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, 2021~~March 31, 2022

☐ 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~~501 Congress Avenue

Suite ~~400~~150

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 ~~November 10, 2021~~May 4, 2022 was ~~7,082,276.~~7,083,692.

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, 2021~~March 31, 2022 (unaudited) and December 31, ~~2020~~2021	4

	Unaudited Condensed Consolidated Statements of Operations for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2022 and 2021 ~~and 2020~~	5

	Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2022 and 2021 ~~and 2020~~	6

	Unaudited Condensed Consolidated Statements of Stockholders' Deficit for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2022 and 2021 ~~and 2020~~	7

	Unaudited Condensed Consolidated Statements of Cash Flows for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2022 and 2021 ~~and 2020~~	109

	Notes to the Unaudited Condensed Consolidated Financial Statements	1110

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	3028

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	4235

Item 4.	Controls and Procedures	4335

PART II.	Other Information	4437

Item 1.	Legal Proceedings	4437

Item 1A.	Risk Factors	4437

Item 2	Unregistered Sales of Equity Securities and use of Proceeds	37

Item 3	Defaults Upon Senior Securities	37

Item 4	Mine Safety Disclosures	37

Item 5	Other Information	37

Item 6.	Exhibits	4538

SIGNATURES		4639

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS


		September 30, 2021		December 31, 2020			March 31, 2022		December 31, 2021
		(unaudited)					(unaudited)
Assets	Assets					Assets
Current assets:	Current assets:					Current assets:
Cash and cash equivalents	Cash and cash equivalents	$	3,474,784	$	1,920,656	Cash and cash equivalents	$	3,381,639	$	3,181,209

Accounts receivable, net of allowances	Accounts receivable, net of allowances	2,285,117		2,836,571		Accounts receivable, net of allowances	825,598		2,855,135
Prepaid expenses and other current assets	Prepaid expenses and other current assets	1,537,267		1,837,596		Prepaid expenses and other current assets	1,264,231		1,074,972
Contract assets	Contract assets	169,835		254,483		Contract assets	426,264		209,936
Inventory	Inventory	15,421		15,275		Inventory	—		7,744

Total current assets	Total current assets	7,482,424		6,864,581		Total current assets	5,897,732		7,328,996
Property and equipment, net	Property and equipment, net	193,028		197,020		Property and equipment, net	128,203		153,904
Operating lease right-of-use assets, net	Operating lease right-of-use assets, net	140,238		536,272		Operating lease right-of-use assets, net	90,893		112,405
Deferred tax assets	Deferred tax assets	310,755		330,552		Deferred tax assets	29,173		30,190
Software development costs, net	Software development costs, net	14,345		19,278		Software development costs, net	41,056		42,695
Other assets	Other assets	114,828		863,964		Other assets	99,834		106,023
Goodwill	Goodwill	4,150,339		4,150,339		Goodwill	4,150,339		4,150,339
Other intangible assets, net	Other intangible assets, net	64,295		100,134		Other intangible assets, net	40,826		51,362
Long-term contract assets	Long-term contract assets	192,286		343,934		Long-term contract assets	463,264		692,712
Total assets	Total assets	$	12,662,538	$	13,406,074	Total assets	$	10,941,320	$	12,668,626
Liabilities and Stockholders' Deficit	Liabilities and Stockholders' Deficit					Liabilities and Stockholders' Deficit
Current liabilities:	Current liabilities:					Current liabilities:
Accounts payable	Accounts payable	$	335,092	$	453,791	Accounts payable	$	638,632	$	297,033
Accrued expenses	Accrued expenses	1,018,878		2,293,765		Accrued expenses	801,815		1,099,257
Current portion of lease liabilities	Current portion of lease liabilities	87,381		665,074		Current portion of lease liabilities	74,349		76,940
Short-term loan, net of debt issuance costs and discounts		—		3,320,863

Deferred revenue	Deferred revenue	3,709,005		4,603,270		Deferred revenue	4,049,503		4,557,317
Total current liabilities	Total current liabilities	5,150,356		11,336,763		Total current liabilities	5,564,299		6,030,547
Other long-term liabilities	Other long-term liabilities	637,099		703,889		Other long-term liabilities	957,860		950,843
Notes payable, net of debt issuance costs and discounts	Notes payable, net of debt issuance costs and discounts	2,150,574		754,000		Notes payable, net of debt issuance costs and discounts	2,156,246		2,154,098

Operating lease liabilities, net of current portion	Operating lease liabilities, net of current portion	53,430		—		Operating lease liabilities, net of current portion	16,544		35,465
Deferred tax liabilities	Deferred tax liabilities	525,512		513,027		Deferred tax liabilities	500,499		500,499
Deferred revenue, net of current portion	Deferred revenue, net of current portion	1,569,813		1,765,859		Deferred revenue, net of current portion	1,395,179		1,578,769
Total liabilities	Total liabilities	10,086,784		15,073,538		Total liabilities	10,590,627		11,250,221
Commitments and contingencies (Note 11)	Commitments and contingencies (Note 11)	0		0		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 $14,195,475 and $13,346,577, respectively		14,075,434		12,940,722
Series A redeemable convertible preferred stock, $0.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $14,791,195						Series A redeemable convertible preferred stock, $0.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $14,791,195	14,700,124		14,384,388
Stockholders' deficit:	Stockholders' deficit:					Stockholders' deficit:
Common stock - $0.001 par value, 30,000,000 shares authorized, 7,074,364 shares and 5,949,463 shares issued and outstanding, respectively		7,074		5,949
Common stock - $0.001 par value, 30,000,000 shares authorized, 7,082,276 shares issued and outstanding						Common stock - $0.001 par value, 30,000,000 shares authorized, 7,082,276 shares issued and outstanding	7,082		7,082
Additional paid-in capital	Additional paid-in capital	112,671,753		110,107,170		Additional paid-in capital	112,042,061		112,349,613
Accumulated deficit	Accumulated deficit	(122,283,348)		(122,733,344)		Accumulated deficit	(124,572,044)		(123,462,638)
Accumulated other comprehensive loss	Accumulated other comprehensive loss	(1,895,159)		(1,987,961)		Accumulated other comprehensive loss	(1,826,530)		(1,860,040)
Total stockholders' deficit	Total stockholders' deficit	(11,499,680)		(14,608,186)		Total stockholders' deficit	(14,349,431)		(12,965,983)
Total liabilities and stockholders' deficit	Total liabilities and stockholders' deficit	$	12,662,538	$	13,406,074	Total liabilities and stockholders' deficit	$	10,941,320	$	12,668,626

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,
		2021		2020		2021		2020			2022		2021
Revenue:	Revenue:									Revenue:
Product revenue	Product revenue	$	1,547,013	$	2,521,695	$	5,288,747	$	5,202,713	Product revenue	$	594,928	$	2,139,729
Support and services revenue	Support and services revenue	1,736,456		1,914,705		5,081,795		5,913,486		Support and services revenue	1,454,179		1,688,597
Total revenue	Total revenue	3,283,469		4,436,400		10,370,542		11,116,199		Total revenue	2,049,107		3,828,326
Cost of revenue:	Cost of revenue:									Cost of revenue:
Product	Product	41,351		48,895		298,966		250,185		Product	20,719		222,834
Support and service	Support and service	400,934		367,063		1,233,067		1,109,379		Support and service	394,549		426,173
Total cost of revenue	Total cost of revenue	442,285		415,958		1,532,033		1,359,564		Total cost of revenue	415,268		649,007
Gross profit	Gross profit	2,841,184		4,020,442		8,838,509		9,756,635		Gross profit	1,633,839		3,179,319
Operating expenses:	Operating expenses:									Operating expenses:
Research and development costs	Research and development costs	711,273		600,430		2,032,360		1,809,354		Research and development costs	705,981		659,940
Selling and marketing	Selling and marketing	1,610,635		1,026,241		4,267,010		3,027,372		Selling and marketing	1,189,846		1,396,640
General and administrative	General and administrative	633,954		358,701		2,129,921		2,297,451		General and administrative	849,939		837,867
Gain on litigation settlement		(632,600)		—		(632,600)		—

Restructuring costs	Restructuring costs	68,704		317,595		792,754		758,740		Restructuring costs	744		302,313
Total operating expenses	Total operating expenses	2,391,966		2,302,967		8,589,445		7,892,917		Total operating expenses	2,746,510		3,196,760
Operating income (loss)	Operating income (loss)	449,218		1,717,475		249,064		1,863,718		Operating income (loss)	(1,112,671)		(17,441)
Gain on debt extinguishment	Gain on debt extinguishment	—		—		754,000		—		Gain on debt extinguishment	—		754,000
Interest and other expense	Interest and other expense	(58,257)		(159,994)		(489,264)		(586,082)		Interest and other expense	(117,995)		(283,648)
Income (loss) before income taxes	Income (loss) before income taxes	390,961		1,557,481		513,800		1,277,636		Income (loss) before income taxes	(1,230,666)		452,911
Income tax expense (benefit)	Income tax expense (benefit)	16,529		11,272		63,804		44,709		Income tax expense (benefit)	(121,260)		44,616
Net income (loss)	Net income (loss)	$	374,432	$	1,546,209	$	449,996	$	1,232,927	Net income (loss)	$	(1,109,406)	$	408,295
Less: Accrual of Series A redeemable convertible preferred stock dividends	Less: Accrual of Series A redeemable convertible preferred stock dividends	288,802		266,007		848,898		812,362		Less: Accrual of Series A redeemable convertible preferred stock dividends	300,921		277,170

Less: Accretion to redemption value of Series A redeemable convertible preferred stock	Less: Accretion to redemption value of Series A redeemable convertible preferred stock	13,517		175,335		285,814		366,566		Less: Accretion to redemption value of Series A redeemable convertible preferred stock	14,815		197,114
Net income (loss) attributable to common stockholders	Net income (loss) attributable to common stockholders	$	72,113	$	1,104,867	$	(684,716)	$	53,999	Net income (loss) attributable to common stockholders	$	(1,425,142)	$	(65,989)
Basic net income (loss) per share attributable to common stockholders	Basic net income (loss) per share attributable to common stockholders	$	0.01	$	0.19	$	(0.11)	$	0.01	Basic net income (loss) per share attributable to common stockholders	$	(0.20)	$	(0.01)
Diluted net income (loss) per share attributable to common stockholders	Diluted net income (loss) per share attributable to common stockholders	$	0.01	$	0.19	$	(0.11)	$	0.01	Diluted net income (loss) per share attributable to common stockholders	$	(0.20)	$	(0.01)
Weighted average basic shares outstanding	Weighted average basic shares outstanding	6,990,723		5,919,837		6,324,370		5,919,773		Weighted average basic shares outstanding	7,082,276		5,949,463
Weighted average diluted shares outstanding	Weighted average diluted shares outstanding	7,039,421		5,959,385		6,324,370		5,943,794		Weighted average diluted shares outstanding	7,082,276		5,949,463

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,
		2021		2020		2021		2020			2022		2021
Net income (loss)	Net income (loss)	$	374,432	$	1,546,209	$	449,996	$	1,232,927	Net income (loss)	$	(1,109,406)	$	408,295
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	11,144		(24,234)		92,802		(45,474)		Foreign currency translation	33,510		86,398

Total other comprehensive income (loss), net of applicable taxes:	Total other comprehensive income (loss), net of applicable taxes:	11,144		(24,234)		92,802		(45,474)		Total other comprehensive income (loss), net of applicable taxes:	33,510		86,398
Total comprehensive income		$	385,576	$	1,521,975	$	542,798	$	1,187,453
Total comprehensive income (loss)										Total comprehensive income (loss)	$	(1,075,896)	$	494,693
Less: Accrual of Series A redeemable convertible preferred stock dividends	Less: Accrual of Series A redeemable convertible preferred stock dividends	288,802		266,007		848,898		812,362		Less: Accrual of Series A redeemable convertible preferred stock dividends	300,921		277,170

Less: Accretion to redemption value of Series A redeemable convertible preferred stock	Less: Accretion to redemption value of Series A redeemable convertible preferred stock	13,517		175,335		285,814		366,566		Less: Accretion to redemption value of Series A redeemable convertible preferred stock	14,815		197,114
Total comprehensive income (loss) attributable to common stockholders	Total comprehensive income (loss) attributable to common stockholders	$	83,257	$	1,080,633	$	(591,914)	$	8,525	Total comprehensive income (loss) attributable to common stockholders	$	(1,391,632)	$	20,409

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, 2021		5,949,463	$	5,949	$	110,107,170	$	(122,733,344)	$	(1,987,961)	$	(14,608,186)
Balance at January 1, 2022													Balance at January 1, 2022	7,082,276	$	7,082	$	112,349,613	$	(123,462,638)	$	(1,860,040)	$	(12,965,983)
Net income (loss)	Net income (loss)						425,248				425,248		Net income (loss)						(1,109,406)				(1,109,406)
Share-based compensation to employees	Share-based compensation to employees				4,471						4,471		Share-based compensation to employees				8,184						8,184

