14,608,186)
Total liabilities and stockholders' deficit	Total liabilities and stockholders' deficit	$	13,487,675	$	15,776,146	Total liabilities and stockholders' deficit	$	13,447,444	$	13,406,074

See accompanying notes to unaudited condensed consolidated financial statements.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019				2021		2020
Revenue:	Revenue:									Revenue:
Product revenue	Product revenue	$	2,521,695	$	1,663,782	$	5,202,713	$	4,879,996	Product revenue		$	2,139,729	$	1,048,963
Support and services revenue	Support and services revenue	1,914,705		2,308,663		5,913,486		7,584,816		Support and services revenue		1,688,597		2,131,224
Total revenue	Total revenue	4,436,400		3,972,445		11,116,199		12,464,812		Total revenue		3,828,326		3,180,187
Cost of revenue:	Cost of revenue:									Cost of revenue:
Product	Product	48,895		241,134		250,185		1,076,604		Product		222,834		139,460
Support and service	Support and service	367,063		531,709		1,109,379		1,639,299		Support and service		426,173		407,920
Total cost of revenue	Total cost of revenue	415,958		772,843		1,359,564		2,715,903		Total cost of revenue		649,007		547,380
Gross profit	Gross profit	4,020,442		3,199,602		9,756,635		9,748,909		Gross profit		3,179,319		2,632,807
Operating expenses:	Operating expenses:									Operating expenses:
Research and development costs	Research and development costs	600,430		782,161		1,809,354		2,503,008		Research and development costs		659,940		674,924
Selling and marketing	Selling and marketing	1,026,241		1,067,436		3,027,372		3,436,783		Selling and marketing		1,396,640		981,191
General and administrative	General and administrative	358,701		1,454,103		2,297,451		4,280,188		General and administrative		837,867		1,093,169

Restructuring costs	Restructuring costs	317,595		384,829		758,740		745,201		Restructuring costs		302,313		287,460
Total operating expenses	Total operating expenses	2,302,967		3,688,529		7,892,917		10,965,180		Total operating expenses		3,196,760		3,036,744
Operating income (loss)	Operating income (loss)	1,717,475		(488,927)		1,863,718		(1,216,271)		Operating income (loss)		(17,441)		(403,937)
Gain on debt extinguishment										Gain on debt extinguishment		754,000		0
Interest and other expense	Interest and other expense	(159,994)		(123,261)		(586,082)		(468,717)		Interest and other expense		(266,695)		(245,839)
Income (loss) before income taxes	Income (loss) before income taxes	1,557,481		(612,188)		1,277,636		(1,684,988)		Income (loss) before income taxes		469,864		(649,776)
Income tax expense (benefit)	Income tax expense (benefit)	11,272		(55,274)		44,709		168,556		Income tax expense (benefit)		44,616		70,064
Net income (loss)	Net income (loss)	$	1,546,209	$	(556,914)	$	1,232,927	$	(1,853,544)	Net income (loss)		$	425,248	$	(719,840)
Less: Accrual of Series A redeemable convertible preferred stock dividends	Less: Accrual of Series A redeemable convertible preferred stock dividends	266,007		266,447		812,362		770,027		Less: Accrual of Series A redeemable convertible preferred stock dividends		277,170		285,760

Less: Accretion to redemption value of Series A redeemable convertible preferred stock	Less: Accretion to redemption value of Series A redeemable convertible preferred stock	175,335		139,399		366,566		402,861		Less: Accretion to redemption value of Series A redeemable convertible preferred stock		197,114		26,090
Net income (loss) attributable to common stockholders	Net income (loss) attributable to common stockholders	$	1,104,867	$	(962,760)	$	53,999	$	(3,026,432)	Net income (loss) attributable to common stockholders		$	(49,036)	$	(1,031,690)
Basic net income (loss) per share attributable to common stockholders	Basic net income (loss) per share attributable to common stockholders	$	0.19	$	(0.16)	$	0.01	$	(0.51)	Basic net income (loss) per share attributable to common stockholders		$	(0.01)	$	(0.17)
Diluted net income (loss) per share attributable to common stockholders	Diluted net income (loss) per share attributable to common stockholders	$	0.15	$	(0.16)	$	0.01	$	(0.51)	Diluted net income (loss) per share attributable to common stockholders		$	(0.01)	$	(0.17)
Weighted average basic shares outstanding	Weighted average basic shares outstanding	5,919,837		5,910,718		5,919,773		5,887,638		Weighted average basic shares outstanding		5,949,463		5,919,643
Weighted average diluted shares outstanding	Weighted average diluted shares outstanding	7,393,082		5,910,718		7,197,050		5,887,638		Weighted average diluted shares outstanding		5,949,463		5,919,643

See accompanying notes to unaudited condensed consolidated financial statements.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019				2021		2020
Net income (loss)	Net income (loss)	$	1,546,209	$	(556,914)	$	1,232,927	$	(1,853,544)	Net income (loss)		$	425,248	$	(719,840)
Other comprehensive income (loss), net of applicable taxes	Other comprehensive income (loss), net of applicable taxes									Other comprehensive income (loss), net of applicable taxes
Foreign currency translation	Foreign currency translation	(24,234)		(131,497)		(45,474)		(161,515)		Foreign currency translation		86,398		(13,153)

Total other comprehensive income (loss), net of applicable taxes:	Total other comprehensive income (loss), net of applicable taxes:	(24,234)		(131,497)		(45,474)		(161,515)		Total other comprehensive income (loss), net of applicable taxes:		86,398		(13,153)
Total comprehensive income (loss)	Total comprehensive income (loss)	$	1,521,975	$	(688,411)	$	1,187,453	$	(2,015,059)	Total comprehensive income (loss)		$	511,646	$	(732,993)
Less: Accrual of Series A redeemable convertible preferred stock dividends	Less: Accrual of Series A redeemable convertible preferred stock dividends	266,007		266,447		812,362		770,027		Less: Accrual of Series A redeemable convertible preferred stock dividends		277,170		285,760

Less: Accretion to redemption value of Series A redeemable convertible preferred stock	Less: Accretion to redemption value of Series A redeemable convertible preferred stock	175,335		139,399		366,566		402,861		Less: Accretion to redemption value of Series A redeemable convertible preferred stock		197,114		26,090
Total comprehensive income (loss) attributable to common stockholders	Total comprehensive income (loss) attributable to common stockholders	$	1,080,633	$	(1,094,257)	$	8,525	$	(3,187,947)	Total comprehensive income (loss) attributable to common stockholders		$	37,362	$	(1,044,843)

See accompanying notes to unaudited condensed consolidated financial statements.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT

(UNAUDITED)


		Common Stock Outstanding	Common Stock		Additional Paid-In Capital		Accumulated Deficit		Accumulated Other Comprehensive Loss, Net		Total Stockholders' Deficit			Common Stock Outstanding	Common Stock		Additional Paid-In Capital		Accumulated Deficit		Accumulated Other Comprehensive Loss, Net		Total Stockholders' Deficit
Balance at January 1, 2020		5,918,733	$	5,919	$	111,727,888	$	(123,871,853)	$	(1,893,260)	$	(14,031,306)
Balance at January 1, 2021													Balance at January 1, 2021	5,949,463	$	5,949	$	110,107,170	$	(122,733,344)	$	(1,987,961)	$	(14,608,186)
Net income (loss)	Net income (loss)						(719,840)				(719,840)		Net income (loss)						425,248				425,248
Share-based compensation to employees													Share-based compensation to employees				4,471						4,471
Restricted stock issued	Restricted stock issued	1,104	1		(1)						0		Restricted stock issued	0	0		0						0
Share-based compensation to employees					4,510						4,510
Accretion of Series A redeemable convertible preferred stock	Accretion of Series A redeemable convertible preferred stock				(26,090)						(26,090)		Accretion of Series A redeemable convertible preferred stock				(197,114)						(197,114)
Dividends on Series A redeemable convertible preferred stock	Dividends on Series A redeemable convertible preferred stock				(285,760)						(285,760)		Dividends on Series A redeemable convertible preferred stock				(277,170)						(277,170)
Foreign currency translation	Foreign currency translation								(13,153)		(13,153)		Foreign currency translation								86,398		86,398
Balance at March 31, 2020		5,919,837	$	5,920	$	111,420,547	$	(124,591,693)	$	(1,906,413)	$	(15,071,639)
Net income (loss)							$	406,558			$	406,558
Balance at March 31, 2021													Balance at March 31, 2021	5,949,463	$	5,949	$	109,637,357	$	(122,308,096)	$	(1,901,563)	$	(14,566,353)

Share-based compensation to employees					$	3,060					$	3,060
Accretion of Series A redeemable convertible preferred stock					$	(165,141)					$	(165,141)
Dividends on Series A redeemable convertible preferred stock					$	(260,595)					$	(260,595)
Foreign currency translation									$	(8,087)	$	(8,087)
Balance at June 30, 2020		5,919,837	$	5,920	$	110,997,871	$	(124,185,135)	$	(1,914,500)	$	(15,095,844)
Net income (loss)							$	1,546,209			$	1,546,209

Share-based compensation to employees					$	3,822					$	3,822
Accretion of Series A redeemable convertible preferred stock					$	(175,335)					$	(175,335)
Dividends on Series A redeemable convertible preferred stock					$	(266,007)					$	(266,007)
Foreign currency translation									$	(24,234)	$	(24,234)
Balance at September 30, 2020		5,919,837	$	5,920	$	110,560,351	$	(122,638,926)	$	(1,938,734)	$	(14,011,389)

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT

(UNAUDITED)


		Common Stock Outstanding	Common Stock		Additional Paid-In Capital		Accumulated Deficit		Accumulated Other Comprehensive Loss, Net		Total Stockholders' Deficit			Common Stock Outstanding	Common Stock		Additional Paid-In Capital		Accumulated Deficit		Accumulated Other Comprehensive Loss, Net		Total Stockholders' Deficit
Balance at January 1, 2019		5,872,552	$	5,873	$	113,243,227	$	(122,119,899)	$	(1,895,102)	$	(10,765,901)
Balance at January 1, 2020													Balance at January 1, 2020	5,918,733	$	5,919	$	111,727,888	$	(123,871,853)	$	(1,893,260)	$	(14,031,306)
Net income (loss)	Net income (loss)						(124,907)				(124,907)		Net income (loss)						(719,840)				(719,840)
Share-based compensation to employees	Share-based compensation to employees				9,251						9,251		Share-based compensation to employees				4,510						4,510
Restricted stock issued													Restricted stock issued	1,104	1		(1)						0
Accretion of Series A redeemable convertible preferred stock	Accretion of Series A redeemable convertible preferred stock				(129,239)						(129,239)		Accretion of Series A redeemable convertible preferred stock				(26,090)						(26,090)
Dividends on Series A redeemable convertible preferred stock	Dividends on Series A redeemable convertible preferred stock				(247,027)						(247,027)		Dividends on Series A redeemable convertible preferred stock				(285,760)						(285,760)
Foreign currency translation	Foreign currency translation								19,392		19,392		Foreign currency translation								(13,153)		(13,153)
Balance at March 31, 2019		5,872,552	$	5,873	$	112,876,212	$	(122,244,806)	$	(1,875,710)	$	(11,238,431)
Net income (loss)							$	(1,171,723)			$	(1,171,723)
Share-based compensation to employees					$	16,231					$	16,231
Warrants exercised		15,181	$	15	$	(15)					$	0
Accretion of Series A redeemable convertible preferred stock					$	(134,223)					$	(134,223)
Dividends on Series A redeemable convertible preferred stock					$	(256,553)					$	(256,553)
Foreign currency translation									$	(49,410)	$	(49,410)
Balance at June 30, 2019		5,887,733	$	5,888	$	112,501,652	$	(123,416,529)	$	(1,925,120)	$	(12,834,109)
Net income (loss)							(556,914)				(556,914)
Share-based compensation to employees					3,100						3,100
Restricted stock issued		31,000	31		(31)						0
Balance at March 31, 2020													Balance at March 31, 2020	5,919,837	$	5,920	$	111,420,547	$	(124,591,693)	$	(1,906,413)	$	(15,071,639)

Accretion of Series A redeemable convertible preferred stock					(139,399)						(139,399)
Dividends on Series A redeemable convertible preferred stock					(266,447)						(266,447)
Foreign currency translation									(131,497)		(131,497)
Balance at September 30, 2019		5,918,733	5,919		112,098,875		(123,973,443)		(2,056,617)		(13,925,266)

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)


		Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019			2021		2020
Cash flows from operating activities:	Cash flows from operating activities:					Cash flows from operating activities:
Net income (loss)	Net income (loss)	$	1,232,927	$	(1,853,544)	Net income (loss)	$	425,248	$	(719,840)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:	Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:					Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization	Depreciation and amortization	162,127		320,388		Depreciation and amortization	57,486		33,563
Amortization of debt discount on notes payable	Amortization of debt discount on notes payable	361,193		217,336		Amortization of debt discount on notes payable	75,705		109,861
Amortization of right of use assets	Amortization of right of use assets	987,542		784,204		Amortization of right of use assets	333,777		353,715
Gain on debt extinguishment						Gain on debt extinguishment	(754,000)		0
Share-based payment compensation	Share-based payment compensation	11,392		28,582		Share-based payment compensation	4,471		4,510

Provision for (recovery of) returns and doubtful accounts	Provision for (recovery of) returns and doubtful accounts	70,932		(128,628)		Provision for (recovery of) returns and doubtful accounts	0		(81,244)
Deferred income taxes (benefit)	Deferred income taxes (benefit)	(5,485)		0		Deferred income taxes (benefit)	7,878		24,545
Changes in operating assets and liabilities:	Changes in operating assets and liabilities:					Changes in operating assets and liabilities:
Accounts receivable	Accounts receivable	(138,271)		1,778,241		Accounts receivable	(129,714)		1,720,163
Prepaid expenses and other current assets	Prepaid expenses and other current assets	249,383		(173,775)		Prepaid expenses and other current assets	(250,034)		121,591
Contract assets	Contract assets	432,204		79,192		Contract assets	30,179		229,042
Inventory	Inventory	15,713		(89,843)		Inventory	0		15,539
Other assets	Other assets	(254)		(782,802)		Other assets	(1,031)		(51)
Accounts payable	Accounts payable	(571,231)		487,202		Accounts payable	536,721		(433,791)
Accrued expenses and other long-term liabilities	Accrued expenses and other long-term liabilities	(589,952)		45,039		Accrued expenses and other long-term liabilities	114,335		(171,461)
Operating lease liabilities	Operating lease liabilities	(1,204,155)		(980,937)		Operating lease liabilities	(429,112)		(403,100)
Deferred revenue	Deferred revenue	(1,317,239)		(1,163,169)		Deferred revenue	115,750		(1,201,373)
Net cash provided by (used in) operating activities	Net cash provided by (used in) operating activities	(303,174)		(1,432,514)		Net cash provided by (used in) operating activities	137,659		(398,331)
Cash flows from investing activities:	Cash flows from investing activities:					Cash flows from investing activities:

Purchases of property and equipment	Purchases of property and equipment	0		(175,139)		Purchases of property and equipment	(41,121)		0

Security deposits	Security deposits	(125)		33,815		Security deposits	1,588		(82,908)
Purchase of intangible assets	Purchase of intangible assets	(63,005)		(46,674)		Purchase of intangible assets	0		(11,360)
Net cash provided by (used in) investing activities	Net cash provided by (used in) investing activities	(63,130)		(187,998)		Net cash provided by (used in) investing activities	(39,533)		(94,268)
Cash flows from financing activities:

Proceeds from issuance of PPP loan		754,000		0
Payments of short-term debt		(1,000,000)		0
Payments of long-term debt		0		(489,321)

Net cash provided by (used in) financing activities		(246,000)		(489,321)

Effect of exchange rate changes on cash and cash equivalents	Effect of exchange rate changes on cash and cash equivalents	8,419		10,557		Effect of exchange rate changes on cash and cash equivalents	2,207		(6,446)
Net increase (decrease) in cash and cash equivalents	Net increase (decrease) in cash and cash equivalents	(603,885)		(2,099,276)		Net increase (decrease) in cash and cash equivalents	100,333		(499,045)
Cash and cash equivalents, beginning of period	Cash and cash equivalents, beginning of period	1,475,166		3,059,677		Cash and cash equivalents, beginning of period	1,920,656		1,475,166
Cash and cash equivalents, end of period	Cash and cash equivalents, end of period	$	871,281	$	960,401	Cash and cash equivalents, end of period	$	2,020,989	$	976,121
Supplemental disclosures:	Supplemental disclosures:					Supplemental disclosures:
Cash paid for interest	Cash paid for interest	$	261,095	$	176,008	Cash paid for interest	$	75,816	$	52,546

Non-cash investing and financing activities:	Non-cash investing and financing activities:					Non-cash investing and financing activities:
Undistributed Series A redeemable convertible preferred stock dividends	Undistributed Series A redeemable convertible preferred stock dividends	$	812,362	$	770,027	Undistributed Series A redeemable convertible preferred stock dividends	$	277,170	$	285,760

Accretion of Series A redeemable convertible preferred stock	Accretion of Series A redeemable convertible preferred stock	$	366,566	$	402,861	Accretion of Series A redeemable convertible preferred stock	$	197,114	$	26,090

See accompanying notes to unaudited condensed consolidated financial statements.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

(1) Basis of Presentation

(a) The Company and Nature of Operations

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

(b) Liquidity

As of ~~September 30, 2020,~~March 31, 2021, the Company had a working capital deficiency of ~~$5.2~~$3.6 million, which is inclusive of current deferred revenue of ~~$4.0~~$4.2 million, and a stockholders' deficit of ~~$14.0~~$14.6 million. During the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, the Company had net income of ~~$1.2~~$0.4 million and ~~negative~~positive cash flow from operations of ~~$0.3~~$0.1 million. The Company's total cash balance at ~~September 30, 2020~~March 31, 2021 was ~~$0.9~~$2.0 million, ~~a decrease~~an increase of ~~$603,885~~$100,333 compared to December 31, 2019. On April 28, 2020, the Company entered into a loan with Peapack-Gladstone Bank in an aggregate principal amount of $754,000 (the "Loan"), pursuant to the Paycheck Protection Program (the "PPP") under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act"). As described below, the Company repaid the $1,000,000 Term Loan (as herewith defined).2020.

The ~~Company's ability~~Company’s principal sources of liquidity at March 31, 2021 consisted of cash and future cash anticipated to ~~continue as a going concern for~~be generated from operations. The Company generated positive net income and cash flows from operations during the ~~next twelve~~three months ~~depends on its ability to execute its business plan, increase revenue and billings and reduce expenditures. In the third quarter of 2019,~~ended March 31, 2021. Although the Company ~~adopted~~reported negative working capital as of March 31, 2021, it was primarily due to notes payable and deferred revenue. The Company is currently a ~~plan~~party to ~~better align~~ the Company’s cost structure with the skills and resources required to more effectively execute the Company’s long-term growth strategy and to support revenue levels the Company expected to achieve on a go forward basis (the "2019 Plan"). In connection with the 2019 Plan, the Company eliminated 23 positions worldwide, implemented tighter expense controls, ceased non-core activities and downsized several facilities. As of September 30, 2020, the 2019 Plan is considered to be substantially completed.

~~On December 27, 2019, the Company entered into Amendment No. 1 to~~ Amended and Restated Term Loan Credit Agreement, ~~(the “Amendment”),~~dated as of February 23, 2018, as amended December 27, 2019, by and among the ~~Company, certain of the Company’s affiliates in their capacities as guarantors,~~company, HCP-FVA, LLC (“HCP-FVA”) ~~as administrative agent for~~, EW Capital, LLC, the lenders party thereto ~~(the “Lenders”), ESW Capital, LLC (“ESW”), as co-agent,~~ and the ~~Lenders, to provide for, among~~ other ~~things, a new term~~ loan ~~facility of up to $2,500,000 to the Company with an interest rate of 15%~~parties named therein (the ~~“2019 Term Loan”~~“Amended and Restated Loan Agreement”). The ~~Amendment also provides for certain financial covenants. On December 27, 2019,~~maturity date of the Company’s obligations under the Amended and Restated Loan Agreement is June 30, 2021 and as of March 31, 2021, the Company ~~drew down $1,000,000~~is obligated to repay the loan parties $3.5 million, of which $2.2 million is owed to HCP-FVA. The Company also has outstanding Series A Redeemable Convertible Preferred Stock (the “Series A Preferred Stock”) which currently can be redeemed by the holders of the ~~2019 Term Loan and~~Series A Preferred Stock at July 30, 2021. If such Series A Preferred Stock was redeemed at March 31, 2021, the Company ~~has a fixed amount of interest on such advance equal~~would be required to ~~15%~~pay the holders of the ~~principal amount advanced. The Company paid~~Series A Preferred Stock $13.6 million. HCP-FVA is the ~~2019 Term Loan in full on September 27, 2020.~~majority holder of the Series A Preferred Stock and no Series A Preferred Stock can be redeemed without the consent of HCP-FVA.

~~Given~~HCP-FVA is an affiliated party of Hale Capital Partners and Hale Capital Partners and affiliated entities (“HCP”) have agreed if necessary to extend the ~~commercial uncertainty caused by~~maturity date of the ~~novel coronavirus pandemic, or COVID-19,~~indebtedness owed to HCP-FVA under the ~~Company developed~~Amended and ~~implemented an even more aggressive expense control plan in March 2020, that it is prepared~~Restated Loan Agreement from June 30, 2021 to ~~keep in place for~~at least July 1, 2022. Similarly, HCP has agreed if necessary to extend the ~~remainder~~commencement of ~~2020. This plan reduced~~ the ~~Company's annual cash expense run rate by $4.0 million or 29%.~~optional redemption date of the Series A Preferred Stock from July 30, 2021 to at least July 1, 2022. The Company ~~has furloughed 21 positions worldwide,~~believes its current cash balances together with anticipated cash flows from operating activities, and 8its plans to extend the maturity of ~~these positions were reinstated in~~its borrowings from HCP-FVA and commencement of the ~~second and third quarters~~optional redemption date of ~~2020. We believe~~ the ~~reduced expense level will enable FalconStor to remain profitable during the remainder of 2020, even with the impact of COVID-19.~~

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

~~We believe that our cash flows from operations and existing cash on hand are sufficient to conduct our planned operations and meet our contractual requirements through November 9, 2021.~~

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 ~~2020~~2021 operating plans. The extent to which COVID-19 ultimately impacts our results of operations, cash flow and financial position will depend on future developments, which are uncertain and cannot be predicted, including, but not limited to, the duration and spread of the outbreak, its severity, the actions taken by governments and authorities to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 pandemic has subsided, we may continue to experience materially adverse impacts to our business as a result of its global economic impact, including as a result of any recession that may occur.

(d) 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.

(e) Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The Company’s significant estimates include those related to revenue recognition, accounts receivable allowances, share-based payment compensation, valuation of derivatives, capitalizable software development costs, valuation of goodwill and other intangible assets and income taxes. During the first quarter of 2018, the Company also had significant estimates in the determination of the fair value of Series A Redeemable Convertible Preferred Stock ("Series A Preferred Stock"), notes payable and warrants issued. Actual results could differ from those estimates.

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

(f) Unaudited Interim Financial Information

The accompanying unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements.

In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly state the financial position of the Company at ~~September 30, 2020,~~March 31, 2021, and the results of its operations for the three ~~and nine~~ months ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~2020. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes set forth in the Company's Annual Report on Form 10-K for the year ended December 31, ~~2019~~2020 ("~~2019~~2020 Form 10-K").

(g) Recently Issued Accounting Pronouncements

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

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

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.

(2) Summary of Significant Accounting Policies

The Company's significant accounting policies were described in Note (1) Summary of Significant Accounting Policies of the ~~2019~~2020 Form 10-K. There have been no significant changes in the Company's significant accounting policies since December 31, ~~2019, other than those noted below.~~2020. For a description of the Company's ~~other~~ significant accounting policies refer to the ~~2019~~2020 Form 10-K.

Revenue from Contracts with Customers and Associated Balances

Nature of Products and Services

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

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

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

Contract Balances

Timing of revenue recognition may differ from the timing of invoicing to customers. The Company records a contract asset when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For perpetual licenses with multi-year ~~product~~ maintenance agreements, the ~~Company~~company invoices the license and generally ~~invoices customers at the beginning~~one year of ~~the coverage period.~~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, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, accounts receivable, net of allowance for doubtful accounts, was ~~$3.5~~$3.0 million and ~~$3.4~~$2.8 million, respectively. As of ~~September 30, 2020~~both March 31, 2021 and December 31, ~~2019,~~2020, short and long-term contract assets, net of allowance for doubtful accounts, was $0.6 ~~million and $1.1 million, respectively.~~million.

�� 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~~Three Months Ended ~~September 30, 2020~~March 31, 2021
Balance at December 31, ~~2019~~2020	$	~~7,355,270~~6,369,129
Deferral of revenue	~~9,807,409~~3,915,390
Recognition of revenue	~~(11,116,199)~~(3,828,326)
Change in reserves	~~6,881~~ (1,435)
Balance at ~~September 30, 2020~~March 31, 2021	$	~~6,053,361~~6,454,758

Deferred revenue includes invoiced revenue allocated to remaining performance obligations that has not yet been recognized and will be recognized as revenue in future periods. Deferred revenue was ~~$6.1~~$6.5 million as of ~~September 30, 2020,~~March 31, 2021, of which the Company expects to recognize approximately ~~66%~~64% of such amount as revenue over the next 12 months and the remainder thereafter.

Approximately ~~$2.6~~$2.0 million of revenue is expected to be recognized from remaining performance obligations for unbilled support and services as of ~~September 30, 2020.~~March 31, 2021. We expect to recognize revenue on approximately ~~42%~~39% of these remaining performance obligations over the next twelve months, with the balance recognized thereafter.

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

Significant Judgments

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

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

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

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

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

Disaggregation of Revenue

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

Assets Recognized from Costs to Obtain a Contract with a Customer

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

Leases

We have entered into operating leases for our various facilities. We determine if an arrangement is a lease at inception. Operating leases are included in Right-of-Use ("ROU") assets, and lease liability obligations in our condensed consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liability obligations

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

Right of Use Assets and Liabilities

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


Right of use assets	$	~~854,712~~202,495
Lease liability obligations, current	~~1,074,032~~235,962
Lease liability obligations, less current portion	~~2,194~~0
Total lease liability obligations	$	~~1,076,226~~235,962
Weighted-average remaining lease term	~~0.89~~0.54
Weighted-average discount rate	~~5.99~~5.74		%


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019				2021		2020
Components of lease expense:	Components of lease expense:									Components of lease expense:
Operating lease cost	Operating lease cost	$	466,556	$	323,117	$	1,248,958	$	1,157,390	Operating lease cost		$	414,351	$	489,043
Sublease income	Sublease income	(75,314)		(155,944)		(223,941)		(467,832)		Sublease income		(75,314)		(199,055)
Net lease cost	Net lease cost	$	391,242	$	167,173	$	1,025,017	$	689,558	Net lease cost		$	339,037	$	289,988

During the three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ operating cash flows from operating leases ~~was~~were approximately ~~$357,245~~$354,968 and ~~$480,992, respectively. During the nine months ended September 30, 2020 and 2019, operating cash flows from operating leases was approximately $1,117,557 and $1,476,704,~~$547,623, respectively.