Accretion of Series A redeemable convertible preferred stock	Accretion of Series A redeemable convertible preferred stock				(197,114)						(197,114)		Accretion of Series A redeemable convertible preferred stock				(14,815)						(14,815)
Dividends on Series A redeemable convertible preferred stock	Dividends on Series A redeemable convertible preferred stock				(277,170)						(277,170)		Dividends on Series A redeemable convertible preferred stock				(300,921)						(300,921)
Foreign currency translation	Foreign currency translation								86,398		86,398		Foreign currency translation								33,510		33,510
Balance at March 31, 2021		5,949,463	$	5,949	$	109,637,357	$	(122,308,096)	$	(1,901,563)	$	(14,566,353)
Net income (loss)							(349,684)				(349,684)
Sale of common stock in public offering, net of underwriting discounts and offering costs		811,750	812		2,736,958						2,737,770
Share-based compensation to employees					4,697						4,697
Shares issued in connection with vesting of restricted stock		28,151	28		(28)						—
Accretion of Series A redeemable convertible preferred stock					(75,183)						(75,183)
Dividends on Series A redeemable convertible preferred stock					(282,926)						(282,926)
Foreign currency translation									(4,740)		(4,740)
Balance at June 30, 2021		6,789,364	$	6,789	$	112,020,875	$	(122,657,780)	$	(1,906,303)	$	(12,536,419)
Net income (loss)							374,432				374,432
Sale of common stock in public offering, net of underwriting discounts and offering costs		285,000	285		948,281						948,566

Share-based compensation to employees					4,916						4,916

Accretion of Series A redeemable convertible preferred stock					(13,517)						(13,517)
Dividends on Series A redeemable convertible preferred stock					(288,802)						(288,802)
Foreign currency translation									11,144		11,144
Balance at September 30, 2021		7,074,364	7,074		112,671,753		(122,283,348)		(1,895,159)		(11,499,680)
Balance at March 31, 2022													Balance at March 31, 2022	7,082,276	$	7,082	$	112,042,061	$	(124,572,044)	$	(1,826,530)	$	(14,349,431)

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		(123,665,970)		(1,987,961)		(15,540,812)
Net income (loss)	Net income (loss)						(719,840)				(719,840)		Net income (loss)						408,295				408,295
Share-based compensation to employees	Share-based compensation to employees				4,510						4,510		Share-based compensation to employees				4,471						4,471
Shares issued in connection with vesting of restricted stock	Shares issued in connection with vesting of restricted stock	1,104	1		(1)						—		Shares issued in connection with vesting of restricted stock	0	0		—						—
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
Share-based compensation to employees					3,060						3,060
Balance at March 31, 2021													Balance at March 31, 2021	5,949,463	$	5,949	$	109,637,357	$	(123,257,675)	$	(1,901,563)	$	(15,515,932)

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)

See accompanying notes to unaudited condensed consolidated financial statements.

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)


		Nine Months Ended September 30,					Three Months Ended March 31,
		2021		2020			2022		2021
Cash flows from operating activities:	Cash flows from operating activities:					Cash flows from operating activities:
Net income (loss)	Net income (loss)	$	449,996	$	1,232,927	Net income (loss)	$	(1,109,406)	$	408,295
Adjustments to reconcile net income 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	151,468		162,127		Depreciation and amortization	35,519		57,486
Amortization of debt discount on notes payable	Amortization of debt discount on notes payable	163,769		361,193		Amortization of debt discount on notes payable	2,148		75,705
Amortization of right of use assets	Amortization of right of use assets	396,034		987,542		Amortization of right of use assets	21,512		333,777
Gain on debt extinguishment	Gain on debt extinguishment	(754,000)		—		Gain on debt extinguishment	—		(754,000)
Gain on litigation settlement		(632,600)		—

Share-based payment compensation	Share-based payment compensation	14,084		11,392		Share-based payment compensation	8,184		4,471

Provision for (recovery of) returns and doubtful accounts	Provision for (recovery of) returns and doubtful accounts	—		70,932		Provision for (recovery of) returns and doubtful accounts	(18,740)		—
Deferred income taxes (benefit)	Deferred income taxes (benefit)	12,485		(5,485)		Deferred income taxes (benefit)	—		7,878
Changes in operating assets and liabilities:	Changes in operating assets and liabilities:					Changes in operating assets and liabilities:
Accounts receivable	Accounts receivable	541,249		(138,271)		Accounts receivable	2,044,122		(129,714)
Prepaid expenses and other current assets	Prepaid expenses and other current assets	271,443		249,383		Prepaid expenses and other current assets	(222,019)		(250,034)
Contract assets	Contract assets	236,296		432,204		Contract assets	13,120		30,179
Inventory	Inventory	—		15,713		Inventory	7,667		—
Other assets	Other assets	748,457		(379)		Other assets	5,437		(1,031)
Accounts payable	Accounts payable	(53,814)		(571,231)		Accounts payable	389,847		536,721
Accrued expenses and other long-term liabilities	Accrued expenses and other long-term liabilities	(669,852)		(589,952)		Accrued expenses and other long-term liabilities	(259,405)		131,288
Operating lease liabilities	Operating lease liabilities	(524,263)		(1,204,155)		Operating lease liabilities	(21,512)		(429,112)
Deferred revenue	Deferred revenue	(1,058,641)		(1,317,239)		Deferred revenue	(682,055)		115,750
Net cash provided by (used in) operating activities	Net cash provided by (used in) operating activities	(707,889)		(303,299)		Net cash provided by (used in) operating activities	214,419		137,659
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	(98,702)		—		Purchases of property and equipment	—		(41,121)
Security deposits						Security deposits	—		1,588

Purchase of intangible assets		(10,226)		(63,005)

Net cash provided by (used in) investing activities	Net cash provided by (used in) investing activities	(108,928)		(63,005)		Net cash provided by (used in) investing activities	—		(39,533)
Cash flows from financing activities:	Cash flows from financing activities:					Cash flows from financing activities:

Proceeds from public offering, net of underwriting discounts paid		4,181,908		—
Payments of offering costs		(476,143)		—
Proceeds from issuance of PPP loan		—		754,000
Payments of short-term debt		(1,334,058)		(1,000,000)

Net cash provided by (used in) financing activities	Net cash provided by (used in) financing activities	2,371,707		(246,000)		Net cash provided by (used in) financing activities	—		—
Effect of exchange rate changes on cash and cash equivalents	Effect of exchange rate changes on cash and cash equivalents	(762)		8,419		Effect of exchange rate changes on cash and cash equivalents	(13,989)		2,207
Net increase (decrease) in cash and cash equivalents	Net increase (decrease) in cash and cash equivalents	1,554,128		(603,885)		Net increase (decrease) in cash and cash equivalents	200,430		100,333
Cash and cash equivalents, beginning of period	Cash and cash equivalents, beginning of period	1,920,656		1,475,166		Cash and cash equivalents, beginning of period	3,181,209		1,920,656
Cash and cash equivalents, end of period	Cash and cash equivalents, end of period	$	3,474,784	$	871,281	Cash and cash equivalents, end of period	$	3,381,639	$	2,020,989
Supplemental disclosures:	Supplemental disclosures:					Supplemental disclosures:
Cash paid for interest	Cash paid for interest	$	110,408	$	261,095	Cash paid for interest	$	21,554	$	75,816

Non-cash investing and financing activities:	Non-cash investing and financing activities:					Non-cash investing and financing activities:
Accrual of deferred offering costs		$	19,429	$	—

Undistributed Series A redeemable convertible preferred stock dividends	Undistributed Series A redeemable convertible preferred stock dividends	$	848,898	$	812,362	Undistributed Series A redeemable convertible preferred stock dividends	$	300,921	$	277,170

Accretion of Series A redeemable convertible preferred stock	Accretion of Series A redeemable convertible preferred stock	$	285,814	$	366,566	Accretion of Series A redeemable convertible preferred stock	$	14,815	$	197,114

See accompanying notes to unaudited condensed consolidated financial statements.

109

FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES

Notes to Unaudited Condensed Consolidated Financial Statements

(1) Basis of Presentation

(a) The Company and Nature of Operations

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

(b) Liquidity

As of ~~September 30, 2021,~~March 31, 2022, the Company had a working capital surplus of ~~$2.3~~$0.3 million, which is inclusive of current deferred revenue of ~~$3.7~~$4.0 million, and a stockholders' deficit of ~~$11.5~~$14.3 million. During the ~~nine~~three months ended ~~September 30, 2021,~~March 31, 2022, the Company had net ~~income~~loss of ~~$0.4~~$1.1 million and ~~negative~~positive cash flow from operations of ~~$0.7~~$0.2 million. The Company's total cash balance at ~~September 30, 2021~~March 31, 2022 was ~~$3.5~~$3.4 million, an increase of ~~$1.6~~$0.2 million compared to ~~$1.9~~$3.2 million on December 31, ~~2020.~~2021.

The Company’s principal sources of liquidity at ~~September 30, 2021~~March 31, 2022 consisted of cash and future cash anticipated to be generated from operations. The Company generated negative net income yet positive cash flows from operations during the ~~nine~~three months ended ~~September 30, 2021,~~March 31, 2022, and it reported positive working capital as of ~~September 30, 2021.~~

~~As described in Note (14)~~ ~~Stockholders' Equity~~, on June 23, 2021, the Company issued and sold an aggregate of 811,750 shares of its common stock in a public offering underwritten by Roth Capital Partners, LLC, ("Roth") which included 86,750 shares purchased by Roth pursuant to the partial exercise of its over-allotment option (the "June Offering"). At a price of $4.10 per share, the Company received net proceeds of approximately $2.7 million after deducting the underwriting discount and estimated offering expenses paid by the Company.

Also, on July 27, 2021 the Company issued and sold an aggregate of 285,000 shares of its common stock in a public offering underwritten by Roth. At a price of $4.10 per share, the Company received net proceeds of approximately $0.9 million after deducting the underwriting discount and estimated offering expenses paid by the Company.March 31, 2022.

The Company is currently a party to an Amended and Restated Term Loan Credit Agreement, dated as of February 23, 2018, as amended December 27, 2019, by and between the Company and HCP-FVA, LLC (“HCP-FVA”), (the “Amended and Restated Loan Agreement”). In connection with the then-proposed public offering of the Company as described in the Company's Registration Statement on Form S-1, as amended, originally filed on June 3, 2021 (the ~~"Offering"~~"June Offering"), we entered into a letter agreement with Hale Capital Partners, LP (“Hale Capital”), dated June 2, 2021 (the “Loan Extension Letter Agreement”), that provided for an extension of the maturity date on Hale Capital’s portion of the outstanding indebtedness owed under the Amended and Restated Loan Agreement to June 30, 2023, which constituted approximately $2.2 million of the $3.5 million principal amount outstanding as of June 2, 2021. The remaining $1.3 million of the principal amount outstanding, which was owed to other lenders, was repaid in full on June 30, 2021. See Note (9) Notes Payable for more information. Also, as described further in Note (12) Series A Redeemable Convertible Preferred Stock, the effective date of the mandatory redemption right of the Series A Redeemable Convertible Preferred Stock (the “Series A Preferred Stock”) held by HCP-FVA and Hale Capital was extended from July 30, 2021 to July 30, 2023 pursuant to an amendment to the Certificate of Designations, dated as of June 24, 2021. The amendment was approved by our shareholders at our 2021 annual meeting of stockholders and filed with the Delaware Secretary of State on June 25, 2021. If such Series A Preferred Stock was redeemed at ~~September 30, 2021,~~March 31, 2022, the Company would have been required to pay the holders of the Series A Preferred Stock ~~$14.2~~$14.8 million.