Approximate future minimum lease payments for our ROU assets over the remaining lease periods as of ~~September 30, 2020,~~March 31, 2021, are as follows:


Remainder of 2020		424,592

2021	2021	659,754	2021	237,525
Total minimum lease payments	Total minimum lease payments	1,084,346	Total minimum lease payments	237,525
Less interest	Less interest	(8,120)	Less interest	1,563
Present value of lease liabilities	Present value of lease liabilities	1,076,226	Present value of lease liabilities	235,962

(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 nine~~ months ended ~~September 30, 2020~~March 31, 2021 and ~~2019:~~2020:


		Three Months Ended September 30,		Nine Months Ended September 30,			Three Months Ended March 31,
		2020	2019	2020	2019			2021	2020
Stock options and restricted stock	Stock options and restricted stock	9,945	1,157,537	1,483,450	1,263,009	Stock options and restricted stock		1,395,993	1,178,974
Series A redeemable convertible preferred stock	Series A redeemable convertible preferred stock	87,815	87,815	87,815	87,815	Series A redeemable convertible preferred stock		87,815	87,815
Total anti-dilutive common stock equivalents	Total anti-dilutive common stock equivalents	97,760	1,245,352	1,571,265	1,350,824	Total anti-dilutive common stock equivalents		1,483,808	1,266,789

(4) Property and Equipment

The gross carrying amount and accumulated depreciation of property and equipment as of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 are as follows:


		September 30, 2020		December 31, 2019			March 31, 2021		December 31, 2020

Gross carrying amount	Gross carrying amount	$	18,759,199	$	18,735,885	Gross carrying amount	$	18,813,944	$	18,791,841
Accumulated depreciation	Accumulated depreciation	(18,522,757)		(18,366,612)		Accumulated depreciation	(18,617,314)		(18,594,821)
Property and Equipment, net	Property and Equipment, net	$	236,442	$	369,273	Property and Equipment, net	$	196,630	$	197,020

For the three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ depreciation expense was ~~$44,958~~$39,765 and ~~$62,910, respectively. For the nine months ended September 30, 2020 and 2019, depreciation expense was $135,679 and $196,736,~~$45,943, respectively.

(5) Software Development Costs

The gross carrying amount and accumulated amortization of software development costs as of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 are as follows:


		September 30, 2020		December 31, 2019			March 31, 2021		December 31, 2020

Gross carrying amount	Gross carrying amount	$	2,950,132	$	2,950,132	Gross carrying amount	$	2,950,132	$	2,950,132
Accumulated amortization	Accumulated amortization	(2,929,204)		(2,923,120)		Accumulated amortization	(2,932,493)		(2,930,854)
Software development costs, net	Software development costs, net	$	20,928	$	27,012	Software development costs, net	$	17,639	$	19,278

During the three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ the Company recorded ~~$1,649~~$1,639 and ~~$11,565, respectively, of amortization expense related to capitalized software costs. During the nine months ended September 30, 2020 and 2019, the Company recorded $6,084 and $54,198,~~$2,791, 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 ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019~~2020 are as follows:


		September 30, 2020		December 31, 2019			March 31, 2021		December 31, 2020
Goodwill	Goodwill	$	4,150,339	$	4,150,339	Goodwill	$	4,150,339	$	4,150,339
Other intangible assets:	Other intangible assets:					Other intangible assets:
Gross carrying amount	Gross carrying amount	$	4,010,107	$	3,947,103	Gross carrying amount	$	4,027,912	$	4,027,912
Accumulated amortization	Accumulated amortization	(3,909,749)		(3,889,385)		Accumulated amortization	(3,943,860)		(3,927,778)
Net carrying amount	Net carrying amount	$	100,358	$	57,718	Net carrying amount	$	84,052	$	100,134

For the three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ amortization expense was ~~$18,455~~$16,082 and ~~$22,130, respectively. For the nine months ended September 30, 2020 and 2019, amortization expense was $20,364 and $69,454,~~$(15,171), respectively.

(7) Share-Based Payment Arrangements

On June 22, 2018, the Company's stockholders adopted the FalconStor Software, Inc. 2018 Incentive Stock Plan (the "2018 Plan"). The 2018 Plan is administered by the Compensation Committee and provides for the issuance of up to 1,471,997 shares of the Company's common stock upon the grant of shares with such restrictions as determined by the Compensation Committee to the employees and directors of, and consultants providing services to, the Company or its affiliates. Exercise prices of the options will be determined by the Compensation Committee of the Company's Board of Directors, subject to the consent of Hale Capital Partners, LP. The vesting terms shall be performance based and determined by the Compensation Committee, subject to the consent of Hale Capital Partners, LP, 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 ~~September 30, 2020:~~March 31, 2021:

Shares Available

Name of Plan

Authorized

for Grant

Outstanding

Name of Plan

Authorized

for Grant

Outstanding

FalconStor Software, Inc. 2018 Incentive Stock Plan

1,471,997

(1,248)

1,473,245

FalconStor Software, Inc. 2018 Incentive Stock Plan

1,471,997

(31,368)

1,442,828

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, 2020:~~March 31, 2021:

Name of Plan

Shares Available for Grant

Shares Outstanding

Name of Plan

Shares Available for Grant

Shares Outstanding

FalconStor Software, Inc., 2016 Incentive Stock Plan

3,850

FalconStor Software, Inc., 2016 Incentive Stock Plan

3,850

FalconStor Software, Inc., 2006 Incentive Stock Plan

6,095

FalconStor Software, Inc., 2006 Incentive Stock Plan

5,930

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, 2020~~March 31, 2021 and ~~2019:~~2020:

Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
Cost of revenue - support and service 104 104 310 2,146
Research and development costs 433 371 1,289 5,977
Selling and marketing 186 186 554 3,844
General and administrative 3,099 2,439 9,239 16,615
$ 3,822 $ 3,100 $ 11,392 $ 28,582


	Three Months Ended March 31,
		2021		2020
Cost of revenue - Product		$	227	$	0
Cost of revenue - support and service		181		103
Research and development costs		0		428
Selling and marketing		2,677		184
General and administrative		1,386		3,795
		$	4,471	$	4,510

(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~~three months ended ~~September 30, 2020,~~March 31, 2021, the Company recorded an income tax provision of ~~$44,709.~~$44,616. The effective tax rate for the ~~nine~~three months ended ~~September 30, 2020~~March 31, 2021 was ~~3.5%~~7.0%. 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 ~~September 30,~~March 31, 2021, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and therefore, the Company has not recorded any income tax benefit as such amounts are fully offset with a valuation allowance.

For the three months ended March 31, 2020, the Company recorded an income tax provision of $70,064. The effective tax rate for the three months ended March 31, 2020 was (10.8%). The effective tax rate differs from the statutory rate of 21% due to the mix of foreign and domestic earnings and the application of valuation allowances. As of March 31, 2020, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and therefore, the Company has not recorded any income tax benefit as such amounts are fully offset with a valuation allowance.

For the nine months ended September 30, 2019, the Company recorded an income tax provision of $168,556. The effective tax rate for the nine months ended September 30, 2019 was (10.0%). The effective tax differs from the statutory rate of 21% primarily related to the mix of foreign and domestic earnings as no tax expense or benefit is being recognized on domestic earnings or losses. As of September 30, 2020, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and therefore, the Company has not recorded any income tax expense as such amounts are fully offset with a valuation allowance.

The Company’s total unrecognized tax benefits, excluding interest, at ~~September 30, 2020~~both March 31, 2021 and December 31, ~~2019~~2020 were ~~$76,275 and $134,246, respectively.~~$75,506. As of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, the Company had ~~$33,865~~$37,207 and ~~$63,404,~~$35,340, respectively, of accrued interest reflected in accrued expenses. The Company ~~recognized~~expects approximately ~~$7,000~~$8,000 of tax benefits during the ~~quarter~~next twelve months due due to expiring statute of limitations, which ~~impacted~~will impact the Company's effective tax rate. ~~The Company does not expect any material changes of unrecognized tax benefits during the next twelve months..~~

(9) Notes Payable ~~and Stock Warrants~~

The notes payable balance consists of the following:


~~Notes~~Total notes payable, ~~principal balance~~net at December 31, 2020	$	~~3,000,000~~4,074,863
~~Deferred issuance costs~~Accretion of discount	~~(254,247)~~75,705
~~Discount~~PPP loan forgiveness	~~(288,504)~~(754,000)
Total notes payable, net at ~~inception on February 23, 2018~~	~~2,457,249~~
~~Proceeds from issuance of long-term debt~~	~~1,000,000~~
~~Revaluation of long-term debt~~	~~(447,008)~~
~~Accretion of discount~~	~~202,195~~
~~Deferred issuance costs~~	~~(87,609)~~
~~Total notes payable, net at December~~March 31, ~~2018~~2021	$	~~3,124,827~~3,396,568
~~Repayment of long-term debt~~	~~(489,321)~~
~~Proceeds from issuance of long-term debt~~	~~1,000,000~~
~~Accretion of discount~~	~~273,521~~
~~Deferred issuance costs~~	~~(55,393)~~
~~Total notes payable, net at December 31, 2019~~	$	~~3,853,634~~
~~Accretion of discount~~	~~361,193~~
~~Proceeds from issuance of the PPP loan~~	~~754,000~~
~~Repayment of short-term debt~~	~~(1,000,000)~~
~~Total notes payable, net at September 30, 2020~~	$	~~3,968,827~~

Senior Secured Debt

The $4 million senior secured debt bears interest at prime plus 0.75% and matures on June 30, 2021. ~~On September 27, 2020, we paid the 2019 Term Loan in full.~~ As of ~~September 30, 2020,~~March 31, 2021, the Company was in compliance with the financial covenants contained in the Amended and Restated Term Loan Credit Agreement.

Loan under the Paycheck Protection Program

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

The PPP Loan is evidenced by a promissory note ~~(the “Note”)~~ dated April 28, 2020. The PPP Loan matures two years from the disbursement date and bears interest at a rate of 1.000% per annum, with the first six months of interest deferred. Principal and interest are payable monthly commencing six months after the disbursement date and may be prepaid by the Company at any time prior to maturity with 0 prepayment penalties.

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

The PPP Loan ~~is included in notes payable, net of debt issuance costs and discounts in the accompanying condensed consolidated balance sheet.~~was forgiven on March 30, 2021.

(10) Fair Value Measurements

The Company measures its cash equivalents and derivative instruments at fair value. Fair value is an exit price, representing the amount that would be received on the sale of an asset or that would be paid to transfer a liability in an orderly transaction between market participants. As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value.

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

•Level 1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities. At ~~September 30, 2020,~~March 31, 2021, the Company did not have any Level 1 category assets included in the condensed consolidated balance sheets.

•Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly. At ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, the Company did not have any Level 2 category assets included in the condensed consolidated balance sheets.

•Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. At ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, the Level 3 category included derivatives, which are included within other long-term liabilities in the condensed consolidated balance sheets. The Company did not hold any cash and cash equivalents categorized as Level 3 as of ~~September 30, 2020~~March 31, 2021 or December 31, ~~2019.~~2020.

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at ~~September 30, 2020:~~March 31, 2021:


				Fair Value Measurements at Reporting Date Using									Fair Value Measurements at Reporting Date Using
		Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Inputs (Level 2)		Significant Unobservable Inputs (Level 3)			Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Derivative liabilities:	Derivative liabilities:									Derivative liabilities:
Derivative Instruments	Derivative Instruments	475,561		0		0		475,561		Derivative Instruments	470,222		0		0		470,222
Total derivative liabilities	Total derivative liabilities	475,561		0		0		475,561		Total derivative liabilities	470,222		0		0		470,222

Total assets and liabilities measured at fair value	Total assets and liabilities measured at fair value	$	475,561	$	0	$	0	$	475,561	Total assets and liabilities measured at fair value	$	470,222	$	0	$	0	$	470,222

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at December 31, ~~2019:~~2020:


				Fair Value Measurements at Reporting Date Using									Fair Value Measurements at Reporting Date Using
		Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Inputs (Level 2)		Significant Unobservable Inputs (Level 3)			Total		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant other Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Derivative liabilities:	Derivative liabilities:									Derivative liabilities:
Derivative Instruments	Derivative Instruments	483,804		0		0		483,804		Derivative Instruments	472,851		0		0		472,851
Total derivative liabilities	Total derivative liabilities	483,804		0		0		483,804		Total derivative liabilities	472,851		0		0		472,851

Total assets and liabilities measured at fair value	Total assets and liabilities measured at fair value	$	483,804	$	0	$	0	$	483,804	Total assets and liabilities measured at fair value	$	472,851	$	0	$	0	$	472,851

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

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

The following table presents a reconciliation of the beginning and ending balances of the Company's liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three ~~and nine~~ months ended ~~September 30, 2020~~March 31, 2021 and ~~September 30, 2019:~~March 31, 2020:

Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
Beginning Balance $ 478,312 $ 489,489 $ 483,804 $ 498,086
Total income recognized in earnings (2,751) (2,866) (8,243) (11,463)
Ending Balance $ 475,561 $ 486,623 $ 475,561 $ 486,623


	Three Months Ended March 31,
		2021		2020
Beginning Balance		$	472,851	$	483,804
Total income recognized in earnings		(2,629)		(2,752)
Ending Balance		$	470,222	$	481,052

(11) Commitments and Contingencies

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

Payments Sublease Income Net Commitments
2020 424,592 (75,314) 349,278
2021 659,754 (530,447) 129,307
$ 1,084,346 $ (605,761) $ 478,585


	Payments		Sublease Income		Net Commitments
2021	237,525		(25,105)		212,420
	$	237,525	$	(25,105)	$	212,420

The Company typically provides its customers a warranty on its software products for a period of no more than 90 days. Such warranties are accounted for in accordance with the authoritative guidance issued by the FASB on contingencies. For the three ~~and nine~~ months ended ~~September 30, 2020,~~March 31, 2021, the Company has not incurred any costs related to warranty obligations.