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

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

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

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

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

Embedded Derivative Liability Fair Value Adjustment

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

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


	For the Three Months Ended March 31, 2021
CONSOLIDATED STATEMENT OF OPERATIONS	As Previously Reported		Adjustments		As Revised
Interest and other expense	$	(266,695)	$	(16,953)	$	(283,648)
Income (loss) before income taxes	$	469,864	$	(16,953)	$	452,911
Net income (loss)	$	425,248	$	(16,953)	$	408,295
Net income (loss) attributable to common stockholders	$	(49,036)	$	(16,953)	$	(65,989)
Basic net income (loss) per share attributable to common stockholders	$	(0.01)	$	—	$	(0.01)
Diluted net income (loss) per share attributable to common stockholders	$	(0.01)	$	—	$	(0.01)

	For the Three Months Ended March 31, 2021
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)	As Previously Reported		Adjustments		As Revised
Net income (loss)	$	425,248	$	(16,953)	$	408,295
Total comprehensive income (loss)	$	511,646	$	(16,953)	$	494,693
Total comprehensive income (loss) attributable to common stockholders	$	37,362	$	(16,953)	$	20,409

	Total Stockholders' Deficit
CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT	As Previously Reported		Adjustments		As Revised
Balance at January 1, 2021	$	(14,608,186)	$	(932,626)	$	(15,540,812)
Net income (loss)	$	425,248	$	(16,953)	$	408,295
Balance at March 31, 2021	$	(14,566,353)	$	(949,579)	$	(15,515,932)

	For the Three Months Ended March 31, 2021
CONSOLIDATED STATEMENT OF CASH FLOWS	As Previously Reported		Adjustments		As Revised
Cash flows from operating activities:
Net income (loss)	$	425,248	$	(16,953)	$	408,295
Changes in operating assets and liabilities:
Accrued expenses and other long-term liabilities	$	114,335	$	16,953	$	131,288
Net cash provided by (used in) operating activities	$	137,659	$	—	$	137,659

(d) Impact of the COVID-19 Pandemic

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

Further, our management team is focused on addressing the impacts of COVID-19 on our business, which has required and will continue to require, a large investment of their time and resources and may distract our management team or disrupt our 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, valuation of derivatives, valuation of goodwill and income taxes. Actual results could differ from those estimates.

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

(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, 2021,~~March 31, 2022, and the results of its operations for the three ~~and nine~~ months ended ~~September 30, 2021~~March 31, 2022 and ~~2020.~~2021. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes set forth in the Company's Annual Report on Form 10-K for the year ended December 31, ~~2020~~2021 ("~~2020~~2021 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. Adoption of this new standard did not have a significant impact 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. Adoption of this new standard did not have a material impact on 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.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments – Credit Losses (together with all subsequent amendments, ("Topic 326"))", which replaced the previous U.S. GAAP that required an incurred loss methodology for recognizing credit losses and delayed recognition until it was probable a loss had been incurred. Topic 326 replaced the incurred loss methodology with a methodology that reflects expected credit losses and requires consideration of reasonable and supportable information to estimate credit losses. This provision was effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, with early adoption permitted. In February 2020, the FASB issued ASU 2020-02, "Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842)", which delayed the effective date of Topic 326 for smaller reporting companies until fiscal years beginning after December 15, 2022. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.

(2) Summary of Significant Accounting Policies

The Company's significant accounting policies were described in Note (1) Summary of Significant Accounting Policies of the ~~2020~~2021 Form 10-K. There have been no significant changes in the Company's significant accounting policies since December 31, ~~2020.~~2021. For a description of the Company's significant accounting policies refer to the ~~2020~~2021 Form 10-K.

Revenue from Contracts with Customers and Associated Balances

Nature of Products and Services

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

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

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

Contract Balances

Timing of revenue recognition may differ from the timing of invoicing to customers. The Company records a contract asset when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For perpetual licenses with multi-year maintenance agreements, the company invoices the license and generally one year of maintenance with future maintenance generally invoiced annually. For multi-year subscription licenses, the Company generally invoices customers annually at the beginning of each annual coverage period. The Company records a contract asset related to revenue recognized for multi-year on-premises licenses as its right to payment is conditioned upon providing product support and services in future years.

As of ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020,~~2021, accounts receivable, net of allowance for doubtful accounts, was ~~$2.3~~$0.8 million and ~~$2.8~~$2.9 million, respectively. As of ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020,~~2021, short and long-term contract assets, net of allowance for doubtful accounts, was ~~$0.4~~$0.9 million and ~~$0.6~~$0.9 million, respectively. As of March 31, 2022 and December 31, 2021, allowance for doubtful accounts was $64,833 and $85,816, respectively.

Deferred revenue is comprised mainly of unearned revenue related maintenance and technical support on term and perpetual licenses. Maintenance and technical support revenue is recognized ratably over the coverage period. Deferred

revenue also includes contracts for professional services to be performed in the future which are recognized as revenue when the Company delivers the related service pursuant to the terms of the customer arrangement.

Changes in deferred revenue were as follows:


~~Nine~~Three Months Ended ~~September 30, 2021~~March 31, 2022
Balance at January 1, ~~2020~~2022	$	~~6,369,129~~6,136,086
Deferral of revenue	~~9,281,741~~1,355,454
Recognition of revenue	~~(10,370,542)~~(2,049,107)
Change in reserves	~~(1,510)~~2,249
Balance at ~~September 30, 2021~~March 31, 2022	$	~~5,278,818~~5,444,682

During the three months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ revenue of ~~$1.0~~$1.4 million and ~~$1.2 million, respectively, and the nine months ended September 30, 2021 and 2020, revenue of $3.9 million and $4.4~~$1.5 million respectively, was recognized from the deferred revenue balance at the beginning of each period.

Deferred revenue includes invoiced revenue allocated to remaining performance obligations that has not yet been recognized and will be recognized as revenue in future periods. Deferred revenue was ~~$5.3~~$5.4 million as of ~~September 30, 2021,~~March 31, 2022, of which the Company expects to recognize approximately ~~70%~~74% of such amount as revenue over the next 12 months and the remainder thereafter.

Approximately ~~$1.8~~$1.6 million of revenue is expected to be recognized from remaining performance obligations for unbilled support and services as of ~~September 30, 2021.~~March 31, 2022. We expect to recognize revenue on approximately ~~42%~~41% 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~~are expected to continue through ~~2021.~~2023. Below is a summary of our ROU assets and liabilities as of ~~September 30, 2021.~~March 31, 2022.


Right of use assets	$	~~140,238~~90,893
Lease liability obligations, current	~~87,381~~74,349
Lease liability obligations, less current portion	~~53,430~~16,544
Total lease liability obligations	$	~~140,811~~90,893
Weighted-average remaining lease term	~~1.87~~1.25
Weighted-average discount rate	~~3.57~~3.35		%


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2021		2020		2021		2020				2022		2021
Components of lease expense:	Components of lease expense:									Components of lease expense:
Operating lease cost	Operating lease cost	$	88,593	$	442,501	$	712,911	$	1,386,998	Operating lease cost		$	32,094	$	414,351
Sublease income	Sublease income	—		(75,314)		(100,419)		(430,313)		Sublease income		—		(75,314)
Net lease cost	Net lease cost	$	88,593	$	367,187	$	612,492	$	956,685	Net lease cost		$	32,094	$	339,037

During the three months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ operating cash flows from operating leases were approximately ~~$57,541~~$19,249 and ~~$357,245, respectively. During the nine months ended September 30, 2021 and 2020, operating cash flows from operating leases were approximately $574,757 and $1,117,557,~~$354,968, respectively.

Approximate future minimum lease payments for our ROU assets over the remaining lease periods as of ~~September 30, 2021,~~March 31, 2022, are as follows:


2021		30,063
2022	2022	112,232	2022	57,747
2023			2023	38,498
Total minimum lease payments	Total minimum lease payments	142,295	Total minimum lease payments	96,245
Less interest	Less interest	1,484	Less interest	5,352
Present value of lease liabilities	Present value of lease liabilities	140,811	Present value of lease liabilities	90,893

(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, 2021~~March 31, 2022 and ~~2020:~~2021:


		Three Months Ended September 30,		Nine Months Ended September 30,			Three Months Ended March 31,
		2021	2020	2021	2020		2022	2021
Stock options	Stock options	9,640	9,945	9,640	9,945	Stock options	5,690	9,780
Restricted stock	Restricted stock	—	31,648	63,207	31,648	Restricted stock	86,520	93,612
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	144,321	132,930
Total anti-dilutive common stock equivalents	Total anti-dilutive common stock equivalents	97,455	129,408	160,662	129,408	Total anti-dilutive common stock equivalents	236,531	236,322

(4) Property and Equipment

The gross carrying amount and accumulated depreciation of property and equipment as of ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020~~2021 are as follows:


		September 30, 2021		December 31, 2020			March 31, 2022		December 31, 2021

Gross carrying amount	Gross carrying amount	$	18,876,633	$	18,791,841	Gross carrying amount	$	15,530,663	$	15,544,212
Accumulated depreciation	Accumulated depreciation	(18,683,605)		(18,594,821)		Accumulated depreciation	(15,402,460)		(15,390,308)
Property and Equipment, net	Property and Equipment, net	$	193,028	$	197,020	Property and Equipment, net	$	128,203	$	153,904

For the three months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ depreciation expense was ~~$29,838~~$23,344 and ~~$44,958, respectively. For the nine months ended September 30, 2021 and 2020, depreciation expense was $100,470 and $135,679,~~$39,765, respectively.

(5) Software Development Costs

The gross carrying amount and accumulated amortization of software development costs as of ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020~~2021 are as follows:


		September 30, 2021		December 31, 2020			March 31, 2022		December 31, 2021

Gross carrying amount	Gross carrying amount	$	2,950,132	$	2,950,132	Gross carrying amount	$	2,980,132	$	2,980,132
Accumulated amortization	Accumulated amortization	(2,935,787)		(2,930,854)		Accumulated amortization	(2,939,076)		(2,937,437)
Software development costs, net	Software development costs, net	$	14,345	$	19,278	Software development costs, net	$	41,056	$	42,695

During the three months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ the Company recorded ~~$1,649~~$1,639 and ~~$1,649, respectively, of amortization expense related to capitalized software costs. During the nine months ended September 30, 2021 and 2020, the Company recorded $4,933 and $6,084,~~$1,639, 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, 2021~~March 31, 2022 and December 31, ~~2020~~2021 are as follows:


		September 30, 2021		December 31, 2020			March 31, 2022		December 31, 2021
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	$	4,038,138	$	4,027,912	Gross carrying amount	$	4,038,138	$	4,038,138
Accumulated amortization	Accumulated amortization	(3,973,843)		(3,927,778)		Accumulated amortization	(3,997,312)		(3,986,776)
Net carrying amount	Net carrying amount	$	64,295	$	100,134	Net carrying amount	$	40,826	$	51,362

For the three months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ amortization expense was ~~$13,999~~$10,536 and ~~$18,455, respectively. For the nine months ended September 30, 2021 and 2020, amortization expense was $46,065 and $20,364,~~$16,082, 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 (the “Compensation Committee”) of the Company’s Board of Directors (the “Board”) and initially provided for the issuance of up to 1,471,997 shares of the Company's common stock upon the grant of shares with such restrictions as determined by the Compensation Committee to the employees and directors of, and consultants providing services to, the Company or its affiliates. In June 2021, the Company's stockholders approved an amendment to increase the number of shares of our common stock authorized and reserved for issuance under the 2018 Plan by 220,800 shares to a total of 1,692,797 shares. Exercise prices of the options will be determined by the Compensation Committee, ~~of the Company's Board of Directors (the "Board"),~~ subject to the consent of Hale Capital. The vesting terms ~~shall~~will be performance based and determined by the Compensation Committee, subject to the consent of Hale Capital, based on various factors, including (i) the return of capital to the holders of the Series A Preferred Stock and the Company’s ~~Common Stock~~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, 2021:~~March 31, 2022:

Shares Available

Name of Plan

Authorized

for Grant

Outstanding

Name of Plan

Authorized

for Grant

Outstanding

FalconStor Software, Inc. 2018 Incentive Stock Plan

1,692,797

132,817

1,463,380

FalconStor Software, Inc. 2018 Incentive Stock Plan

1,692,797

52,016

1,545,623

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, 2021:~~March 31, 2022:

Name of Plan

Shares Available for Grant

Shares Outstanding

FalconStor Software, Inc., 2016 Incentive Stock Plan

—

~~3,850~~2,250

FalconStor Software, Inc., 2006 Incentive Stock Plan

—

~~5,790~~3,440

A summary of the Company’s restricted stock activity for the ~~nine~~three months ended ~~September 30, 2021~~March 31, 2022 is below. Such restricted stock did not bestow any voting or dispositive power and is not deemed outstanding until they vest.


						Number of Restricted Stock Awards
Non-Vested at January 1, ~~2021~~2022						~~1,386,213~~1,513,380
Granted						113,230
Vested						~~(36,063)~~(4,248)
Forfeited						— (82,429)
Non-Vested at ~~September 30, 2021~~March 31, 2022						~~1,463,380~~1,539,933

The following table summarizes the share-based compensation expense for all awards issued under the Company’s stock equity plans in the following line items in the condensed consolidated statements of operations for the three ~~and nine~~ months ended ~~September 30, 2021~~March 31, 2022 and ~~2020:~~2021:

Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
Cost of revenue - Product $ 232 $ — $ 688 $ —
Cost of revenue - support and service 185 104 549 310
Research and development costs 167 433 167 1,289
Selling and marketing 2,915 186 8,475 554
General and administrative 1,417 3,099 4,205 9,239
$ 4,916 $ 3,822 $ 14,084 $ 11,392


	Three Months Ended March 31,
	2022		2021
Cost of revenue - Product	$	227	$	227
Cost of revenue - support and service	181		181
Research and development costs	1,879		—
Selling and marketing	4,511		2,677
General and administrative	1,386		1,386
	$	8,184	$	4,471

(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, 2021,~~March 31, 2022, the Company recorded an income tax ~~provision~~benefit of ~~$63,804.~~$121,260. The effective tax rate for the ~~nine~~three months ended ~~September 30, 2021~~March 31, 2022 was ~~12.4%~~9.9%. The effective tax rate differs from the statutory rate of 21% due to the mix of foreign and domestic earnings, foreign withholding taxes and the application of valuation allowances. As of ~~September 30, 2021,~~March 31, 2022, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and therefore, the Company ~~has~~had not recorded any income tax benefit as such amounts are fully offset with a valuation allowance.

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%~~9.9%. The effective tax rate differs from the statutory rate of 21% due to the mix of foreign and domestic earnings and the application of valuation allowances. As of ~~September 30, 2020,~~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~~had not recorded any income tax benefit as such amounts are fully offset with a valuation allowance.

The Company’s total unrecognized tax benefits, excluding interest, ~~at both September 30,~~as of March 31, 2022 and March 31, 2021 were $79,518 and ~~September 30, 2020 were $70,260 and $76,275,~~$75,506, respectively. As of ~~September 30,~~March 31, 2022 and March 31, 2021, ~~and September 30, 2020,~~ the Company had ~~$36,575~~$44,462 and ~~$33,865,~~$37,207, respectively, of accrued interest reflected in accrued expenses.

(9) Notes Payable

The notes payable balance consists of the following:


Total notes payable, net at January 1, ~~2021~~2022	$	~~4,074,863~~2,154,098
Accretion of discount	~~75,705~~
~~PPP loan forgiveness~~	~~(754,000)~~2,148
Total notes payable, net at March 31, ~~2021~~2022	$	~~3,396,568~~
~~Repayment of short-term debt~~	~~(1,334,058)~~
~~Accretion of discount~~	~~84,086~~
~~Total notes payable, net at June 30, 2021~~	$	~~2,146,596~~
~~Accretion of discount~~	$	~~3,978~~
~~Total notes payable, net at September 30, 2021~~	$	~~2,150,574~~2,156,246

Senior Secured Debt

The senior secured debt bears interest at prime plus 0.75% and had an original maturity date of June 30, 2021.

In connection with the June Offering, we entered into the Loan Extension Letter Agreement on June 2, 2021 which provided for an extension of the maturity date on Hale Capital’s portion of the outstanding indebtedness owed under the Amended and Restated Loan Agreement to June 30, 2023. The amount extended constituted approximately $2.2 million of the $3.5 million principal amount outstanding as of June 2, 2021. The remaining $1.3 million of the outstanding principal, which was owed to other lenders, was repaid in full on June 30, 2021.

The Company concluded that the modification created by this amendment resulted in a troubled debt restructuring under Accounting Standard Codification—Debt (Topic 470) as it was determined that a concession was granted by HCP-FVA. However, as the future payments to be made subsequent to the modification are greater than the carrying value at the time of the modification, no gain or loss was required to be recognized on the troubled debt restructuring. The change is accounted for prospectively using the new effective interest rate of the loan.

As of ~~September 30, 2021,~~March 31, 2022, the Company was in compliance with the financial covenants contained in the Amended and Restated Loan Agreement.

~~Loan under the Paycheck Protection Program~~

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

The PPP Loan was evidenced by a promissory note, dated April 28, 2020 and matured two years from the disbursement date and bore interest at a rate of 1.000% per annum, with the first six months of interest deferred. The PPP Loan was subject to forgiveness to the extent proceeds were 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 used a significant majority of the PPP Loan amount for Qualifying Expenses and the PPP Loan 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.

Fair Value Hierarchy

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

•Level 1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities. At ~~September 30, 2021,~~March 31, 2022, the Company did not have any Level 1 category assets included in the condensed consolidated balance sheets.

•Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly. At ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020,~~2021, the Company did not have any Level 2 category assets included in the condensed consolidated balance sheets.

•Level 3 – Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. At ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020,~~2021, the Level 3 category included derivatives, which are included within other long-term liabilities in the condensed consolidated balance sheets. The Company did not hold any cash and cash equivalents categorized as Level 3 as of ~~September 30, 2021~~March 31, 2022 or December 31, ~~2020.~~2021.

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at ~~September 30, 2021:~~March 31, 2022:


				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	464,972		—		—		464,972		Derivative Instruments	784,325		—		—		784,325
Total derivative liabilities	Total derivative liabilities	464,972		—		—		464,972		Total derivative liabilities	784,325		—		—		784,325

Total assets and liabilities measured at fair value	Total assets and liabilities measured at fair value	$	464,972	$	—	$	—	$	464,972	Total assets and liabilities measured at fair value	$	784,325	$	—	$	—	$	784,325

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at December 31, ~~2020:~~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	472,851		—		—		472,851		Derivative Instruments	776,623		—		—		776,623
Total derivative liabilities	Total derivative liabilities	472,851		—		—		472,851		Total derivative liabilities	776,623		—		—		776,623

Total assets and liabilities measured at fair value	Total assets and liabilities measured at fair value	$	472,851	$	—	$	—	$	472,851	Total assets and liabilities measured at fair value	$	776,623	$	—	$	—	$	776,623

Measurement of Fair Value

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

The fair value of the Company's Series A Preferred Stock is based on its future cash flows discounted at a 9% yield. The fair value of the Company's note payable is based on its future cash flows discounted at a 7%5% yield.

The following table presents a reconciliation of the beginning and ending balances of the Company's liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three ~~and nine~~ months ended ~~September 30, 2021~~March 31, 2022 and ~~September 30, 2020:~~March 31, 2021:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2021		2020		2021		2020			2022		2021
Beginning Balance	Beginning Balance	$	467,598	$	478,312	$	472,851	$	483,804	Beginning Balance	$	776,623	$	703,747
Total income recognized in earnings		(2,626)		(2,751)		(7,879)		(8,243)
Total loss recognized in earnings										Total loss recognized in earnings	7,702		14,323
Ending Balance	Ending Balance	$	464,972	$	475,561	$	464,972	$	475,561	Ending Balance	$	784,325	$	718,070

(11) Commitments and Contingencies

The Company’s headquarters are located in Austin, Texas. The Company had an operating lease covering its Melville, New York office facility that expired in April 2021. The Company also has several additional operating leases related to offices in foreign countries. The expiration dates for these leases 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, 2021:

Payments
2021 $ 30,063
2022 112,232
$ 142,295

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, 2021,~~March 31, 2022, 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) Series A Redeemable Convertible Preferred Stock the holders of the Series A Preferred Stock have redemption rights upon certain triggering events. As of ~~September 30, 2021,~~March 31, 2022, the Company did not fail any non-financial covenants related to the Company's Series A Preferred Stock.

In connection with the appointment of Todd Brooks as Chief Executive Officer, the Board approved an offer letter to Mr. Brooks (the “Brooks Agreement”), which was executed on August 14, 2017. The Brooks Agreement provides that Mr. Brooks is entitled to receive an annualized base salary of $350,000, 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 12 months of his base salary if (i) he has been employed by the Company for at least 12 months at the time of termination or (ii) a change of control has occurred within 6 months of Mr. Brooks’ employment. Except as set forth in the preceding sentence, Mr. Brooks is entitled to receive severance equal to 6 months of his base salary if he has been employed by the Company for less than 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~~Mr. Sita’s appointment ~~of Brad Wolfe~~ as ~~the Company's~~ Chief Financial Officer, the Board approved an ~~offer letter to~~Independent Contractor Services Agreement with Alucria Consulting, Inc. (“Alucria”), an entity owned by Mr. ~~Wolfe~~Sita (the ~~“Wolfe Offer Letter”~~“Sita Agreement”), which was

executed on ~~April 4, 2018.~~February 11, 2022. The ~~Wolfe Offer Letter~~Sita Agreement provides that ~~Mr. Wolfe~~Alucria is entitled to receive ~~an annualized base salary~~a fee of ~~$240,000, payable in regular installments in accordance with the Company’s general payroll practices. Mr. Wolfe~~$20,000 per month. Alucria 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~~an additional ~~incentive compensation of an annual bonus~~payment of up to ~~$70,000,~~$60,000 annually, based upon the achievement of goals determined by the Company, to be paid quarterly in accordance with standard Company policies. Mr. Sita will also receive a grant of shares of the Company’s common stock, to be governed by the Company’s 2018 Stock Incentive Plan and subject to ~~attainment~~specific vesting conditions.

The term of ~~performance objectives to be mutually agreed upon and established.~~the Sita Agreement expires on July 1, 2023, unless earlier terminated by either party in accordance with the terms therein.

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

In addition, as of ~~September 30, 2021,~~March 31, 2022, the Company's liability for uncertain tax positions totaled ~~$108,091.~~$123,979. At this time, the settlement period for this liability, including related accrued interest, cannot be determined.

(12) Series A Redeemable Convertible Preferred Stock

The Company has 900,000 shares of Series A Preferred Stock outstanding with a par value $0.001 per share and a stated value of $10 per share. 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 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 Amended and Restated Loan Agreement remains outstanding without the consent of the holders of the Series A Preferred Stock. In addition, the declaration

and payment of dividends is subject to compliance with applicable law and unpaid dividends will accrue. A holder’s right to convert its shares of Series A Preferred Stock and receive dividends in the form of common stock is subject to certain limitations including, among other things, that the shares of common stock issuable upon conversion or as dividends will not, prior to receipt of stockholder approval, result in any holder beneficially owning greater than 9.99% 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 accrued and unpaid dividends with respect thereto) and the closing price as of the occurrence of the triggering event. On or after July 30, 2023, subject to the approval of HCP-FVA, each holder of Series A Preferred Stock can also require the Company to redeem its Series A Preferred Stock in cash at a per share price equal to 100% of the stated value of a share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto. Notwithstanding the forgoing, no holder of Series A Preferred Stock is permitted to exercise any rights or remedies upon a Breach Event (as defined in the Certificate of Designations) or to exercise any redemption rights under the Certificate of Designations, unless approved by the holders of a majority of the then-outstanding shares of Series A Preferred Stock.

Upon consummation of a fundamental sale transaction, the Series A Preferred Stock ~~shall~~will be redeemed at a per share redemption price equal to the greater of (y) 250% of the per share purchase price of the Series A Preferred Stock and (z) the price payable in respect of such share of Series A Preferred Stock if such share of Series A Preferred Stock had been converted

into such number of shares of common stock in accordance with the Certificate of Designations (but without giving effect to any limitations or restrictions contained therein) immediately prior to such fundamental sale transaction; provided however that the 250% threshold is changed to 100% if the fundamental sale transaction is approved by the two Series A Directors (as defined in the Certificate of Designations). In addition, if the Company consummates an equity or debt financing that results in more than $5.0 million of net proceeds to the Company and/or its subsidiaries, the holders of Series A Preferred Stock will have the right, but not the obligation, to require the Company to use the net proceeds in excess of $5.0 million to repurchase all or a portion of the Series A Preferred Stock at a per share price equal to the greater of (i) the sum of 100% of the stated value of such share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto, and (ii) the number of shares of common stock into which such share of Series A Preferred Stock is then convertible multiplied by the greater of (y) the closing price of the common stock on the date of announcement of such financing or (z) the closing price of the common stock on the date of consummation of such financing.

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

The holders of our outstanding Series A Preferred Stock have a mandatory redemption right that may be exercised only with the approval of Hale Capital and HCP-FVA. In connection with the ~~then-proposed public offering of the Company as described in the Company's Registration Statement on Form S-1, as amended, originally filed on~~ June ~~3, 2021,~~Offering, the effective date of such redemption right was extended from July 30, 2021 to July 30, 2023 pursuant to an amendment to the Certificate of Designations, dated as of June 24, 2021. The amendment was approved by our shareholders at our 2021 annual meeting of stockholders and filed with the Delaware Secretary of State on June 25, 2021.

The Company concluded that the modification created by this amendment resulted in a troubled debt restructuring under Accounting Standard Codification—Debt (Topic 470) as it was determined that a concession was granted. However, as the future payments to be made subsequent to the modification are greater than the carrying value at the time of the modification, no gain or loss was required to be recognized on the troubled debt restructuring. The change is accounted for

prospectively using the new effective interest rate of the preferred stock.