Under the terms of substantially all of its software license agreements, the Company indemnifies its customers for all costs and damages arising from claims against such customers based on, among other things, allegations that the Company’s software infringes on the intellectual property rights of a third party. In most cases, in the event of an infringement claim, the Company retains the right to (i) procure for the customer the right to continue using the software; (ii) replace or modify the software to eliminate the infringement while providing substantially equivalent functionality; or (iii) if neither (i) nor (ii) can be reasonably achieved, the Company may terminate the license agreement and refund to the customer a pro-rata portion of the license fee paid to the Company. Such indemnification provisions are accounted for in accordance with the authoritative guidance issued by the FASB on guarantees. From time to time, in the ordinary course of business, the Company receives claims for indemnification, typically from OEMs. The Company is not currently aware of any material claims for indemnification.

As described under Note (12), the holders of the Series A Preferred Stock have redemption rights upon certain triggering events. As of ~~September 30, 2020,~~March 31, 2021, the Company did not fail any non-financial covenants related to the Company's Series A Preferred Stock.

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

In connection with the appointment of Brad Wolfe as the Company's Chief Financial Officer, the Board approved an offer letter to Mr. Wolfe (the “Wolfe Offer Letter”), which was executed on April 4, 2018. The Wolfe Offer Letter provides that Mr. Wolfe is entitled to receive an annualized base salary of $240,000, payable in regular installments in accordance with the Company’s general payroll practices. Mr. Wolfe will also be eligible for a cash bonus of $10,000 for any quarter which has net

working capital cash that exceeds the prior quarter and additional incentive compensation of an annual bonus of up to $70,000, subject to attainment of performance objectives to be mutually agreed upon and established.

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

In addition, as of ~~September 30, 2020,~~March 31, 2021, the Company's liability for uncertain tax positions totaled ~~$110,141.~~$112,712. At this time, the settlement period for this liability, including related accrued interest, cannot be determined.

(12) Series A Redeemable Convertible Preferred Stock

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

Pursuant to the Certificate of Designations, the holders of the Series A Preferred Stock are entitled to receive quarterly dividends at the prime rate (provided in the Wall Street Journal Eastern Edition) plus 5% (up to a maximum dividend rate of 10%), payable in cash or in kind (i.e., through the issuance of additional shares of Series A Preferred Stock), except that the Company is not permitted to pay such dividends in cash while any indebtedness under the Company’s Amended and Restated

Term Loan and Credit Agreement remains outstanding without the consent of the holders of the Series A Preferred Stock. In addition, the declaration and payment of dividends is subject to compliance with applicable law and unpaid dividends will accrue. A holder’s right to convert its shares of Series A Preferred Stock and receive dividends in the form of common stock is subject to certain limitations including, among other things, that the shares of common stock issuable upon conversion or as dividends will not, prior to receipt of stockholder approval, result in any holder beneficially owning greater than ~~19.99%~~9.99% of the Company’s currently outstanding shares of common stock.

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

Upon certain triggering events, such as bankruptcy, insolvency or a material adverse effect or failure of the Company to issue shares of common stock upon conversion of the Series A Preferred Stock in accordance with its obligations, the holders may require the Company to redeem all or some of the Series A Preferred Stock at a price per share equal to the greater of (i) the sum of 100% of the stated value of a share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto, and (ii) the product of the number of shares of common stock underlying a share of Series A Preferred Stock and the closing price as of the occurrence of the triggering event. On or after July 30, 2021, subject to the approval of HCP-FVA, each holder of Series A Preferred Stock can also require the Company to redeem its Series A Preferred Stock in cash at a per share price equal to 100% of the stated value of a share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto. Notwithstanding the forgoing, no holder of Series A Preferred Stock is permitted to exercise any rights or remedies upon a Breach Event or to exercise any redemption rights under the Certificate of Designations, unless approved by the holders of a majority of the then outstanding shares of Series A Preferred Stock. As described under Note (1), HCP-FVA has agreed to extend if necessary the commencement of the optional redemption date of the Series A Preferred Stock from July 30, 2021 to July 1, 2022.

Upon consummation of a fundamental sale transaction, the Series A Preferred Stock shall be redeemed at a per share redemption price equal to the greater of (y) 250% of the per share purchase price of the Series A Preferred Stock and (z) the price payable in respect of such share of Series A Preferred Stock if such share of Series A Preferred Stock had been converted into such number of shares of common stock in accordance with the Certificate of Designations (but without giving effect to any limitations or restrictions contained therein) immediately prior to such fundamental sale transaction; provided however that the 250% threshold is changed to 100% if the fundamental sale transaction is approved by the two Series A Directors (as defined in the Certificate of Designations). In addition, if the Company consummates an equity or debt financing that results in more than $5.0 million of net proceeds to the Company and/or its subsidiaries, the holders of Series A Preferred Stock will have

the right, but not the obligation, to require the Company to use the net proceeds in excess of $5.0 million to repurchase all or a portion of the Series A Preferred Stock at a per share price equal to the greater of (i) the sum of 100% of the stated value of such share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto, and (ii) the number of shares of common stock into which such share of Series A Preferred Stock is then convertible multiplied by the greater of (y) the closing price of the common stock on the date of announcement of such financing or (z) the closing price of the ~~Common Stock~~common stock on the date of consummation of such financing.

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

The Company has classified the Series A Preferred Stock as temporary equity in the financial statements as it is subject to redemption at the option of the holder under certain circumstances. As a result of the ~~Company��s~~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, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, the fair value of these derivative instruments was ~~$475,561~~$470,222 and ~~$483,804,~~$472,851, respectively, and were included in "other long-term liabilities" within the consolidated balance sheets. The loss on

the change in fair value of these derivative instruments for the ~~nine~~three months ended ~~September 30,~~March 31, 2021 and March 31, 2020 of $2,629 and ~~September 30, 2019 of $8,243 and 11,463,~~2,752, respectively, were included in “interest and other loss, net” within the consolidated statement of operations.

The fair value of these derivative instruments and the loss recorded on the change in the fair value of these derivative instruments, which was included in “Interest and other income, net” within the condensed consolidated statement of operations, for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ were as follows:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019				2021		2020
Beginning Balance	Beginning Balance	$	478,312	$	489,489	$	483,804	$	498,086	Beginning Balance		$	472,851	$	483,804
Total income recognized in earnings	Total income recognized in earnings	(2,751)		(2,866)		(8,243)		(11,463)		Total income recognized in earnings		(2,629)		(2,752)
Ending Balance	Ending Balance	$	475,561	$	486,623	$	475,561	$	486,623	Ending Balance		$	470,222	$	481,052

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


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

At the time of issuance, the Company recorded transaction costs, a beneficial conversion feature and the fair value allocated to the embedded derivatives as discounts to the Series A Preferred Stock. These costs were being accreted to the Series A Preferred Stock using the effective interest method through the stated redemption date of August 5, 2017, which represents the earliest redemption date of the instrument. This accretion was accelerated as of December 31, 2016 due to the failure of the financial covenants and the redemption right of the holders at that time. In connection with the Commitment, Hale Capital Partners, LP, which was the sole holder of the Series A Preferred Stock, agreed to the Series A mandatory extension of the mandatory redemption right and waived prior breaches of the terms of the Series A Preferred Stock. The Company included deductions for accretion, deemed and accrued dividends on the Series A Preferred Stock as adjustments to net 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,~~March 31, 2021 and 2020, ~~and 2019,~~ respectively. The following represents a reconciliation of net loss attributable to common stockholders for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ respectively:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019		2020		2019				2021		2020
Net income (loss)	Net income (loss)	$	1,546,209	$	(556,914)	$	1,232,927	$	(1,853,544)	Net income (loss)		$	425,248	$	(719,840)
Effects of Series A redeemable convertible preferred stock:	Effects of Series A redeemable convertible preferred stock:									Effects of Series A redeemable convertible preferred stock:
Less: Accrual of Series A redeemable convertible preferred stock dividends	Less: Accrual of Series A redeemable convertible preferred stock dividends	266,007		266,447		812,362		770,027		Less: Accrual of Series A redeemable convertible preferred stock dividends		277,170		285,760

Less: Accretion to redemption value of Series A redeemable convertible preferred stock	Less: Accretion to redemption value of Series A redeemable convertible preferred stock	175,335		139,399		366,566		402,861		Less: Accretion to redemption value of Series A redeemable convertible preferred stock		197,114		26,090
Net income (loss) attributable to common stockholders	Net income (loss) attributable to common stockholders	$	1,104,867	$	(962,760)	$	53,999	$	(3,026,432)	Net income (loss) attributable to common stockholders		$	(49,036)	$	(1,031,690)

The Series A Preferred Stock consists of the following:


~~Series A redeemable convertible preferred stock principal balance~~	$	~~9,000,000~~
~~Accrued dividends~~	~~1,312,112~~
~~Discount~~	~~(1,602,428)~~
~~Total Series A redeemable convertible preferred stock, net at inception on February 23, 2018~~	~~8,709,684~~
~~Accrued dividends~~	~~683,742~~
~~Accretion of preferred stock~~	~~363,280~~
Total Series A redeemable convertible preferred stock, net at December 31, ~~2018~~2020	$	~~9,756,706~~12,940,722
Accrued dividends	~~1,157,762~~$	277,170
Accretion of preferred stock	~~389,811~~$	197,114
Total Series A redeemable convertible preferred stock, net at ~~December~~March 31, ~~2019~~2021	$	~~11,304,279~~
~~Accrued dividends~~	~~812,362~~
~~Accretion of preferred stock~~	~~366,565~~
~~Total Series A redeemable convertible preferred stock, net at September 30, 2020~~	$	~~12,483,206~~13,415,006

(13) Accumulated Other Comprehensive Loss

The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended ~~September 30, 2020~~March 31, 2021 are as follows:

2322


		Foreign Currency Translation		Net Minimum Pension Liability		Total			Foreign Currency Translation		Net Minimum Pension Liability		Total
Accumulated other comprehensive income (loss) at June 30, 2020		$	(1,948,066)	$	33,566	$	(1,914,500)
Accumulated other comprehensive income (loss) at December 31, 2020								Accumulated other comprehensive income (loss) at December 31, 2020	$	(1,995,680)	$	7,719	$	(1,987,961)
Other comprehensive income (loss)	Other comprehensive income (loss)							Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications	Other comprehensive income (loss) before reclassifications	(24,234)		0		(24,234)		Other comprehensive income (loss) before reclassifications	86,398		0		86,398
Total other comprehensive income (loss)	Total other comprehensive income (loss)	(24,234)		0		(24,234)		Total other comprehensive income (loss)	86,398		0		86,398
Accumulated other comprehensive income (loss) at September 30, 2020		$	(1,972,300)	$	33,566	$	(1,938,734)
Accumulated other comprehensive income (loss) at March 31, 2021								Accumulated other comprehensive income (loss) at March 31, 2021	$	(1,909,282)	$	7,719	$	(1,901,563)

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

Foreign Currency
Translation Net Minimum
Pension Liability Total
Accumulated other comprehensive income (loss) at June 30, 2019 $ (1,951,923) $ 26,803 $ (1,925,120)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications (131,497) 0 (131,497)
Total other comprehensive income (loss) (131,497) 0 (131,497)
Accumulated other comprehensive income (loss) at September 30, 2019 $ (2,083,420) $ 26,803 $ (2,056,617)

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

Foreign Currency
Translation Net Minimum
Pension Liability Total
Accumulated other comprehensive income (loss) at December 31, 2019 $ (1,926,826) $ 33,566 $ (1,893,260)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications (45,474) 0 (45,474)
Total other comprehensive income (loss) (45,474) 0 (45,474)
Accumulated other comprehensive income (loss) at September 30, 2020 $ (1,972,300) $ 33,566 $ (1,938,734)

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

Foreign Currency
Translation Net Minimum
Pension Liability Total
Accumulated other comprehensive income (loss) at December 31, 2018 $ (1,921,905) $ 26,803 $ (1,895,102)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications (161,515) 0 (161,515)
Total other comprehensive income (loss) (161,515) 0 (161,515)
Accumulated other comprehensive income (loss) at September 30, 2019 $ (2,083,420) $ 26,803 $ (2,056,617)


	Foreign Currency Translation		Net Minimum Pension Liability		Total
Accumulated other comprehensive income (loss) at December 31, 2019	$	(1,926,826)	$	33,566	$	(1,893,260)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications	(13,153)		0		(13,153)
Total other comprehensive income (loss)	(13,153)		0		(13,153)
Accumulated other comprehensive income (loss) at March 31, 2020	$	(1,939,979)	$	33,566	$	(1,906,413)

(14) Stockholders' Equity

Stock Repurchase Activity

During the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ the Company did 0t repurchase any shares of its common stock. As of ~~September 30, 2020,~~March 31, 2021, the Company had the authorization under previous Board approved stock repurchase plans to repurchase 49,078 shares of its common stock based upon its judgment and market conditions.

(15) Litigation

In view of the inherent difficulty of predicting the outcome of litigation, particularly where the claimants seek very large or indeterminate damages, the Company generally cannot predict what the eventual outcome of the pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties related to each pending matter may be.

In accordance with the authoritative guidance issued by the FASB on contingencies, the Company accrues anticipated costs of settlement, damages and losses for claims to the extent specific losses are probable and estimable. The Company records a receivable for insurance recoveries when such amounts are probable and collectable. In such cases, there may be an exposure to loss in excess of any amounts accrued. If, at the time of evaluation, the loss contingency related to a litigation is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable and, the Company will expense these costs as incurred. If the estimate of a probable loss is a range and no amount within the range is more likely, the Company will accrue the minimum amount of the range.

The Company is subject to various legal proceedings and claims, asserted or unasserted, which arise in the ordinary course of business. While the outcome of any such matters cannot be predicted with certainty, such matters are not expected to have a material adverse effect on the Company’s financial condition or operating results.