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

As of ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020,~~2021, the fair value of these derivative instruments was ~~$464,972~~$784,325 and ~~$472,851,~~$776,623, respectively, and were included in "other long-term liabilities" within the consolidated balance sheets. The (income) loss on the change in fair value of these derivative instruments for the ~~nine~~three months ended ~~September 30,~~March 31, 2022 and March 31, 2021 of 7,702 and ~~September 30, 2020 of $7,879 and $8,243,~~$14,323, respectively, were included in “interest and other ~~loss,~~expense, net” within the consolidated statement of operations.

The fair value of these derivative instruments and the loss recorded on the change in the fair value of these derivative instruments, which was included in “Interest and other income, net” within the condensed consolidated statement of operations, for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ were as follows:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2021		2020		2021		2020			2022		2021
Beginning Balance	Beginning Balance	$	467,598	$	478,312	$	472,851	$	483,804	Beginning Balance	$	776,623	$	703,747
Total income recognized in earnings		(2,626)		(2,751)		(7,879)		(8,243)
Total loss recognized in earnings										Total loss recognized in earnings	7,702		14,323
Ending Balance	Ending Balance	$	464,972	$	475,561	$	464,972	$	475,561	Ending Balance	$	784,325	$	718,070

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 June Offering, Hale Capital Partners, which was the sole holder of the Series A Preferred Stock, agreed to the Series A mandatory extension of the mandatory redemption right and waived prior breaches of the terms of the Series A Preferred Stock. The Company included deductions for accretion, deemed and accrued dividends on the Series A Preferred Stock as adjustments to net ~~income (loss)~~loss attributable to common stockholders on the statement of operations and in determining ~~income (loss)~~loss per share for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ respectively.

The Series A Preferred Stock consists of the following:


Total Series A redeemable convertible preferred stock, net at January 1, ~~2021~~2022	$	~~12,940,722~~14,384,388
Accrued dividends	~~277,170~~300,921
Accretion of preferred stock	~~197,114~~14,815
Total Series A redeemable convertible preferred stock, net at March 31, ~~2021~~2022	$	~~13,415,006~~
~~Accrued dividends~~	~~282,926~~
~~Accretion of preferred stock~~	~~75,183~~
~~Total Series A redeemable convertible preferred stock, net at June 30, 2021~~	$	~~13,773,115~~
~~Accrued dividends~~	~~288,802~~
~~Accretion of preferred stock~~	~~13,517~~
~~Total Series A redeemable convertible preferred stock, net at September 30, 2021~~	$	~~14,075,434~~14,700,124

(13) Accumulated Other Comprehensive Loss

The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended ~~September 30, 2021~~March 31, 2022 are as follows:

2524


		Foreign Currency Translation		Net Minimum Pension Liability		Total			Foreign Currency Translation		Net Minimum Pension Liability		Total
Accumulated other comprehensive income (loss) at July 1, 2021		$	(1,914,022)	$	7,719	$	(1,906,303)
Accumulated other comprehensive income (loss) at January 1, 2022								Accumulated other comprehensive income (loss) at January 1, 2022	$	(1,881,005)	$	20,965	$	(1,860,040)
Other comprehensive income (loss)	Other comprehensive income (loss)							Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications	Other comprehensive income (loss) before reclassifications	11,144		—		11,144		Other comprehensive income (loss) before reclassifications	33,510		—		33,510
Total other comprehensive income (loss)	Total other comprehensive income (loss)	11,144		—		11,144		Total other comprehensive income (loss)	33,510		—		33,510
Accumulated other comprehensive income (loss) at September 30, 2021		$	(1,902,878)	$	7,719	$	(1,895,159)
Accumulated other comprehensive income (loss) at March 31, 2022								Accumulated other comprehensive income (loss) at March 31, 2022	$	(1,847,495)	$	20,965	$	(1,826,530)

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

Foreign Currency
Translation Net Minimum
Pension Liability Total
Accumulated other comprehensive income (loss) at July 1, 2020 $ (1,948,066) $ 33,566 $ (1,914,500)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications (24,234) — (24,234)
Total other comprehensive income (loss) (24,234) — (24,234)
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,~~March 31, 2021 are as follows:

Foreign Currency
Translation Net Minimum
Pension Liability Total
Accumulated other comprehensive income (loss) at January 1, 2021 $ (1,995,680) $ 7,719 $ (1,987,961)
Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications 92,802 — 92,802
Total other comprehensive income (loss) 92,802 — 92,802
Accumulated other comprehensive income (loss) at September 30, 2021 $ (1,902,878) $ 7,719 $ (1,895,159)

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


		Foreign Currency Translation		Net Minimum Pension Liability		Total			Foreign Currency Translation		Net Minimum Pension Liability		Total
Accumulated other comprehensive income (loss) at January 1, 2020		$	(1,926,826)	$	33,566	$	(1,893,260)
Accumulated other comprehensive income (loss) at January 1, 2021								Accumulated other comprehensive income (loss) at January 1, 2021	$	(1,995,680)	$	7,719	$	(1,987,961)
Other comprehensive income (loss)	Other comprehensive income (loss)							Other comprehensive income (loss)
Other comprehensive income (loss) before reclassifications	Other comprehensive income (loss) before reclassifications	(45,474)		—		(45,474)		Other comprehensive income (loss) before reclassifications	86,398		—		86,398
Total other comprehensive income (loss)	Total other comprehensive income (loss)	(45,474)		—		(45,474)		Total other comprehensive income (loss)	86,398		—		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)

(14) Stockholders' Equity

Stock Repurchase Activity

During the three ~~and nine~~ months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ the Company did not repurchase any shares of its common stock. As of ~~September 30, 2021,~~March 31, 2022, 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.

Common Stock Offerings

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

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

(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.

~~Litigation Settlement with Datatech Enterprises, Inc.~~

The Company ~~has been involved in~~continues to assess certain litigation ~~with Datatech Enterprises, Inc. ("Datatech") since April 27, 2015 when Falconstor commenced~~and claims to determine the amounts, if any, that the Company believes may be paid as a ~~lawsuit regarding a contractual dispute with Datatech. Falconstor recorded an accrual for a loss contingency~~result of such claims and litigation and, therefore, additional losses may be accrued and paid in the ~~amount of $0.8 million in~~future, which could materially adversely impact the ~~fiscal year ended 2015. On September 23, 2021, Falconstor~~Company’s financial results, its cash flows and Datatech entered into a settlement agreement which resulted in Falconstor issuing payment of $0.2 million to Datatech and recording a gain of $0.6 million. Falconstor issued the payment in full on September 23, 2021. The matter is now fully concluded.its cash reserves.

(16) Segment Reporting and Concentrations

The Company is organized in a single operating segment for purposes of making operating decisions and assessing performance. Revenue from the United States to customers in the following geographical areas for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ and the location of long-lived assets as of ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020,~~2021, are summarized as follows:


		Three Months Ended September 30,				Nine Months Ended September 30,					Three Months Ended March 31,
		2021		2020		2021		2020			2022		2021
Revenue:	Revenue:									Revenue:
Americas	Americas	$	880,010	$	1,834,443	$	4,422,598	$	4,085,936	Americas	$	848,308	$	1,708,177
Europe, Middle East, Africa and Other	Europe, Middle East, Africa and Other	1,265,526		1,650,812		3,817,767		4,116,849		Europe, Middle East, Africa and Other	804,994		1,610,856
Asia Pacific	Asia Pacific	1,137,933		951,145		2,130,177		2,913,414		Asia Pacific	395,805		509,293
Total Revenue	Total Revenue	$	3,283,469	$	4,436,400	$	10,370,542	$	11,116,199	Total Revenue	$	2,049,107	$	3,828,326


		September 30, 2021		December 31, 2020			March 31, 2022		December 31, 2021
Long-lived assets:	Long-lived assets:					Long-lived assets:
Americas	Americas	$	388,860	$	1,735,986	Americas	$	614,477	$	858,417
Europe, Middle East, Africa and Other	Europe, Middle East, Africa and Other	19,695		52,690		Europe, Middle East, Africa and Other	15,889		18,364
Asia Pacific	Asia Pacific	556,925		502,344		Asia Pacific	222,057		261,148
Total long-lived assets	Total long-lived assets	$	965,480	$	2,291,020	Total long-lived assets	$	852,423	$	1,137,929

For the three ~~and nine~~ months ended ~~September 30, 2021,~~March 31, 2022, the Company had 2 customers that accounted for 10% or more of total revenue, respectively. For the three ~~and nine~~ months ended ~~September 30, 2020,~~March 31, 2021, the Company had 2 ~~customer~~customers that accounted for 10% or more of total revenue, respectively.

As of ~~September 30, 2021,~~March 31, 2022, the Company had 23 customers that accounted for 10% or more of the gross accounts receivable balance. As of December 31, ~~2020,~~2021, the Company had ~~1 customer~~2 customers 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 its former 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,~~March 31, 2021, the Company incurred lease disposal-related costs for this property of ~~$0.7~~$0.3 million. The Melville, NY lease which ended on April 30, 2021 with a gross annualized rental cost of $1.5 million, will not be replaced. The Company expects the remaining accrued severance-related costs of ~~$141,340 at September 30, 2021~~$132,129 as of March 31, 2022 to be paid once final settlement litigation is completed, which is expected to occur by December 31, ~~2021.~~2022.

In the third quarter of 2019, the Company adopted 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 (the "2020 Plan"). The 2020 Plan reduced the Company's annual cash expense run rate by $4.0 million or 29%. The Company furloughed 21 positions worldwide, and 20 of these positions were reinstated by December 31, 2020. During the nine months ended September 30, 2021, the Company has not yet incurred severance expense as a result of this action.

The following table summarizes the activity during ~~2020 and~~ 2021 through March 31, 2022 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 January 1, 2020		$	293,799	$	237,493	$	531,292
Additions (Reductions)		76,708		210,752		287,460
Utilized/Paid		(156,415)		(225,835)		(382,250)
Balance at March 31, 2020		$	214,092	$	222,410	$	436,502
Additions (Reductions)		—		153,685		153,685
Translation Adjustment		4,674		—		4,674
Utilized/Paid		—		(201,211)		(201,211)
Balance at June 30, 2020		$	218,766	$	174,884	$	393,650
Additions (Reductions)		—		317,595		317,595
Translation Adjustment		9,554		—		9,554
Utilized/Paid		—		(366,562)		(366,562)
Balance at September 30, 2020		$	228,320	$	125,917	$	354,237
Additions (Reductions)		—		274,086		274,086
Translation Adjustment		11,124		—		11,124
Utilized/Paid		—		(324,537)		(324,537)
Balance at December 31, 2020		$	239,444	$	75,466	$	314,910
Additions (Reductions)		—		302,313		302,313
Balance at January 1, 2021								Balance at January 1, 2021	$	239,444	$	75,466	$	314,910
Provisions/Additions								Provisions/Additions	—		302,313		302,313
Translation Adjustment	Translation Adjustment	(10,393)		—		(10,393)		Translation Adjustment	(10,393)		—		(10,393)
Utilized/Paid	Utilized/Paid	—		(357,184)		(357,184)		Utilized/Paid	—		(357,184)		(357,184)
Balance at March 31, 2021	Balance at March 31, 2021	$	229,051	$	20,595	$	249,646	Balance at March 31, 2021	$	229,051	$	20,595	$	249,646
Additions (Reductions)		—		421,737		421,737
Provisions/Additions								Provisions/Additions	—		421,737		421,737
Translation Adjustment	Translation Adjustment	2,734		—		2,734		Translation Adjustment	2,734		—		2,734
Utilized/Paid	Utilized/Paid	(90,445)		(442,332)		(532,777)		Utilized/Paid	(90,445)		(442,332)		(532,777)
Balance at June 30, 2021	Balance at June 30, 2021	$	141,340	$	—	$	141,340	Balance at June 30, 2021	$	141,340	$	—	$	141,340
Translation Adjustment	Translation Adjustment	(3,429)		—		(3,429)		Translation Adjustment	(3,429)		—		(3,429)
Balance at September 30, 2021	Balance at September 30, 2021	$	137,911	$	—	$	137,911	Balance at September 30, 2021	$	137,911	$	—	$	137,911
Translation Adjustment								Translation Adjustment	(3,248)		—		(3,248)
Balance at December 31, 2021								Balance at December 31, 2021	$	134,663	$	—	$	134,663
Provisions/Additions								Provisions/Additions	—		744		744
Translation Adjustment								Translation Adjustment	(2,534)		—		(2,534)
Balance at March 31, 2022								Balance at March 31, 2022	$	132,129	$	744	$	132,873

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 2020 Plans~~Plan are included within “restructuring costs” in the accompanying condensed consolidated statements of operations.