(16) Segment Reporting and Concentrations

The Company is organized in a single operating segment for purposes of making operating decisions and assessing performance. Revenue from the United States to customers in the following geographical areas for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ and the location of long-lived assets as of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, are summarized as follows:

Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
Revenue:
Americas $ 1,834,443 $ 600,590 $ 4,085,936 $ 3,098,395
Asia Pacific 951,145 1,662,689 2,913,414 3,930,077
Europe, Middle East, Africa and Other 1,650,812 1,709,166 4,116,849 5,436,340
Total Revenue $ 4,436,400 $ 3,972,445 $ 11,116,199 $ 12,464,812


	Three Months Ended March 31,
		2021		2020
Revenue:
Americas		$	1,708,177	$	1,094,904
Asia Pacific		509,293		983,795
Europe, Middle East, Africa and Other		1,610,856		1,101,488
Total Revenue		$	3,828,326	$	3,180,187


		September 30, 2020		December 31, 2019			March 31, 2021		December 31, 2020
Long-lived assets:	Long-lived assets:					Long-lived assets:
Americas	Americas	$	5,888,483	$	6,811,578	Americas	$	1,253,841	$	1,735,986
Asia Pacific	Asia Pacific	724,224		860,023		Asia Pacific	485,147		502,344
Europe, Middle East, Africa and Other	Europe, Middle East, Africa and Other	161,337		190,928		Europe, Middle East, Africa and Other	40,752		52,690
Total long-lived assets	Total long-lived assets	$	6,774,044	$	7,862,529	Total long-lived assets	$	1,779,740	$	2,291,020

For the three ~~and nine~~ months ended ~~September 30, 2020,~~March 31, 2021, the Company had 2 customers that accounted for 10% or more of total revenue, respectively. For the three ~~and nine~~ months ended ~~September 30, 2019,~~March 31, 2020, the Company had 2 customers ~~and 2 customer~~ that accounted for 10% or more of total revenue, respectively.

As of ~~September 30, 2020,~~March 31, 2021, the Company had 42 customers that accounted for 10% or more of the gross accounts receivable balance. As of December 31, ~~2019,~~2020, the Company had 1 customer that accounted for 10% or more of the gross accounts receivable balance.

(17) Restructuring Costs

In June 2017, the Board approved a comprehensive plan to increase operating performance (the “2017 Plan”). The 2017 Plan was substantially completed by the end of the Company’s fiscal year ended December 31, 2017, and when combined with previous workforce reductions in the second quarter of fiscal 2017 reduced the Company’s workforce to approximately 86 employees at December 31, 2018. In making these changes, the Company prioritized customer support and development while consolidating operations and streamlining direct sales resources, allowing the Company to focus on the install base and develop alternate channels to the market. As part of this consolidation effort the Company vacated a portion of the ~~Mellville,~~Melville, NY office space during the three months ended June 30, 2018. In accordance with accounting standards governing costs associated with exit or disposal activities, expenses related to future rental payments for which the Company no longer intends to receive any economic benefit are accrued, net of any anticipated sublease income, when the Company ceases use of the leased space. During the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, the Company incurred lease disposal-related costs for this property of ~~$0.7~~$0.3 million. As of March 31, 2021, $20,595 of the Company's remaining accrued lease disposal cost has been recorded as a component of operating lease liabilities. The Company expects the remaining accrued severance-related costs of $229,051 at March 31, 2021 to be paid once final settlement litigation is completed, which is expected to occur by December 31, 2021.

In the third quarter of 2019, the Company adopted ~~the 2019 Plan~~an expense control plan (the "2019 Plan") to better align the Company’s cost structure with the skills and resources required to more effectively execute the Company’s long-term growth strategy and to support revenue levels the Company expected to achieve on a go forward basis. In connection with the 2019 Plan, the Company eliminated 23 positions worldwide, implemented tighter expense controls, ceased non-core activities and downsized several facilities. During the three months ended March 31, 2020, the Company incurred $0.1 million in severance expense as a result of this action. The 2019 Plan was substantially completed as of March 31, 2020.

Given the commercial uncertainty caused by the novel coronavirus pandemic, or COVID-19, the Company developed and implemented an even more aggressive expense control plan in March 2020, that it is prepared to keep in place for the remainder of 2020 (the "2020 Plan"). The 2020 Plan reduced the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 820 of these positions were reinstated ~~in the second and third quarters of~~by December 31, 2020. During the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, the Company has not yet incurred severance expense as a result of this action. ~~We believe the reduced expense level will enable FalconStor to remain profitable during the remainder of 2020, even with continued revenue challenges throughout.~~

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


		Severance Related Costs		Facility and Other Costs		Total			Severance Related Costs		Facility and Other Costs		Total

Balance at December 31, 2018		$	461,362	$	453,446	$	914,808
Additions (Reductions)		0		157,693		157,693
Utilized/Paid		0		(187,833)		(187,833)
Balance at March 31, 2019		$	461,362	$	423,306	$	884,668
Additions (Reductions)		0		202,679		202,679
Utilized/Paid		0		(238,090)		(238,090)
Balance at June 30, 2019		$	461,362	$	387,895	$	849,257
Additions (Reductions)		214,050		170,779		384,829
Utilized/Paid		(214,050)		(257,453)		(471,503)
Balance at September 30, 2019		$	461,362	$	301,221	$	762,583
Additions (Reductions)		31,860		327,257		359,117
Utilized/Paid		(199,423)		(390,985)		(590,408)

Balance at December 31, 2019	Balance at December 31, 2019	$	293,799	$	237,493	$	531,292	Balance at December 31, 2019	$	293,799	$	237,493	$	531,292
Additions (Reductions)	Additions (Reductions)	76,708		210,752		287,460		Additions (Reductions)	76,708		210,752		287,460
Utilized/Paid	Utilized/Paid	(156,415)		(225,835)		(382,250)		Utilized/Paid	(156,415)		(225,835)		(382,250)
Balance at March 31, 2020	Balance at March 31, 2020	$	214,092	$	222,410	$	436,502	Balance at March 31, 2020	$	214,092	$	222,410	$	436,502
Additions (Reductions)	Additions (Reductions)	0		153,685		153,685		Additions (Reductions)	0		153,685		153,685
Translation Adjustment	Translation Adjustment	4,674		0		4,674		Translation Adjustment	4,674		0		4,674
Utilized/Paid	Utilized/Paid	0		(201,211)		(201,211)		Utilized/Paid	0		(201,211)		(201,211)
Balance at June 30, 2020	Balance at June 30, 2020	$	218,766	$	174,884	$	393,650	Balance at June 30, 2020	$	218,766	$	174,884	$	393,650
Additions (Reductions)	Additions (Reductions)	0		317,595		317,595		Additions (Reductions)	0		317,595		317,595
Translation Adjustment	Translation Adjustment	9,554		0		9,554		Translation Adjustment	9,554		0		9,554
Utilized/Paid	Utilized/Paid	0		(366,562)		(366,562)		Utilized/Paid	0		(366,562)		(366,562)
Balance at September 30, 2020	Balance at September 30, 2020	$	228,320	$	125,917	$	354,237	Balance at September 30, 2020	$	228,320	$	125,917	$	354,237
Additions (Reductions)								Additions (Reductions)	0		274,086		274,086
Translation Adjustment								Translation Adjustment	11,124		0		11,124
Utilized/Paid								Utilized/Paid	0		(324,537)		(324,537)
Balance at December 31, 2020								Balance at December 31, 2020	$	239,444	$	75,466	$	314,910
Additions (Reductions)								Additions (Reductions)	0		302,313		302,313
Translation Adjustment								Translation Adjustment	(10,393)		0		(10,393)
Utilized/Paid								Utilized/Paid	0		(357,184)		(357,184)
Balance at March 31, 2021								Balance at March 31, 2021	$	229,051	$	20,595	$	249,646

The severance and facility related liabilities are included within “accrued expenses” in the accompanying condensed consolidated balance sheets. The expenses under the 2017, 2019 and ~~2019~~2020 Plans are included within “restructuring costs” in the accompanying condensed consolidated statements of operations.

2725

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

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

OVERVIEW

FalconStor ~~Software, Inc.~~ is a ~~modern enterprise-class~~ data protection technology company ~~that is mobilizing the past, energizing the present,~~enabling enterprises to modernize their data backup and ~~empowering the future~~archival operations across multiple sites and public clouds. We deliver increased data security and provide fast recovery from ransomware attacks, while driving down an enterprise’s data storage footprint by up to 90%. As an established technology leader with 47 patents and patent applications, we have over an exabyte of data ~~storage~~under management and ~~archival. The company provides software~~offer products that are used by more than 600 enterprise customers. Our products are offered through and ~~cloud~~supported by a worldwide network of leading service providers, systems integrators, resellers, managed services ~~that optimize long-term retention~~providers (“MSPs”) and ~~activation of historical data, enhance the performance and scalability of retaining present data, and deliver the flexibility to adopt and seamlessly migrate future storage technologies.~~ Our customers achieve lower costs, simpler operations, greater data security, higher confidence in their business continuity, and greater ability to effectively use their data assets to drive innovation.original equipment manufacturers (“OEMs”).

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

~~During~~In 2020, we focused our ~~commercial strategy has been~~go to ~~build~~market efforts on long-term data retention and recovery data protection segment, building on the ~~sales~~ momentum we generated in 2019 ~~while~~and increasing profitability. ~~This plan has been anchored on a continued focus on~~We increased our ~~long-term archive retention and reinstatement products, FalconStor Virtual Tape Library (“VTL”) and StorSafe~~TM~~, an increase in~~ go-to-market investment within our core regions of the Americas, EMEA, Japan, Korea, and Southeast Asia, and onwe released StorSafeTM, the next generation of our Virtual Tape Library (“VTL”) product family built for the cloud, while carefully managing operating expenses.

During ~~Q3,~~first quarter of 2021, we delivered ~~37%~~20% year-over-year total ~~bookings~~revenue growth despite the economic turmoil caused by the global COVID-19 pandemic. While uncertainties continue to exist as a result of COVID-19, we have seen our customers and prospects continue to invest in the business critical area of data production in which we sell our solutions. The strongest performance came from our Americas region, where bookings increased 68% year-over-year. In addition, bookings in our EMEA region increased by 29%. Total bookings increases in both regions were exclusively driven by increased adoption of our long-term data retention and reinstatement products, VTL and StorSafeTM~~. Across the globe, bookings from first-time FalconStor customers grew by 19% year-over-year.~~

~~Strong Q3 sales generated a~~ GAAP revenue ~~increase of $464 thousand~~increased by $0.6 million during the first quarter of 2021, compared to ~~Q3 2019. In addition, the proactive expense management plan we implemented at the end~~first quarter of ~~Q1, allowed us to deliver $1.5~~2020. We delivered $0.4 million of net income in the first quarter of 2021, compared to a net loss of ~~$0.6~~$0.7 million in Q3first quarter of ~~2019.~~ 2020. The $0.4 million in net income in the first quarter of 2021 includes a gain on debt extinguishment of $0.7 million which resulted from the forgiveness of the Paycheck Protection Loan we received under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") loan program (the "PPP Loan"). Our ~~significantly~~ improved profitability has allowed us to make additional targeted investments, primarily related to Sales, R&D, and Support personnel, while maintaining a profitable expense base.

~~Total cost~~During the first quarter of ~~revenue for~~2021, our strategy was to continue focus within our core regions of the three months ended September 30, 2020 decreased 46% to $0.4 million, compared with $0.8 million in the prior year period. Total gross profit increased $0.8 million, or 26%, to $4.0 million for the three months ended September 30, 2020, compared with $3.2 million for the prior year period. Total gross margin increased to 91% for the three months ended September 30, 2020, compared with 81% for the prior year period. TheAmericas, EMEA, Japan, Korea, and Southeast Asia.As result of this strategy, we delivered:

•73% increase in new customer bookings year-over-year across all product lines

During the first quarter of 2021, we continued to deliver innovation and enhance each of our ~~total gross margin,~~products. Our StorSafeTM solution is a vital backup long-term archive retention tool in enterprise IT departments’ data protection arsenal. It enables them to modernize their backup and ~~total gross profit in absolute dollars, were primarily due to an intentional reduction in hardware sales. Generally, our total gross profits~~archive environments, leverage efficient hybrid- and ~~total gross margins fluctuate based on several factors, including (i) revenue growth levels, (ii) changes in personnel headcount~~public-cloud storage environments, such as those provided by AWS and ~~related~~Microsoft Azure, save operational costs, and ~~(iii) our product offerings and mix of sales.~~

~~Overall, our total GAAP operating expenses~~improve restore performance for ~~the three months ended September 30, 2020 decreased $1.4 million, or 38%, to $2.3 million, compared to $3.7 million for the same period of the previous year.~~rapid remote disaster recovery.

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Through StorSafeTM, we are making progress expanding our technology to deliver an enterprise-class, highly flexible backup and archive data storage optimization solution.

By leveraging patent pending industry-standard container technology to enable persistent long-term archive storage, StorSafeTM not only retains the data reduction delivered as it exports data to lower cost on premise repositories and industry leading cloud providers like AWS, Microsoft Azure and IBM but also enables archive data portability, accessibility, security, and integrity validation. As a result, a full spectrum of archive data storage options will be made available to our enterprise customers to efficiently utilize essentially any storage environment, while confidently ensuring data security and efficient archive access.

Beyond our long-term archive retention and reinstatement products, our NSS and CDP business continuity driven data replication products give our customers the ability to move workloads to the right destination, on-premise or in the cloud, with advanced insight. These products are designed for 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. These products are modern, comprehensive and easy-to-use software solutions that enable IT professionals to have complete insight into and control over their organization’s data. Data is an organization’s most precious resource which, if managed and protected properly, can help an enterprise unlock competitive advantage, whether by gaining a better understanding of customers, uncovering ways to improve operations and reduce costs, or inventing new products, services and business models.

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 legacy data centers, hyper-converged infrastructure, cloud and/or hybrids.

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

Our “Business Partner” program for our resellers provides financial incentives, for those resellers 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 resellers in all regions. We decided to focus on only those resellers 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.Now, we also offer our capacity-based licenses on a subscription or term-based model, which gives a customer the right to utilize the licensed terabyte capacity over a designated period of time. We expect revenue from subscription-based capacity 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.