2927

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

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

Our products are utilized by enterprises and MSPs to address two key areas of enterprise data protection: (i) long-term data retention and recovery, and (ii) data replication to preserve business continuity. ~~As enterprises increasingly look to focus their core IT staffs on application development and refresh, MSPs are increaseingly assuming responsibility for cloud integration and data pretection.~~ Our integration with modern cloud-based data storage environments, such as IBM Cloud, ~~Amazon Web Services (“AWS”)~~AWS and Microsoft Azure, enables our enterprise customers to significantly reduce costs and improve the portability, security and accessibility of their enterprise ~~data and enables MSPs to serve their cusrtomers with their cloud of choice.~~data. We believe this accessibility is key in our modern world, where data must be protected and intelligently leveraged to facilitate learning, improve product design and drive competitive advantage. Our products can be used regardless of the underlying hardware, cloud and source-data, which enables our enterprise customers to leverage their existing hardware and software investments.

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

~~GAAP subscription revenue increased 35% in~~During the ~~third~~first quarter of ~~2021 year-over-year and increased 54% for the year-to-date ending September 30, 2021. Desipite the increase in GAAP subscription revenue, GAAP total revenue in the third quarter of 2021 declined~~ ~~26.0%~~ ~~year-over-year, and GAAP total revenue for the year-to-date ending September 30, 2021~~ ~~decreased~~ ~~year-over-year by~~ ~~6.7%~~. ~~During the~~ ~~third quarter, we generated a net income of $0.4 million, compared to a net income of $1.5 million in~~ ~~third quarter of 2020. For the year to date September 30, 2021, we generated a net income of~~ ~~$0.4 million, compared to a net income of~~ ~~$1.2 million~~ ~~for year to date September 30, 2020.~~

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.

~~During the third quarter of 2021~~2022, we continued to deliver innovation and enhance each of our products. Our StorSafeTM solution is a vital backup long-term archive retention tool in enterprise IT departments’ data protection arsenal and for MSPs that provide data protection as a service to enterprise companies. It enables them to modernize their backup and archive environments, leverage efficient hybrid- and public-cloud storage environments, such as those provided by IBM Cloud, AWS and Microsoft Azure, save operational costs, and improve restore performance for rapid remote disaster recovery.

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

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

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

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

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

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

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

During the first quarter of 2022, our shift to recurring revenue based revenue took a material step forward as we worked to secure a strategic reseller relationship with IBM. Through this strategic reseller relationship, IBM and FalconStor will co-market joint solutions consisting of FalconStor’s VTL/StorSafe software, IBM Cloud Object Storage (“COS”), and IBM Power Virtual Servers (“Power VS”) for efficient application and data migration from on-premises environments to IBM Power VS, and on-going SaaS-based backup and restore within IBM Power VS. While we expect this relationship to provide healthy recurring revenue growth in the future as our joint solutions will be sold on a monthly consumption basis (MRR), our accelerated focus in these types of hybrid cloud relationships, and associated realignment of our sales teams, will continue to contribute to total GAAP revenue fluctuations in the short-term. In fact, GAAP total revenue in the first quarter of 2022 declined 46.5% year-over-year as our accelerated focus on advancing critical hybrid cloud relationships negatively impacted our legacy on-premises revenue. Given the reduction in GAAP Q1 2022 revenue we incurred a net loss of $1.1 million, compared to a net income of $0.4 million in first quarter of 2021, even though we managed operating costs to $2.7 million in the quarter compared to $3.2 million in Q1 2021. Despite the reduction in legacy on-premises revenue during the quarter, our legacy recurring renewal rate was a healthy 86%.

COVID-19

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

RESULTS OF OPERATIONS – FOR THE THREE MONTHS ENDED ~~SEPTEMBER 30, 2021~~MARCH 31, 2022 COMPARED WITH THE THREE MONTHS ENDED ~~SEPTEMBER 30, 2020.~~MARCH 31, 2021.

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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, 2020~~March 31, 2022 and ~~2020~~2021 and the period-over-period dollar and percentage changes for those line items. Our results of operations are reported as one business segment, represented by our single operating segment.


		Three Months Ended September 30,			Change Period to Period												Three Months Ended March 31,				Change Period to Period
(amounts in dollars)	(amounts in dollars)		2021	2020					(amounts in dollars)										2022	2021			Change Period to Period
Revenue:	Revenue:																	Revenue:
Product revenue	Product revenue				$	1,547,013	47	%	$	2,521,695		57	%	$	(974,682)	(39)	%	Product revenue									$	594,928			29	%	$	2,139,729			56	%	$	(1,544,801)	(72)	%
Support and services revenue	Support and services revenue				1,736,456		53	%	1,914,705			43	%	(178,249)		(9)	%	Support and services revenue									1,454,179				71	%	1,688,597				44	%	(234,418)		(14)	%
Total revenue	Total revenue				3,283,469		100	%	4,436,400			100	%	(1,152,931)		(26)	%	Total revenue									2,049,107				100	%	3,828,326				100	%	(1,779,219)		(46)	%
Cost of revenue:	Cost of revenue:																	Cost of revenue:
Product	Product				41,351		1	%	48,895			1	%	(7,544)		(15)	%	Product									20,719				1	%	222,834				6	%	(202,115)		(91)	%
Support and service	Support and service				400,934		12	%	367,063			8	%	33,871		9	%	Support and service									394,549				19	%	426,173				11	%	(31,624)		(7)	%
Total cost of revenue	Total cost of revenue				442,285		13	%	415,958			9	%	26,327		6	%	Total cost of revenue									415,268				20	%	649,007				17	%	(233,739)		(36)	%
Gross profit	Gross profit				2,841,184		87	%	4,020,442			91	%	(1,179,258)		(29)	%	Gross profit									1,633,839				80	%	3,179,319				83	%	(1,545,480)		(49)	%
Operating expenses:	Operating expenses:																	Operating expenses:
Research and development costs	Research and development costs				711,273		22	%	600,430			14	%	110,843		18	%	Research and development costs									705,981				34	%	659,940				17	%	46,041		7	%
Selling and marketing	Selling and marketing				1,610,635		49	%	1,026,241			23	%	584,394		57	%	Selling and marketing									1,189,846				58	%	1,396,640				36	%	(206,794)		(15)	%
General and administrative	General and administrative				633,954		19	%	358,701			8	%	275,253		77	%	General and administrative									849,939				41	%	837,867				22	%	12,072		1	%
Gain on litigation settlement	Gain on litigation settlement				(632,600)		(19)	%	—			—	%	(632,600)		—	%	Gain on litigation settlement									—				—	%	—				—	%	—		—	%
Restructuring costs	Restructuring costs				68,704		2	%	317,595			7	%	(248,891)		(78)	%	Restructuring costs									744				—	%	302,313				8	%	(301,569)		(100)	%
Total operating expenses	Total operating expenses				2,391,966		73	%	2,302,967			52	%	88,999		4	%	Total operating expenses									2,746,510				134	%	3,196,760				84	%	(450,250)		(14)	%
Operating income (loss)	Operating income (loss)				449,218		14	%	1,717,475			39	%	(1,268,257)		(74)	%	Operating income (loss)									(1,112,671)				(54)	%	(17,441)				—	%	(1,095,230)		(6,280)	%

Gain on debt extinguishment											Gain on debt extinguishment											—		—	%	754,000			20	%		(754,000)			(100)	%
Interest and other expense	Interest and other expense				(58,257)		(2)	%	(159,994)			(4)	%	101,737		64	%	Interest and other expense									(117,995)				(6)	%	(283,648)				(7)	%	165,653		58	%
Income (loss) before income taxes	Income (loss) before income taxes				390,961		12	%	1,557,481			35	%	(1,166,520)		(75)	%	Income (loss) before income taxes									(1,230,666)				(60)	%	452,911				12	%	(1,683,577)		(372)	%
Income tax expense (benefit)	Income tax expense (benefit)				16,529		1	%	11,272			—	%	5,257		47	%	Income tax expense (benefit)									(121,260)				(6)	%	44,616				1	%	(165,876)		(372)	%
Net income (loss)	Net income (loss)				$	374,432	11	%	$	1,546,209		35	%	$	(1,171,777)	(76)	%	Net income (loss)									$	(1,109,406)			(54)	%	$	408,295			11	%	$	(1,517,701)	(372)	%
Less: Accrual of Series A redeemable convertible preferred stock dividends	Less: Accrual of Series A redeemable convertible preferred stock dividends				288,802		9	%	266,007			6	%	22,795		9	%	Less: Accrual of Series A redeemable convertible preferred stock dividends									300,921				15	%	277,170				7	%	23,751		9	%

Less: Accretion to redemption value of Series A redeemable convertible preferred stock	Less: Accretion to redemption value of Series A redeemable convertible preferred stock				13,517		—	%	175,335			4	%	(161,818)		(92)	%	Less: Accretion to redemption value of Series A redeemable convertible preferred stock									14,815				1	%	197,114				5	%	(182,299)		(92)	%
Net income (loss) attributable to common stockholders	Net income (loss) attributable to common stockholders				$	72,113	2	%	$	1,104,867		25	%	$	(1,032,754)	(93)	%	Net income (loss) attributable to common stockholders									$	(1,425,142)			(70)	%	$	(65,989)			(2)	%	$	(1,359,153)	(2,060)	%

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, 2021,~~March 31, 2022, we recognized revenue of ~~$3.3~~$2.0 million, compared with ~~$4.4~~$3.8 million in the prior year period.

Product Revenue

Product revenue is comprised of sales of both licenses for our software solutions and sales of the platforms on which the software is installed. This includes stand-alone software applications and, on occasion, software integrated with industry standard hardware. We no longer primarily source or sell hardware, rather we facilitate our customers in buying their own hardware. Our products are sold through (i) value-added resellers, (ii) distributors, and/or (iii) directly to end-users. These revenues are recognized when all the applicable criteria under accounting principles generally accepted in the United States are met.

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For the three months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ product revenue represented ~~47%~~29% and ~~57%~~56% of our total revenue, respectively. Product revenue of ~~$1,547,013~~$594,928 for the three months ended ~~September 30, 2021~~March 31, 2022 decreased ~~$974,682,~~$1,544,801, or ~~39%~~72%, from ~~$2,521,695~~$2,139,729 in the prior year period. The decrease in product revenue is due to ~~revenue from three large contracts~~a delay in orders until the ~~three months ended September 30, 2020 that did not repeat in the three months ended September 30, 2021.~~second quarter of 2022.

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

Support and Services Revenue

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

Maintenance and technical support services revenue for the three months ended ~~September 30, 2021~~March 31, 2022 decreased to ~~$1.6~~$1.4 million, compared to ~~$1.9~~$1.6 million in the prior year period. The decrease in maintenance and technical support services revenue is primarily due to a decline in maintenance renewals. 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~~from the previous year reflects a decline in maintenance renewal revenue as a result of conversion to subscription ~~contracts and customer attrition.~~contracts.

Professional services revenue for the three months ended ~~September 30, 2021 increased~~March 31, 2022 decreased to ~~$94,543,~~$5,835, compared to ~~$31,269~~$104,493 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, 2021 increased 6%~~March 31, 2022 decreased 36% to ~~$442,285,~~$415,268, compared with ~~$415,958~~$649,007 in the prior year period. Total gross profit decreased ~~$1.2~~$1.5 million, or ~~29%~~49%, to ~~$2.8~~$1.6 million for the three months ended ~~September 30, 2021,~~March 31, 2022, compared with ~~$4.0~~$3.2 million for the prior year period. Total gross margin decreased to ~~87%~~80% for the three months ended ~~September 30, 2021,~~March 31, 2022, compared with ~~91%~~83% for the prior year period. The decrease in our total gross profit, in absolute dollars, was ~~primarily~~ due to decreased revenue. Generally, our total gross profits and total gross margins fluctuate based on several factors, including (i) revenue growth levels, (ii) changes in personnel headcount and related costs, and (iii) our product offerings and mix of sales.

Cost of Product Revenue, Gross Profit and Gross Margin

Cost of product revenue consists primarily of hardware and warranty expenses. Cost of product revenue for the three months ended ~~September 30, 2021~~March 31, 2022 decreased to ~~$41,351,~~$20,719, compared with ~~$48,895~~$222,834 in the prior year period. Product gross margin for the three months ended ~~September 30, 2021 decreased slightly,~~March 31, 2022 increased, year over year, to 97% from ~~98%~~90% for the same period in ~~2020.~~2021. This decrease in cost of product revenue for the three months ended ~~September 30, 2021~~March 31, 2022 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 revenue consists primarily of personnel and other costs associated with providing software implementations, technical support under maintenance contracts and training. Cost of support and service revenue for the three months ended ~~September 30, 2021 increased 9%~~March 31, 2022 decreased 7% to ~~$400,934,~~$394,549, compared with ~~$367,063~~$426,173 in the prior year period. Support and service gross margin decreased slightly to ~~77%~~73% for the three months ended ~~September 30, 2021,~~March 31, 2022, compared with ~~81%~~75% for the prior year period. The ~~increase~~decrease in the cost of support and service revenue, in absolute dollars, was primarily related to ~~an increase in personnel related~~a decrease rental costs resulting from our reinstatement of workforce that was reduced as part of the 2020 Restructuring Plan implemented in response to the novel coronavirus pandemic. For further information, refer to Note (17) ~~Restructuring Costs~~ ~~to our unaudited condensed consolidated financial statements.~~and employee bonuses.