RESULTS OF OPERATIONS – FOR THE THREE MONTHS ENDED ~~SEPTEMBER 30, 2020~~MARCH 31, 2021 COMPARED WITH THE THREE MONTHS ENDED ~~SEPTEMBER 30, 2019.~~MARCH 31, 2020.

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,~~March 31, 2021 and 2020 ~~and 2019~~ and the period-over-period dollar and percentage changes for those line items. Our results of operations are reported as one business segment, represented by our single operating segment.


		Three Months Ended September 30,								Change Period to Period					Three Months Ended March 31,			Change Period to Period
		2020				2019
(amounts in dollars)														(amounts in dollars)		2021	2020					Change Period to Period
Revenue:	Revenue:													Revenue:
Product revenue	Product revenue	$	2,521,695	57	%	$	1,663,782	42	%	$	857,913	52	%	Product revenue				$	2,139,729	56	%		$	1,048,963	33	%	$	1,090,766	104	%
Support and services revenue	Support and services revenue	1,914,705		43	%	2,308,663		58	%	(393,958)		(17)	%	Support and services revenue				1,688,597		44	%		2,131,224		67	%	(442,627)		(21)	%
Total revenue	Total revenue	4,436,400		100	%	3,972,445		100	%	463,955		12	%	Total revenue				3,828,326		100	%		3,180,187		100	%	648,139		20	%
Cost of revenue:	Cost of revenue:													Cost of revenue:
Product	Product	48,895		1	%	241,134		6	%	(192,239)		(80)	%	Product				222,834		6	%		139,460		4	%	83,374		60	%
Support and service	Support and service	367,063		8	%	531,709		13	%	(164,646)		(31)	%	Support and service				426,173		11	%		407,920		13	%	18,253		4	%
Total cost of revenue	Total cost of revenue	415,958		9	%	772,843		19	%	(356,885)		(46)	%	Total cost of revenue				649,007		17	%		547,380		17	%	101,627		19	%
Gross profit	Gross profit	4,020,442		91	%	3,199,602		81	%	820,840		26	%	Gross profit				3,179,319		83	%		2,632,807		83	%	546,512		21	%
Operating expenses:	Operating expenses:													Operating expenses:
Research and development costs	Research and development costs	600,430		14	%	782,161		20	%	(181,731)		(23)	%	Research and development costs				659,940		17	%		674,924		21	%	(14,984)		(2)	%
Selling and marketing	Selling and marketing	1,026,241		23	%	1,067,436		27	%	(41,195)		(4)	%	Selling and marketing				1,396,640		36	%		981,191		31	%	415,449		42	%
General and administrative	General and administrative	358,701		8	%	1,454,103		37	%	(1,095,402)		(75)	%	General and administrative				837,867		22	%		1,093,169		34	%	(255,302)		(23)	%

Restructuring costs	Restructuring costs	317,595		7	%	384,829		10	%	(67,234)		(17)	%	Restructuring costs				302,313		8	%		287,460		9	%	14,853		5	%
Total operating expenses	Total operating expenses	2,302,967		52	%	3,688,529		93	%	(1,385,562)		(38)	%	Total operating expenses				3,196,760		84	%		3,036,744		95	%	160,016		5	%
Operating income (loss)	Operating income (loss)	1,717,475		39	%	(488,927)		(12)	%	2,206,402		451	%	Operating income (loss)				(17,441)		—	%		(403,937)		(13)	%	386,496		96	%
Interest and other loss		(159,994)		(4)	%	(123,261)		(3)	%	(36,733)		(30)	%
Gain on debt extinguishment														Gain on debt extinguishment				754,000		20	%		—		—	%	754,000		—	%
Interest and other expense														Interest and other expense				(266,695)		(7)	%		(245,839)		(8)	%	(20,856)		(8)	%
Income (loss) before income taxes	Income (loss) before income taxes	1,557,481		35	%	(612,188)		(15)	%	2,169,669		354	%	Income (loss) before income taxes				469,864		12	%		(649,776)		(20)	%	1,119,640		172	%
Income tax expense (benefit)	Income tax expense (benefit)	11,272		—	%	(55,274)		(1)	%	66,546		120	%	Income tax expense (benefit)				44,616		1	%		70,064		2	%	(25,448)		(36)	%
Net income (loss)	Net income (loss)	$	1,546,209	35	%	$	(556,914)	(14)	%	$	2,103,123	378	%	Net income (loss)				$	425,248	11	%		$	(719,840)	(23)	%	$	1,145,088	159	%
Less: Accrual of Series A redeemable convertible preferred stock dividends	Less: Accrual of Series A redeemable convertible preferred stock dividends	266,007		6	%	266,447		7	%	(440)		—	%	Less: Accrual of Series A redeemable convertible preferred stock dividends				277,170		7	%		285,760		9	%	(8,590)		(3)	%

Less: Accretion to redemption value of Series A redeemable convertible preferred stock	Less: Accretion to redemption value of Series A redeemable convertible preferred stock	175,335		4	%	139,399		4	%	35,936		26	%	Less: Accretion to redemption value of Series A redeemable convertible preferred stock				197,114		5	%		26,090		1	%	171,024		656	%
Net income (loss) attributable to common stockholders	Net income (loss) attributable to common stockholders	$	1,104,867	25	%	$	(962,760)	(24)	%	$	2,067,627	215	%	Net income (loss) attributable to common stockholders				$	(49,036)	(1)	%		$	(1,031,690)	(32)	%	$	982,654	95	%

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, 2020,~~March 31, 2021, we recognized revenue of ~~$4.4~~$3.8 million, compared with ~~$4.0~~$3.2 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, ~~sold as one complete integrated solution or sold on a subscription or consumption basis.~~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.

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For the three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ product revenue represented ~~57%~~56% and ~~42%~~33% of our total revenue, respectively. Product revenue of ~~$2.5~~$2.1 million for the three months ended ~~September 30, 2020~~March 31, 2021 increased ~~$0.9~~$1.1 million, or ~~52%~~104%, from ~~$1.7~~$1.0 million 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. ~~Professional services revenue is recognized in the period that the related services are performed. Engineering~~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, 2020~~March 31, 2021 decreased to ~~$1.9~~$1.6 million, compared to ~~$2.3~~$2.0 million in the prior year period. Our maintenance and technical support service revenue results primarily from (i) the purchase of maintenance and support contracts by our customers, and (ii) the renewal of maintenance and support contracts by our existing and new customers after their initial contracts expire. The decrease in maintenance and technical support service revenue over the previous year reflects a decline in maintenance renewal revenue as a result of conversion to subscription contracts and customer attrition.

~~For~~Professional services revenue for the three months ended ~~September 30, 2020 and 2019, we recognized negligible professional services revenue.~~March 31, 2021 decreased to $0.1 million, compared to $0.2 million in the prior year period. Professional services revenue can vary from period to period based upon (i) the number of solutions sold during the existing and previous periods, (ii) the number of our customers who elect to purchase professional services, (iii) the number of professional services contracts that are performed during the period, and (iv) the number of customers who elect to purchase engineering services. 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, 2020 decreased 46%~~March 31, 2021 increased 19% to ~~$0.4~~$0.6 million, compared with ~~$0.8~~$0.5 million in the prior year period. Total gross profit increased ~~$0.8~~$0.5 million, or ~~26%~~21%, to ~~$4.0~~$3.2 million for the three months ended ~~September 30, 2020,~~March 31, 2021, compared with ~~$3.2~~$2.6 million for the prior year period. Total gross margin ~~increased to 91%~~remained the same at 83% for the three months ended ~~September 30, 2020,~~March 31, 2021, compared with ~~81% for~~ the prior year period. The increase in our ~~total gross margin and~~ total gross profit, in absolute dollars, was primarily due to product mix, and as a result of an intentional shift away from selling hardware, which yields significantly lower profit margins, compared to our key proprietary software license offerings. Generally, our total gross profits and total gross margins fluctuate based on several factors, including (i) revenue growth levels, (ii) changes in personnel headcount and related costs, and (iii) our product offerings and mix of sales.

Cost of Product Revenue, Gross Profit and Gross Margin

Cost of product revenue consists primarily of personnel costs and amortization of capitalized ~~software costs.~~software. Cost of product revenue for the three months ended ~~September 30, 2020 decreased~~March 31, 2021 increased to ~~$48,895,~~$0.2 million, compared with ~~$241,134~~$0.1 million in the prior year period. Product gross margin for the three months ended ~~September 30, 2020~~March 31, 2021 increased, year over year, to ~~98%~~90% from ~~86%~~87% for the same period in ~~2019.~~2020. The ~~decrease~~increase in cost of product revenue and increase in ~~product~~ gross margin for the current year was primarily due to an intentional shift away from hardware sales in the current period, compared to the prior year period.

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

Cost of support and service consists primarily of personnel and other costs associated with providing software implementations, technical support under maintenance contracts and training. Cost of support and service revenue for the three months ended ~~September 30, 2020 decreased 31%~~March 31, 2021 increased 4% to $0.4 million, compared with ~~$0.5~~$0.4 million in the prior year period. Support and service gross margin ~~increased~~decreased to ~~81%~~75% for the three months ended ~~September 30, 2020,~~March 31, 2021, compared with ~~77%~~81% for the prior year period, which was primarily attributable to ~~an reduction~~a decrease in maintenance and support services revenue ~~that was less in proportion to the reduction in~~while costs increased slightly, year over year.

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Operating Expenses

Our operating expenses for the three months ended ~~September 30, 2020 decreased $1.4~~March 31, 2021 increased $0.2 million to ~~$2.3~~$3.2 million from ~~$3.7~~$3.0 million, for the previous year period.

Research and Development Costs

Research and development costs consist primarily of personnel costs for product development, and other related costs associated with the development of new products, enhancements to existing products, quality assurance and testing. Research and development costs decreased ~~$0.2 million,~~$14,984, or ~~23%~~2%, to ~~$0.6~~$0.7 million for the three months ended ~~September 30, 2020,~~March 31, 2021, from ~~$0.8~~$0.7 million in the prior year period. The decrease was primarily related to a decrease in personnel related costs resulting from our realignment and reduction in workforce and continued efforts to allocate the appropriate level of resources based upon the product development roadmap schedule. We continue to provide substantial resources in support of our research and development activities to continue to enhance and to test our core products and in the development of new innovative products, features and options.

Selling and Marketing

Selling and marketing expenses ~~declined $41,195,~~increased $0.4 million, or 4%42%, to ~~$1.0~~$1.4 million for the three months ended ~~September 30, 2020~~March 31, 2021 from ~~$1.1~~$1.0 million in the prior year period. The increase in selling and marketing expenses is primarily due to an increase in commissions and bonuses compared to the prior year period. Selling and marketing expenses consist primarily of sales and marketing personnel and related costs, travel, public relations expense, marketing literature and promotions, commissions, trade show expenses, and the costs associated with our foreign sales offices.

General and Administrative

General and administrative expenses consist primarily of personnel costs of general and administrative functions, public company related costs, directors’ and officers’ insurance, legal and professional fees, and other general corporate overhead costs. General and administrative expenses declined ~~$1.1~~$0.3 million to ~~$0.4~~$0.8 million for the three months ended ~~September 30, 2020,~~March 31, 2021, compared to ~~$1.5~~$1.1 million for the prior year ~~period which is~~period. The decrease in general and administrative expenses was due primarily to employee and contractor positions eliminated as part of the ~~2019 Plan and 2020 Plan.~~Company's restructuring plans. For further information, refer to Note (17) Restructuring Costs, to our unaudited condensed consolidated financial statements.

Restructuring

In June 2017, the Board approved ~~the 2017 Plan~~a comprehensive plan to increase operating performance (the ~~“2017 Plan”~~"2017 Plan"). The 2017 Plan resulted in a realignment and reduction in workforce. The 2017 Plan was substantially completed by the end of our fiscal year ended December 31, 2017 and when combined with previous workforce reductions in the second quarter of Fiscal 2017 reduced our workforce to approximately 81 employees at December 31, 2017. As part of this consolidation effort, the Company vacated a portion of the Melville, NY office space during the three months ended June 30, 2018. In accordance with accounting standards governing costs associated with exit or disposal activities, expenses related to future rental payments for which the Company no longer intends to receive any economic benefit are accrued, net of any anticipated sublease income, when the Company ceases use of the leased space. During the three months ended ~~September 30, 2020,~~March 31, 2021, the Company incurred lease disposal-related costs for this property of $0.3 million.

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

Given the commercial uncertainty caused by the novel coronavirus pandemic, or COVID-19, the Company developed and implemented an even more aggressive expense control plan in March 2020, that it is ~~prepared to keep~~kept in place for the remainder of 2020 (the "2020 Plan"). The 2020 Plan reduced the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 820 of these positions were reinstated ~~in the second and third quarters of~~by December 31, 2020. We believe the reduced expense level will enable FalconStor to remain profitable during the remainder of 2020, even with continued revenue challenges throughout. During the three months ended ~~September 30, 2020,~~March 31, 2021, the Company has not yet incurred severance expense as a result of this action.

Restructuring expense ~~decreased $67,234~~increased $14,853 for the three months ended ~~September 30, 2020~~March 31, 2021 to ~~$317,595,~~$302,313, compared to a restructuring expense of ~~$384,829~~$287,460 in the prior year period. For further information, refer to Note (17) Restructuring Costs, to our unaudited condensed consolidated financial statements.

31Gain on debt extinguishment

Gain on debt extinguishment increased $754,000, to a gain of $754,000 for the three months ended March 31, 2021, compared to $0 in the prior year period. The Company's loan under the Paycheck Protection Program was forgiven on March 30, 2021. For further information, refer to Note(9)Notes Payable, to our unaudited condensed consolidated financial statements.