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Operating Expenses

Our operating expenses for the three months ended ~~September 30, 2021 increased slightly~~March 31, 2022 decreased by ~~$0.1~~$0.5 million to ~~$2.4~~$2.7 million from ~~$2.3~~$3.2 million, for the previous year period.

Research and Development Costs

Research and development costs consist primarily of personnel costs for product development, and other related costs associated with the development of new products, enhancements to existing products, quality assurance and testing. Research and development costs increased ~~$0.1 million,~~$46,041, or ~~18%~~7%, to ~~$0.7 million~~$705,981 for the three months ended ~~September 30, 2021,~~March 31, 2022, from ~~$0.6 million~~$659,940 in the prior year period. The increase in research and development costs was primarily related to an increase in personnel related costs resulting from our reinstatement of workforce that was reduced as part of the 2020 Restructuring Plan implemented in response to the novel coronavirus pandemic. For further information, refer to Note (17) ~~Restructuring Costs~~ to our unaudited condensed consolidated financial statements. 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.costs.

Selling and Marketing

Selling and marketing expenses consist primarily of sales and marketing personnel and related costs, travel, public relations expense, marketing literature and promotions, commissions, trade show expenses, and the costs associated with our foreign sales offices. Selling and marketing expenses ~~increased $0.6~~declined $0.2 million, or ~~57%~~15%, to ~~$1.6~~$1.2 million for the three months ended ~~September 30, 2021~~March 31, 2022 from ~~$1.0~~$1.4 million in the prior year period. The ~~increase~~decrease in selling and marketing expenses was primarily related to reductions in commissions and employee bonuses ~~and promotional campaign expenses and~~which were partially offset by an increase in personnel related costs resulting from our reinstatement of workforce that was reduced as part of the 2020 Restructuring Plan implemented in response to the novel coronavirus pandemic. For further information, refer to Note (17) ~~Restructuring Costs~~ ~~to our unaudited condensed consolidated financial statements.~~

~~Gain on Litigation Settlement~~

During the three months ended September 30, 2021, we recorded a gain of $0.6 million for a legal settlement of a contractual dispute with a marketing/sales firm. For further information, refer to Note (15) ~~Litigation, to our unaudited condensed consolidated financial statements.~~consulting fees.

General and Administrative

General and administrative expenses consist primarily of personnel costs of general and administrative functions, public company related costs, directors’ and officers’ insurance, legal and professional fees, and other general corporate overhead costs. General and administrative expenses increased ~~$0.3 million~~slightly by $12,072 to ~~$0.6 million~~$849,939 for the three months ended ~~September 30, 2021,~~March 31, 2022, compared to ~~$0.4 million~~$837,867 for the prior year period. The increase in general and administrative expenses was due primarily to an ~~accrual reversal for Board fees that occurred in three months ended September 30, 2020 and reductions~~increase in professional ~~fees.~~services which are partially offset by a reduction in employee bonuses.

Restructuring

In June 2017, the Board ~~approved~~of Directors of the ~~2017 Plan,~~Company (the “Board”) approved a comprehensive plan to increase operating ~~performance.~~performance ("the 2017 Plan"). The 2017 Plan resulted in a realignment and reduction in workforce. The 2017 Plan was substantially completed by the end of our fiscal year ended December 31, 2017 and when combined with previous workforce reductions in the second quarter of Fiscal 2017 reduced our workforce to approximately 81 employees at December 31, 2017. As part of this consolidation effort, the Company vacated a portion of its former Melville, NY office space during the three months ended June 30, 2018. 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. As the lease has terminated in April 2021, there are no further restructuring costs associated with this lease.

During the three months ended September 30, 2019, the Company adopted the 2019 Plan, 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, implement tighter expense controls, cease non-core activities and downsize several facilities. During the three months ended September 30, 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 the 2020 Plan, an even more aggressive expense control plan in March 2020, that was kept in place for the duration of 2020. The 2020 Plan reduced the Company's annual cash expense run rate by $4.0 million or 29%. The Company furloughed 21 positions worldwide, and 20 of these positions were reinstated by December 31, 2020. During the three months ended September 30, 2021, the Company has not incurred severance expense as a result of this action.

Restructuring expense decreased ~~$0.2 million~~$301,569 for the three months ended ~~September 30, 2021~~March 31, 2022 to ~~$0.1 million,~~$744, compared to a restructuring expense of ~~$0.3 million~~$302,313 in the prior year period. ~~Restructuring~~The decrease in restructuring expense ~~primarily consists~~is due to the reduction in lease expenses that were classified as restructuring costs.

Gain on Debt Extinguishment

Gain on debt extinguishment decreased $754,000 for the three months ended March 31, 2022, from $754,000 for the three months ended March 31, 2021. The debt extinguishment during such three months ended March 31, 2021 reflected the forgiveness of ~~lease disposal activities.~~the Company’s PPP Paycheck Protection Program loan, which was issued by Peapack Gladstone Bank in an aggregate principal amount of $754,000, and forgiven in full on March 30, 2021.

Interest and Other (Loss) Income, Net

Interest and other ~~income (loss),~~expense, net, decreased ~~$101,737~~$165,653 to a loss of ~~$58,257~~$117,995 for the three months ended ~~September 30, 2021,~~March 31, 2022, compared with a loss of ~~$159,994~~$283,648 in the prior year period. The ~~increase~~decrease in interest and other ~~income (loss)~~expense primarily relates to payments made on outstanding debt. The fluctuation in interest and other ~~income (loss)~~expense from quarter to quarter also relates to interest expense, foreign currency gains and losses, interest income, sublease income and the change in fair value of our embedded derivatives. For more information on our derivative instruments, see Note (10) Fair Value Measurements to our unaudited condensed consolidated financial statements.

Income Taxes

Our provision for income taxes consists of state and local, and foreign taxes. For the three months ended ~~September 30,~~March 31, 2022 and 2021, ~~and 2020,~~ the Company recorded income tax ~~expense of $16,529 and~~ benefit of ~~$11,272,~~$121,260 and provision of $44,616, respectively, consisting primarily of state and local, and foreign taxes.

As of ~~September 30, 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.~~

~~RESULTS OF OPERATIONS – FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2021 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 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 nine months ended September 30, 2021 and 2020 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)
2021 2020
Revenue:
Product revenue $ 5,288,747 51 % $ 5,202,713 47 % $ 86,034 2 %
Support and services revenue 5,081,795 49 % 5,913,486 53 % (831,691) (14) %
Total revenue 10,370,542 100 % 11,116,199 100 % (745,657) (7) %
Cost of revenue:
Product 298,966 3 % 250,185 2 % 48,781 19 %
Support and service 1,233,067 12 % 1,109,379 10 % 123,688 11 %
Total cost of revenue 1,532,033 15 % 1,359,564 12 % 172,469 13 %
Gross profit 8,838,509 85 % 9,756,635 88 % (918,126) (9) %
Operating expenses:
Research and development costs 2,032,360 20 % 1,809,354 16 % 223,006 12 %
Selling and marketing 4,267,010 41 % 3,027,372 27 % 1,239,638 41 %
General and administrative 2,129,921 21 % 2,297,451 21 % (167,530) (7) %
Gain on litigation settlement (632,600) (6) % — — % (632,600) — %
Restructuring costs 792,754 8 % 758,740 7 % 34,014 4 %
Total operating expenses 8,589,445 83 % 7,892,917 71 % 696,528 9 %
Operating income (loss) 249,064 2 % 1,863,718 17 % (1,614,654) (87) %
Gain on debt extinguishment 754,000 7 % — — % 754,000 — %
Interest and other expense (489,264) (5) % (586,082) (5) % 96,818 17 %
Income (loss) before income taxes 513,800 5 % 1,277,636 11 % (763,836) (60) %
Income tax expense (benefit) 63,804 1 % 44,709 — % 19,095 43 %
Net income (loss) $ 449,996 4 % $ 1,232,927 11 % $ (782,931) (64) %
Less: Accrual of Series A redeemable convertible preferred stock dividends 848,898 8 % 812,362 7 % 36,536 4 %
Less: Accretion to redemption value of Series A redeemable convertible preferred stock 285,814 3 % 366,566 3 % (80,752) (22) %
Net income (loss) attributable to common stockholders $ (684,716) (7) % $ 53,999 — % $ (738,715) (1,368) %

~~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, 2021, we recognized revenue of $10.4 million, compared with $11.1 million in the prior year period.

~~Product Revenue~~

For the nine months ended September 30, 2021 and 2020, product revenue represented 51% and 47% of our total revenue, respectively. Product revenue of $5.3 million for the nine months ended September 30, 2021 increased $0.1 million, or 2%, from $5.2 million in the prior year period.

~~Support and Services Revenue~~

Maintenance and technical support services revenue for the nine months ended September 30, 2021 decreased to $4.8 million, compared to $5.7 million in the prior year period. The decrease is primarily due to a decline in maintenance renewals. 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.

Professional services revenue for the nine months ended September 30, 2021 increased to $255,522, compared to $183,976 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 nine months ended September 30, 2021 increased 13% to $1.5 million, compared with $1.4 million in the prior year period. Total gross profit decreased $0.9 million, or 9%, to $8.8 million for the nine months ended September 30, 2021, compared with $9.8 million for the prior year period. Total gross margin decreased to 85% compared with 88% for the nine months ended September 30, 2021. The decrease in our total gross profit, in absolute dollars, was primarily due to decreased revenue. Generally, our total gross profits and total gross margins fluctuate based on several factors, including (i) revenue growth levels, (ii) changes in personnel headcount and related costs, and (iii) our product offerings and mix of sales.

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

Cost of product revenue consists primarily of hardware and warranty expenses. Cost of product revenue for the nine months ended September 30, 2021 increased slightly to $298,966, compared with $250,185 in the prior year period. Product gross margin for the nine months ended September 30, 2021 declined slightly, year over year, to 94% from 95% for the same period in 2020. The slight increase in cost of product revenue and slight decrease in gross margin for the current year was primarily due to an increase in product revenue while costs increased at a slightly higher rate.

~~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, 2021 increased 11% to $1.2 million, compared with $1.1 million in the prior year period. Support and service gross margin decreased to 76% for the nine months ended September 30, 2021, compared with 81% for the prior year period. The increase was primarily related to an increase in personnel related costs resulting from our reinstatement of workforce that was reduced as part of the 2020 Restructuring Plan implemented in response to the novel coronavirus pandemic.

~~Operating Expenses~~

~~Our operating expenses for the nine months ended September 30, 2021 increased $0.7 million to $8.6 million from $7.9 million, for the previous year period.~~

~~Research and Development Costs~~

Research and development costs consist primarily of personnel costs for product development, and other related costs associated with the development of new products, enhancements to existing products, quality assurance and testing. Research and development costs increased $0.2 million, or 12%, to $2.0 million for the nine months ended September 30, 2021, from $1.8 million in the prior year period. The increase was primarily related to an increase in personnel related costs resulting from our reinstatement of workforce that was reduced as part of the 2020 Restructuring Plan implemented in response to the novel coronavirus pandemic. For further information, refer to Note (17) ~~Restructuring Costs~~ to our unaudited condensed consolidated financial statements. 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 consist primarily of sales and marketing personnel and related costs, travel, public relations expense, marketing literature and promotions, commissions, trade show expenses, and the costs associated with our foreign sales offices. Selling and marketing expenses increased $1.2 million, or 41%, to $4.3 million for the nine months ended September 30, 2021 from $3.0 million in the prior year period. The increase in selling and marketing expenses is primarily due to an increase in commissions, bonuses and promotional campaign expenses and an increase in personnel related costs resulting from our reinstatement of workforce that was reduced as part of the 2020 Restructuring Plan implemented in response to the novel coronavirus pandemic. For further information, refer to Note (17) ~~Restructuring Costs~~ ~~to our unaudited condensed consolidated financial statements.~~

~~Gain on Litigation Settlement~~

During the nine months ended September 30, 2021, we recorded a gain of $0.6 million for a legal settlement of a contractual dispute with a marketing/sales firm. For further information, refer to Note (15) ~~Litigation, to our unaudited condensed consolidated financial statements.~~

~~General and Administrative~~

General and administrative expenses consist primarily of personnel costs of general and administrative functions, public company related costs, directors’ and officers’ insurance, legal and professional fees, and other general corporate overhead costs. General and administrative expenses declined $0.2 million to $2.1 million for the nine months ended September 30, 2021, compared to $2.3 million for the prior year period. The decrease in general and administrative expenses was due primarily to an accrual reversal for Board fees that occurred in three months ended September 30, 2020 and reductions in professional fees.