Interest and other (loss) income, net

Interest and other income (loss), net, ~~decreased $36,733~~increased $20,856 to a loss of ~~$0.2 million~~$266,695 for the three months ended ~~September 30, 2020,~~March 31, 2021, compared with a loss of ~~$0.1 million~~$245,839 in the prior year period. The fluctuation in interest and other income (loss) from quarter to quarter relates to interest expense, foreign currency gains and losses, interest income, sublease income and the change in fair value of our embedded derivatives.

Income Taxes

Our provision for income taxes consists of state and local, and foreign taxes. For the three months ended ~~September 30,~~March 31, 2021 and 2020, ~~and 2019,~~ the Company recorded an income tax ~~benefit of $11,272 and~~ expense of ~~$55,274,~~$44,616 and $70,064, respectively, consisting primarily of state and local, and foreign taxes.

As of ~~September 30, 2020,~~March 31, 2021, our conclusion regarding the realizability of our US deferred tax assets did not change and we have recorded a full valuation allowance against them.

COVID-19

While our Q3Q1 2021 results were an improvement compared to Q1 2020 results, ~~were strong,~~ we are closely monitoring the impact of the 2019 novel coronavirus, or COVID-19, on all aspects of our business. In March 2020, the World Health Organization characterized COVID-19 as a pandemic and the President of the United States declared the COVID-19 outbreak a national emergency. Since then, the COVID-19 pandemic has rapidly spread across the globe and has already resulted in significant volatility, uncertainty and economic disruption. The outbreak of COVID-19 has caused and may continue to cause travel bans or disruptions, and in some cases, prohibitions of non-essential activities, disruption and shutdown of businesses and greater uncertainty in global financial markets. The impact of COVID-19 is fluid and uncertain, but it has caused and may continue to cause various negative effects, including an inability to meet with actual or potential customers, our end customers deciding to delay or abandon their planned purchases or failing to make payments, and delays or disruptions in our or our partners’ supply chains. ~~Please see “Risk Factors-Our results of operations may be negatively impacted by the coronavirus outbreak” for further information.~~

~~RESULTS OF OPERATIONS – FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2020 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2019.~~

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

Nine Months Ended September 30, Change
Period to Period
(amounts in dollars)
2020 2019
Revenue:
Product revenue $ 5,202,713 47 % $ 4,879,996 39 % $ 322,717 7 %
Support and services revenue 5,913,486 53 % 7,584,816 61 % (1,671,330) (22) %
Total revenue 11,116,199 100 % 12,464,812 100 % (1,348,613) (11) %
Cost of revenue:
Product 250,185 2 % 1,076,604 9 % (826,419) (77) %
Support and service 1,109,379 10 % 1,639,299 13 % (529,920) (32) %
Total cost of revenue 1,359,564 12 % 2,715,903 22 % (1,356,339) (50) %
Gross profit 9,756,635 88 % 9,748,909 78 % 7,726 — %
Operating expenses: 10 %
Research and development costs 1,809,354 16 % 2,503,008 20 % (693,654) (28) %
Selling and marketing 3,027,372 27 % 3,436,783 28 % (409,411) (12) %
General and administrative 2,297,451 21 % 4,280,188 34 % (1,982,737) (46) %
Restructuring costs 758,740 7 % 745,201 6 % 13,539 2 %
Total operating expenses 7,892,917 71 % 10,965,180 88 % (3,072,263) (28) %
Operating income (loss) 1,863,718 17 % (1,216,271) (10) % 3,079,989 253 %
Interest and other expense (586,082) (5) % (468,717) (4) % (117,365) (25) %
Income (loss) before income taxes 1,277,636 11 % (1,684,988) (14) % 2,962,624 176 %
Income tax expense (benefit) 44,709 — % 168,556 1 % (123,847) (73) %
Net income (loss) $ 1,232,927 11 % $ (1,853,544) (15) % $ 3,086,471 167 %
Less: Accrual of Series A redeemable convertible preferred stock dividends 812,362 7 % 770,027 6 % 42,335 5 %
Less: Accretion to redemption value of Series A redeemable convertible preferred stock 366,566 3 % 402,861 3 % (36,295) (9) %
Net income (loss) attributable to common stockholders $ 53,999 — % $ (3,026,432) (24) % $ 3,080,431 102 %

~~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, 2020, we recognized revenue of $11.1 million, compared with $12.5 million in the prior year period.

~~Product revenue~~

Product revenue is comprised of sales of both licenses for our software solutions and sales of the platforms on which the software is installed. This includes stand-alone software applications and software integrated with industry standard hardware, sold as one complete integrated solution or sold on a subscription or consumption basis. Our products are sold through (i) value-added resellers, (ii) distributors, and/or (iii) directly to end-users. These revenues are recognized when all the applicable criteria under accounting principles generally accepted in the United States are met.

For the nine months ended September 30, 2020 and 2019, product revenue represented 47% and 39% of our total revenue, respectively. Product revenue of $5.2 million for the nine months ended September 30, 2020 increased $0.3 million, or 7%, from $4.9 million in the prior year period.

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

~~Support and services revenue~~

Support and services revenue is comprised of revenue from (i) maintenance and technical support services, (ii) professional services primarily related to the implementation of our software, and (iii) engineering services. Revenue derived from maintenance and technical support contracts are deferred and recognized ratably over the contractual maintenance term. Professional services revenue is recognized in the period that the related services are performed. Engineering services are recognized upon customer acceptance.

Maintenance and technical support services revenue for the nine months ended September 30, 2020 decreased to $5.7 million, compared to $7.3 million in the prior year period. Our maintenance and technical support service revenue results primarily from (i) the purchase of maintenance and support contracts by our customers, and (ii) the renewal of maintenance and support contracts by our existing and new customers after their initial contracts expire. The decrease in maintenance and technical support service revenue over the previous year reflects a decline in maintenance renewal revenue as a result of customer attrition.

Professional services revenue for the nine months ended September 30, 2020 decreased to $0.2 million, compared to $0.3 million in the prior year period. Professional services revenue can vary from period to period based upon (i) the number of solutions sold during the existing and previous periods, (ii) the number of our customers who elect to purchase professional services, (iii) the number of professional services contracts that are performed during the period, and (iv) the number of customers who elect to purchase engineering services.

~~Cost of Revenue, Gross Profit and Gross Margin~~

Total cost of revenue for the nine months ended September 30, 2020 decreased 50% to $1.4 million, compared with $2.7 million in the prior year period. Total gross profit increased $7,726, or 0.1%, to $9.8 million for the nine months ended September 30, 2020, compared with $9.7 million for the prior year period. Total gross margin increased to 88% for the nine months ended September 30, 2020, compared with 78% for the prior year period. The increase in our total gross margin and increase in our total gross profit, in absolute dollars, was primarily due to product mix, and as a result of an intentional shift away from selling hardware, which yields significantly lower profit margins, compared to our key proprietary software license offerings. Generally, our total gross profits and total gross margins fluctuate based on several factors, including (i) revenue growth levels, (ii) changes in personnel headcount and related costs, and (iii) our product offerings and mix of sales.

~~Cost of Product Revenue, Gross Profit and Gross Margin~~

Cost of product revenue consists primarily of personnel costs and amortization of capitalized software. Cost of product revenue for the nine months ended September 30, 2020 decreased to $250,185, compared with $1,076,604 in the prior year period. Product gross margin for the nine months ended September 30, 2020 increased, year over year, to 95% from 78% for the same period in 2019. The decrease in cost of product revenue and increase in gross margin for the current year was primarily due to an intentional shift away from hardware sales in the current period, compared to the prior year period.

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

Cost of support and service consists primarily of personnel and other costs associated with providing software implementations, technical support under maintenance contracts and training. Cost of support and service revenue for the nine months ended September 30, 2020 decreased 32% to $1.1 million, compared with $1.6 million in the prior year period. Support and service gross margin increased to 81% for the nine months ended September 30, 2020, compared with 78% for the prior year period, primarily attributable to a reduction in maintenance and support services revenue, year over year.

~~Operating Expenses~~

~~Our operating expenses for the nine months ended September 30, 2020 decreased $3.1 million to $7.9 million from $11.0 million, for the previous year period.~~

~~Research and Development Costs~~

Research and development costs consist primarily of personnel costs for product development, and other related costs associated with the development of new products, enhancements to existing products, quality assurance and testing. Research and development costs decreased $0.7 million, or 28%, to $1.8 million for the nine months ended September 30, 2020, from $2.5 million in the prior year period. The decrease was primarily related to a decrease in personnel related costs resulting from our realignment and reduction in workforce and continued efforts to allocate the appropriate level of resources based upon the product development roadmap schedule. We continue to provide substantial resources in support of our research and development activities to continue to enhance and to test our core products and in the development of new innovative products, features and options.

~~Selling and Marketing~~

Selling and marketing expenses declined $0.4 million, or 12%, to $3.0 million for the nine months ended September 30, 2020 from $3.4 million in the prior year period. Selling and marketing expenses consist primarily of sales and marketing personnel and related costs, travel, public relations expense, marketing literature and promotions, commissions, trade show expenses, and the costs associated with our foreign sales offices.

~~General and Administrative~~

~~Restructuring~~

In June 2017, the Board approved the 2017 Plan to increase operating performance. The 2017 Plan resulted in a realignment and reduction in workforce. The 2017 Plan was substantially completed by the end of our fiscal year ended December 31, 2017 and when combined with previous workforce reductions in the second quarter of Fiscal 2017 reduced our workforce to approximately 81 employees at December 31, 2017. As part of this consolidation effort, the Company vacated a portion of the Melville, NY office space during the three months ended June 30, 2018. In accordance with accounting standards governing costs associated with exit or disposal activities, expenses related to future rental payments for which the Company no longer intends to receive any economic benefit are accrued, net of any anticipated sublease income, when the Company ceases use of the leased space. During the nine months ended September 30, 2020, the Company incurred lease disposal-related costs for this property of $0.7 million.

During the three months ended September 30, 2019, the Company adopted a plan to better align the Company’s cost structure with the skills and resources required to more effectively execute the Company’s long-term growth strategy and to support revenue levels the Company expected to achieve on a go forward basis (the "2019 Plan"), implemented tighter expense controls, ceased non-core activities and downsized several facilities. During the nine months ended September 30, 2020, the Company incurred $76,708 in severance expense as a result of this action. The 2019 Plan was substantially completed as of March 31, 2020.

In March 2020, given the commercial uncertainty caused by the novel coronavirus pandemic, or COVID-19, the Company developed and implemented the 2020 Plan, which is an even more aggressive expense control plan, that it is prepared to keep in place for the remainder of 2020. The 2020 Plan reduced the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 8 of these positions were reinstated in the second quarter of 2020. We believe the reduced expense level will enable FalconStor to remain profitable during the remainder of 2020, even with continued revenue challenges throughout. During the nine months ended September 30, 2020, the Company has not yet incurred severance expense as a result of this action.

Restructuring expense increased $13,539 for the nine months ended September 30, 2020 to $758,740, compared to a restructuring expense of $745,201 in the prior year period. For further information, refer to Note (17) ~~Restructuring Costs, to our unaudited condensed consolidated financial statements.~~

~~Interest and other (loss) income, net~~

Interest and other income (loss), net, increased $117,365 to a loss of $586,082 for the nine months ended September 30, 2020, compared with a loss of $468,717 in the prior year period. The fluctuation in interest and other income (loss) from quarter to quarter relates to interest expense, foreign currency gains and losses, interest income, sublease income and the change in fair value of our embedded derivatives.

~~Income Taxes~~

Our provision for income taxes consists of state and local, and foreign taxes. For the nine months ended September 30, 2020 and 2019, the Company recorded income tax expense of $44,709 and $0.2 million, respectively, consisting primarily of state and local, and foreign taxes.

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

~~COVID-19~~

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

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, 2020~~March 31, 2021 and December 31, ~~2019~~2020 totaled ~~$0.9~~$2.0 million and ~~$1.5~~$1.9 million, respectively.

OnWe are currently a party to the Amended and Restated Term Loan Credit Agreement, dated as of February 23, 2018, as amended December 27, 2019, ~~the Company entered into the Amendment,~~ by and among our company, HCP-FVA, LLC (“HCP-FVA”), EW Capital, LLC, the lenders party thereto and the other loan parties named therein (the “Amended and Restated Loan Agreement”). The maturity date of our obligations under the Amended and Restated Loan Agreement is June 30, 2021 and as of March 31, 2021, we are obligated to repay the loan parties $3.5 million, of which $2.2 million is owed to HCP-FVA. The Company also has outstanding Series A Redeemable Convertible Preferred Stock (the “Series A Preferred Stock”) which currently can be redeemed by the holders of the Series A Preferred Stock at July 30, 2021. If such Series A Preferred Stock was redeemed at March 31, 2021, the Company ~~certain~~would be required to pay the holders of the ~~Company’s affiliates in their capacities as guarantors, HCP-FVA,~~Series A Preferred Stock $13.6 million.

The Amended and Restated Term 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 Term 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 Restated Term 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 Term Loan Credit Agreement, and seek other available remedies.

The restrictions in the Amended and Restated Term Loan Agreement may prevent us from taking actions that we believe would be in the best interests of our business, and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted. In addition, our ability to comply with the ~~Lenders party thereto, ESW, as co-agent,~~financial and other covenants and restrictions in the ~~Lenders,~~Amended and Restated Term Loan Agreement will largely depend on the pricing of our products and services, and our ability to ~~provide for, among other things, a new term loan facility of up to $2,500,000~~successfully implement our overall business strategy. We cannot assure you that we will be granted waivers or amendments to the ~~Company.~~Amended and Restated Term Loan Agreement if for any reason we are unable to comply with these covenants and restrictions. The ~~Amendment also provides for certain financial covenants. On December 27, 2019,~~breach of any of these covenants and restrictions could result in a default under the ~~Company drew down $1,000,000~~Amended and Restated Term Loan Agreement, which could result in an acceleration of our indebtedness.

HCP-FVA is an affiliated party of Hale Capital Partners and Hale Capital Partners and affiliated entities (“HCP”) have agreed if necessary to extend the maturity date of the ~~2019 Term~~indebtedness owed to HCP-FVA under the Amended and Restated Loan ~~and~~Agreement from June 30, 2021 to at least July 1, 2022. Similarly, HCP has agreed if necessary to extend the ~~Company will pay a fixed amount of interest on such advance equal to 15%~~commencement of the ~~principal amount advanced. Pursuant~~optional redemption date of the Series A Preferred Stock from July 31, 2021 to at least July 1, 2022. Under the ~~Amendment, we repaid $1,000,000 on September 27, 2020.~~terms of the Series A Preferred Stock, no holder of Series A Preferred Stock can exercise their redemption right without the consent of HCP-FVA.

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

Liquidity

As of ~~September 30, 2020,~~March 31, 2021, we had a working capital deficiency of ~~$5.2~~$3.6 million, which is inclusive of current deferred revenue of ~~$4.0~~$4.2 million, and a stockholders' deficit of ~~$14.0~~$14.6 million. During the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, the Company had a net income of ~~$1.2~~$0.4 million and ~~negative~~positive cash flow from operations of ~~$0.3~~$0.1 million. The Company's total cash balance at ~~September 30, 2020~~March 31, 2021 was ~~$0.9~~$2.0 million, ~~a decrease~~an increase of ~~$603,885~~$100,333 compared to December 31, ~~2019.~~2020. On April 28, 2020, the company entered into the Loan with Peapack-Gladstone Bank in an aggregate principal amount of $754,000, pursuant to the PPP under the CARES ~~act. The~~act, which was forgiven by the Small Business Administration in March 2021.

In December 2019, the Company entered into an amendment to the Amended and Restated Credit Agreement which provided for a new $2,500,000 term loan facility to the Company with an interest rate of 15% (the “2019 Term Loan”). In addition, while any portion of the 2019 Term Loan is outstanding the Company must satisfy additional financial covenants under the Amended and Restated Credit Agreement. In December 2019, the Company drew down $1,000,000 of the 2019 Term Loan, all of which was repaid in September 2020. Accordingly, no amounts are currently outstanding under the 2019 Term Loan.

~~The Company's ability to continue as a going concern, depends on its ability to execute its business plan, increase revenue and billings and reduce expenditures.~~ In the ~~second~~third quarter of 2019, the Company adopted a plan to better align the Company’s cost structure with the skills and resources required to more effectively execute the Company’s long-term growth strategy and to support revenue levels the Company expected to achieve on a go forward basis (the "2019 Plan"). In connection with the 2019 Plan, the Company eliminated 23 positions worldwide, implemented tighter expense controls, ceased non-core activities and downsized several facilities. As of December 31, 2020, the 2019 Plan is considered to be completed.

Given the commercial uncertainty caused by the novel coronavirus pandemic, or COVID-19, the Company ~~approved~~developed and implemented the 2020 Plan, ~~which included actions to reduce its cost structure. The 2020 Plan addresses weakened global economic conditions stemming from~~that it kept in place for the ~~COVID-19 pandemic and related pace~~remainder of ~~recovery in a few of it's markets along with further opportunities to optimize~~2020. This plan reduced the Company's ~~long-term growth strategy.~~annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 820 of these positions were reinstated ~~in the second quarter of~~by December 31, 2020. ~~During the nine months ended September 30,~~The 2020 ~~the Company has not yet incurred severance expense as a result of this action.~~Plan was completed on December 31, 2020.

~~A primary focus for the Company in 2020 will be to maintain appropriate balance sheet flexibility, including cash~~

Based on ~~hand, due to the uncertain nature and unpredictable timing of the COVID-19 pandemic.~~

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

~~We believe that our cash flows from operations~~activities, cost cutting measures in place and existing cash on hand, ~~are~~the Company is projecting to have sufficient liquidity and to ~~conduct our planned operations and meet our contractual requirements~~be cash flow positive through ~~at least November 9, 2021.~~May 5, 2022.

Cash Flow Analysis

Cash flow information is as follows:


		Nine Months Ended September 30,					Three Months Ended March 31,
		2020		2019			2021		2020
Cash provided by (used in):	Cash provided by (used in):					Cash provided by (used in):
Operating activities	Operating activities	(303,174)		(1,432,514)		Operating activities	137,659		(398,331)
Investing activities	Investing activities	(63,130)		(187,998)		Investing activities	(39,533)		(94,268)
Financing activities	Financing activities	(246,000)		(489,321)		Financing activities	—		—
Effect of exchange rate changes	Effect of exchange rate changes	8,419		10,557		Effect of exchange rate changes	2,207		(6,446)
Net increase (decrease) in cash and cash equivalents	Net increase (decrease) in cash and cash equivalents	$	(603,885)	$	(2,099,276)	Net increase (decrease) in cash and cash equivalents	$	100,333	$	(499,045)

Net cash ~~used in~~provided by operating activities totaled ~~$0.3~~$0.1 million for the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, compared with ~~$1.4~~$0.4 million of net cash used in operating activities in the prior year period. The changes in net cash ~~used in~~provided by operating activities for the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, was primarily due to our net income (loss) and adjustments for net changes in operating assets and liabilities, primarily changes in our accounts receivable, deferred revenue, prepaid expenses, inventory, other assets, accounts payable, accrued expenses and other long-term liabilities contributed to the decrease.

Net cash used in investing activities totaled ~~$63,130~~$0.0 million for the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, compared with net cash used in investing activities of ~~$187,998~~$0.1 million in the prior year period. Included in investing activities are purchases of property and equipment, intangible assets and cash ~~paid for~~received from security ~~deposits and purchases of intangible assets.~~deposits.

Net cash used in financing activities totaled ~~$0.2~~$0.0 million for the ~~nine~~three months ended ~~September 30, 2020,~~March 31, 2021, compared with net cash used in financing activities of ~~$0.5~~$0.0 million in the prior year period. The nine months ended September 30, 2020 reflects the $0.8 million in proceeds from the PPP loan and the $1.0 payoff of the term loan. The nine months ended September 30, 2019 reflects the partial repayment of $0.5 million of principal under our Term Loan in January 2019.

Total cash and cash equivalents ~~decreased $603,885~~increased $0.1 million to ~~$0.9~~$2.0 million at ~~September 30, 2020~~March 31, 2021 compared to December 31, ~~2019.~~2020.

Contractual Obligations

As of ~~September 30, 2020,~~March 31, 2021, our significant commitments are related to (i) the Amended and Restated Term Loan Credit Agreement, (ii) our operating leases for our office facilities, (iii) dividends (including accrued dividends) on our Series A Preferred Stock, and (iv) the potential redemption of the Series A Preferred Stock as discussed above.

The following is a schedule summarizing our significant obligations to make future payments under contractual obligations as of ~~September 30, 2020:~~March 31, 2021:

Operating Leases Note Payable (a) Interest Payments (a) Long-Term Income Tax Payable (b) Series A Preferred Stock Mandatory Redemption Dividends on Series A Preferred Stock
2020 $ 424,592 $ — $ 35,107 $ — $ — $ —
2021 659,754 3,510,679 70,213 — — —
2022 — 754,000 — — — —
Other — — — 110,141 9,000,000 4,906,673
Total contractual obligations $ 1,084,346 $ 4,264,679 $ 105,320 $ 110,141 $ 9,000,000 $ 4,906,673
Sublease income $ (605,761) $ — $ — $ — $ — $ —
Net contractual obligations $ 478,585 $ 4,264,679 $ 105,320 $ 110,141 $ 9,000,000 $ 4,906,673


	Operating Leases		Note Payable (a)		Interest Payments (a)		Long-Term Income Tax Payable (b)		Series A Preferred Stock Mandatory Redemption		Dividends on Series A Preferred Stock
2021	237,525		3,510,679		35,107		—		—		—
2022	—		—		—		—		—		—


Other	—		—		—		112,712		9,000,000		5,002,282
Total contractual obligations	$	237,525	$	3,510,679	$	35,107	$	112,712	$	9,000,000	$	5,002,282
Sublease income	$	(25,105)	$	—	$	—	$	—	$	—	$	—
Net contractual obligations	$	212,420	$	3,510,679	$	35,107	$	112,712	$	9,000,000	$	5,002,282

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

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

Critical Accounting Policies and Estimates

We describe our significant accounting policies in Note (1), "Summary of Significant Accounting Policies" of our ~~2019~~2020 Form 10-K. We discuss our critical accounting estimates in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our ~~2019~~2020 Form 10-K. There have been no significant changes in our significant accounting policies or critical accounting estimates since December 31, ~~2019, other than those noted below.~~2020.

~~Revenue Recognition~~

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

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

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

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

Impact of Recently Issued Accounting Pronouncements

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

Off-Balance Sheet Arrangements

As of ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019,~~2020, we had no off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Risk.

We have several offices outside the United States. Accordingly, we are subject to exposure from adverse movements in foreign currency exchange rates. For the ~~nine~~three months ended ~~September 30,~~March 31, 2021 and 2020, approximately 55% and ~~2019, approximately 63% and 77%~~66%, respectively, of our sales were from outside North America. Not all of these transactions were made in foreign currencies. Our primary exposure is to fluctuations in exchange rates for the U.S. Dollar versus the Euro and Japanese Yen, and to a lesser extent the Canadian Dollar, the Korean Won and the British Pound. Changes in exchange rates in the functional currency for each geographic area’s revenues are primarily offset by the related expenses associated with such revenues. However, changes in exchange rates of a particular currency could impact the re-measurement of such balances on our balance sheets.

If foreign currency exchange rates were to change adversely by 10% from the levels at ~~September 30, 2020,~~March 31, 2021, the effect on our results before taxes from foreign currency fluctuations on our balance sheet would be approximately $1.7 million. The above analysis disregards the possibility that rates for different foreign currencies can move in opposite directions and that losses from one currency may be offset by gains from another currency.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

~~Disclosure~~The Company maintains “disclosure controls and procedures, ~~are 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 ~~by us~~ in ~~the~~its reports, ~~that we file or submit under~~pursuant to the ~~Securities~~ Exchange Act, ~~of 1934, as amended (the "Exchange Act"),~~

is recorded, processed, summarized and reported within the time periods specified in the ~~SEC's~~SEC’s rules and ~~forms. Disclosure controls~~forms, and ~~procedures include, without limitation, controls and procedures designed to ensure~~ that such information ~~required to be disclosed by us in the reports that we file under the Exchange Act~~ is accumulated and communicated to ~~our~~its management, including ~~our principal executive officer~~its Chief Executive Officer and ~~principal financial officer,~~Chief Financial Officer, as appropriate, to allow timely decisions regarding the required ~~disclosure.~~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.

~~Under the supervision and with the participation of our management, including our~~The Company’s Chief Executive Officer (its principal executive officer) and Chief Financial Officer (its principal financial officer and principal ~~financial officer, we~~accounting officer) have evaluated the effectiveness of ~~the design and operation of our disclosure~~its “disclosure controls and ~~procedures~~procedures” as of the end of the period covered by this report, and, based on their evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are not effective as of the end of the period covered by this report. ~~We describe this deficiency and the steps we have taken to remedy such deficiency in our discussion of internal control over financial reporting below.~~

Internal Control Over Financial Reporting

Management’s Report on Internal Control Over Financial Reporting

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

The Company’s management has assessed the effectiveness of the Company’s internal control over financial reporting as of ~~September 30, 2020,~~March 31, 2021, using the COSO framework (2013). The Company’s management has determined that the Company’s internal control over financial reporting is ~~not~~ effective as of that ~~date because of the following material weakness:~~date.

During the three months ended September 30, 2020, the Company did not fully document all the COSO framework (2013) mandated system controls in place nor did the Company have an independent party complete testing of the controls as of

~~September 30, 2020.~~ The Company has implemented certain mitigating controls such as secondary reviews by senior management, variance analysis reporting and cash-flow monitoring, which insured that both internal and external financial reporting included all the information and disclosures required by generally accepted accounting principles in the United States of America.

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

~~Remediation~~Changes in Internal Control over Financial Reporting

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

materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

~~Item 1. Legal Proceedings~~

~~See the discussion of the Company’s material litigation in Note (15)~~ ~~Litigation,~~ ~~to the unaudited condensed consolidated financial statements, which is incorporated by reference in Item 1.~~None.

Item 1A. Risk Factors

We are affected by risks specific to us as well as factors that affect all businesses operating in a global market. The significant factors known to us that could materially adversely affect our business, financial condition, or operating results are set forth ~~below and~~ in Item 1A to our ~~2019~~2020 Form 10-K.

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

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

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

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.

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Item 6. Exhibits


31.1			Certification of the Chief Executive Officer

31.2			Certification of the Chief Financial Officer

32.1			Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350)

32.2			Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. § 1350)

101.1			The following financial statements from FalconStor Software, Inc’s Quarterly Report on Form 10-Q for the quarterly period ended ~~September 30, 2020,~~March 31, 2021, formatted in XBRL (eXtensible Business Reporting Language):


			(i)			unaudited Condensed Consolidated Balance Sheets – ~~September 30, 2020~~March 31, 2021 and December 31, ~~2019.~~2020.

			(ii)			unaudited Condensed Consolidated Statement of Operations – Three ~~and Nine~~ Months Ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~2020.

			(iii)			unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) – Three ~~and Nine~~ Months Ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~2020.

			(iv)			unaudited Condensed Consolidated Statements of Stockholder's Deficit - Three ~~and Nine~~ Months Ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~2020.

			(v)			unaudited Condensed Consolidated Statement of Cash Flows – Three ~~and Nine~~ Months Ended ~~September 30, 2020~~March 31, 2021 and ~~2019.~~2020.

			(vi)			Notes to unaudited Condensed Consolidated Financial Statements – ~~September 30, 2020.~~March 31, 2021.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


			FALCONSTOR SOFTWARE, INC.
			(Registrant)

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


			/s/ Todd Brooks
			Todd Brooks
			President & Chief Executive Officer
~~November 9, 2020~~May 5, 2021			(principal executive officer)

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