~~Restructuring~~

In June 2017, the Board approved the 2017 Plan, a comprehensive 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 its former 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. As the lease has terminated in April 2021, there are no further restructuring costs associated with this lease.

During the three months ended September 30, 2019, the Company adopted the 2019 Plan, 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, implement tighter expense controls, cease non-core activities and downsize several facilities. During the nine months ended September 30, 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 the 2020 Plan, an even more aggressive expense control plan in March 2020, that it kept 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 furloughed 21 positions worldwide, and 20 of these positions were reinstated by December 31, 2020. During the nine months ended September 30, 2021, the Company has not yet incurred severance expense as a result of this action.

Restructuring expense increased $34,014 for the nine months ended September 30, 2021 to $792,754, compared to a restructuring expense of $758,740 in the prior year period. For further information, refer to Note (17) ~~Restructuring Costs~~ ~~to our unaudited condensed consolidated financial statements.~~

~~Gain on Debt Extinguishment~~

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

~~Interest and Other (Loss) Income, Net~~

Interest and other income (loss), net, decreased $96,818 to a loss of $489,264 for the nine months ended September 30, 2021, compared with a loss of $586,082 in the prior year period. The increase in interest and other income (loss) primarily relates to payments made on outstanding debt. The fluctuation in interest and other income (loss) from quarter to quarter also relates to interest expense, foreign currency gains and losses, interest income, sublease income and the change in fair value of our embedded derivatives. For more information on our derivative instruments, see Note (10) ~~Fair Value Measurements~~ ~~to our unaudited condensed consolidated financial statements.~~

~~Income Taxes~~

Our provision for income taxes consists of state and local, and foreign taxes. For the nine months ended September 30, 2021 and 2020, the Company recorded income tax expense of $63,804 and $44,709, respectively, consisting primarily of state and local, and foreign taxes.

~~As of September 30, 2021,~~2022, our conclusion regarding the realizability of our US deferred tax assets did not change and we have recorded a full valuation allowance against them.

LIQUIDITY AND CAPITAL RESOURCES

Principal Sources of Liquidity and Company Obligations

Our principal sources of liquidity are our cash and cash equivalents balances generated from operating, investing and financing activities. Our cash and cash equivalents balance as of ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020~~2021 totaled ~~$3.5~~$3.4 million and ~~$1.9~~$3.2 million, respectively.

As described in Note (14) Stockholders' Equity to our unaudited condensed consolidated financial statements, on June 23, 2021, the Company issued and sold an aggregate of 811,750 shares of its common stock in a public offering underwritten by Roth, which included 86,750 shares purchased by Roth pursuant to the partial exercise of its over-allotment option. At a price of $4.10 per share, the Company received net proceeds of approximately $2.7 million after deducting the underwriting discount and estimated offering expenses paid by the Company.

Also, as described in Note (14) Stockholders' Equity to our unaudited condensed consolidated financial statements, on July 27, 2021 the Company issued and sold an aggregate of 285,000 shares of its common stock in a public offering underwritten by Roth. At a price of $4.10 per share, the Company received net proceeds of approximately $0.9 million after deducting the underwriting discount and estimated offering expenses paid by the Company.

We are currently a party to the Amended and Restated Term Loan ~~Agreement.~~Credit Agreement, dated as of February 23, 2018, as amended December 27, 2019, by and between the Company and HCP-FVA, LLC (“HCP-FVA”), (the “Amended and Restated Loan Agreement”). In connection with the then-proposed public offering of the Company as described in the Company's Registration Statement on Form S-1, as amended, originally filed on June 3, 2021, we entered into the Loan Extension Letter Agreement, which provided for an extension of the maturity date on ~~Hale Capital’s~~the portion of the outstanding indebtedness owed to Hale Capital Partners, LP (“Hale Capital”) under the Amended and Restated Loan Agreement to June 30, 2023, which constituted $2.2 million of the $3.5 million principal amount outstanding as of June 2, 2021. The remaining $1.3 million of the principal amount outstanding, which was owed to other lenders, was repaid in full on June 30, 2021. See Note (9) Notes Payable to our unaudited condensed consolidated financial statements for more information. Also, as described further in Note (12) Series A Redeemable Convertible Preferred Stock to our unaudited condensed consolidated financial statements, Hale Capital, HCP-FVA, an affiliated party of Hale Capital, and other affiliates of Hale Capital extended the commencement of the optional redemption date of the Company’s Series A Redeemable Convertible Preferred Stock (the "Series A Preferred Stock") from July 30, 2021 to July 30, 2023. The amendment was approved by our shareholders at our 2021 annual meeting of stockholders and filed with the Delaware Secretary of State on June 25, 2021. If such Series A Preferred Stock was redeemed at ~~September 30, 2021,~~March 31, 2022, the Company would have been required to pay the holders of the Series A Preferred Stock ~~$14.2~~$14.8 million. The Company believes its current cash balances, together with anticipated cash flows from operating activities and the extensions of the maturity of its borrowings and preferred stock, will be sufficient to meet its working capital requirements for at least one year from the date the consolidated financial statements were available to be issued.

The Amended and Restated Loan Agreement has customary representations, warranties and affirmative and negative covenants. The negative covenants include financial covenants relating to in-force annual contract value. The Amended and Restated Loan Agreement also contains customary events of default, including but not limited to payment defaults, cross defaults with certain other indebtedness, breaches of covenants, bankruptcy events and a change of control. In the case of an event of default, as administrative agent under the Amended and Restated Loan Agreement, HCP-FVA, an affiliate of Hale Capital may (and upon the written request of lenders holding in excess of 50% of the term loans, which must include HCP-FVA, is required to) accelerate payment of all obligations under the Amended and Restated Loan Agreement, and seek other available remedies.

The restrictions in the Amended and Restated 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 financial and other covenants and restrictions in the Amended and Restated Loan Agreement will largely depend on the pricing of our products and services, and our ability to successfully implement our overall business strategy. We cannot assure you that we

will be granted waivers or amendments to the Amended and Restated Loan Agreement if for any reason we are unable to comply with these covenants and restrictions. The breach of any of these covenants and restrictions could result in a default under the Amended and Restated Loan Agreement, which could result in an acceleration of our indebtedness.

~~As described in Part I, Item 1, Note (9)~~ ~~Notes Payable and Stock Warrants~~ to our unaudited condensed consolidated financial statements, to help ensure adequate liquidity during this period and in light of uncertainties posed by the COVID-19 pandemic, the Company entered into the PPP Loan with Peapack-Gladstone Bank on April 28, 2020 which had an aggregate principal amount of $754,000. The PPP Loan was forgiven on March 30, 2021.

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

Liquidity

As of ~~September 30, 2021,~~March 31, 2022, we had a working capital surplus of ~~$2.3~~$0.3 million, which is inclusive of current deferred revenue of ~~$3.7~~$4.0 million, and a stockholders' deficit of ~~$11.5~~$14.3 million. During the ~~nine~~three months ended ~~September 30, 2021,~~March 31, 2022, the Company had a net ~~income~~loss of ~~$0.4~~$1.1 million and ~~negative~~positive cash flow from operations of ~~$0.7~~$0.2 million. The Company's total cash balance at ~~September 30, 2021~~March 31, 2022 was ~~$3.5~~$3.4 million, an increase of ~~$1.6~~$0.2 million compared to December 31, 2020. On April 28, 2020, the Company entered into the PPP Loan with Peapack-Gladstone Bank in an aggregate principal amount of $754,000, which was forgiven by the Small Business Administration on March 30, 2021. On June 30, 2021, the Company repaid in full $1.3 million of the $3.5 million principal amount that was outstanding as of June 2, 2021 under the Amended and Restated Loan Agreement.

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.~~

In the third quarter of 2019, the Company adopted the 2019 Plan, 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. 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 developed and implemented the 2020 Plan that it kept in place for the remainder of 2020. This plan reduced the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 20 of these positions were reinstated by December 31, 2020. The 2020 Plan was completed on December 31, 2020.

Based on its projected cash flows from operations, recently completed financing activities, cost cutting measures in place and existing cash on hand, the Company is projecting to have sufficient liquidity and to be cash flow positive through ~~November 10, 2022.~~May 11, 2023.

Cash Flow Analysis

Cash flow information is as follows:


		Nine Months Ended September 30,					Three Months Ended March 31,
		2021		2020			2022		2021
Cash provided by (used in):	Cash provided by (used in):					Cash provided by (used in):
Operating activities	Operating activities	(707,889)		(303,299)		Operating activities	214,419		137,659
Investing activities	Investing activities	(108,928)		(63,005)		Investing activities	—		(39,533)
Financing activities	Financing activities	2,371,707		(246,000)		Financing activities	—		—
Effect of exchange rate changes	Effect of exchange rate changes	(762)		8,419		Effect of exchange rate changes	(13,989)		2,207
Net increase (decrease) in cash and cash equivalents	Net increase (decrease) in cash and cash equivalents	$	1,554,128	$	(603,885)	Net increase (decrease) in cash and cash equivalents	$	200,430	$	100,333

Net cash ~~used in~~provided by operating activities totaled ~~$0.7~~$0.2 million for the ~~nine~~three months ended ~~September 30, 2021,~~March 31, 2022, compared with ~~$0.3~~$0.1 million of net cash ~~used in~~provided by 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, 2021,~~March 31, 2022, was primarily due to our net ~~income (loss)~~loss, non-cash adjustments to net 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.~~liabilities.

There was no cash used in or provided by investing activities for the three months ended March 31, 2022. Net cash used in investing activities ~~totaled $0.1 million for the nine months ended September 30, 2021, compared with net cash used in investing activities of $0.1 million~~ in the prior year ~~period.~~period totaled $39,533. Included in investing activities for the three months ended March 31, 2021 are purchases of property and equipment ~~intangible assets~~ and cash received from security deposits.

~~Net~~There was no cash used in or provided by financing activities ~~totaled $2.4 million~~ for the ~~nine~~three months ended ~~September 30, 2021, compared with net cash used in financing activities of $0.2 million in~~March 31, 2022 and the ~~prior year period. The change in net cash provided by financing activities in the nine~~three months ended September 30, 2021 included net proceeds from public offerings of our common stock, less offering costs, and payments on our long-term debt. The net cash used in financing activities in the nine months ended September 30, 2020 was attributable to proceeds from the issuance of the PPP Loan and the payoff of the term loan.March 31, 2021.

Total cash and cash equivalents increased ~~$1.6~~$0.2 million to ~~$3.5~~$3.4 million at ~~September 30, 2021~~March 31, 2022 compared to December 31, ~~2020.~~2021.

Contractual Obligations

As of ~~September 30, 2021,~~March 31, 2022, our significant commitments are related to (i) the Amended and Restated Loan Agreement, (ii) our operating leases for our office facilities, (iii) dividends (including accrued dividends) on our Series A Preferred Stock, and (iv) the potential redemption of the Series A Preferred Stock as discussed above.

The following is a schedule summarizing our significant obligations to make future payments under contractual obligations as of ~~September 30, 2021:~~March 31, 2022:

Operating Leases Note Payable (a) Interest Payments (a) Long-Term Income Tax Payable (b) Series A Preferred Stock Mandatory Redemption (c) Dividends on Series A Preferred Stock (d)
2021 30,063 — 35,107 — — —
2022 112,232 — 140,427 — — —
2023 — 2,176,621 70,214 — — —
Other — — — 108,091 9,000,000 7,504,873
Total contractual obligations $ 142,295 $ 2,176,621 $ 245,748 $ 108,091 $ 9,000,000 $ 7,504,873


	Operating Leases		Note Payable (a)		Interest Payments (a)		Long-Term Income Tax Payable (b)		Series A Preferred Stock Mandatory Redemption (c)		Dividends on Series A Preferred Stock (d)
2022	57,747		—		87,065		—		—		—
2023	38,498		2,176,621		43,532		—		—		—

Other	—		—		—		123,979		9,000,000		7,504,873
Total contractual obligations	$	96,245	$	2,176,621	$	130,597	$	123,979	$	9,000,000	$	7,504,873

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

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

(c) Represents our potential liability if the holders of our Series A Preferred Stock redeem their shares for cash. The earliest date in which a redemption can occur is July 30, 2023. For further information, see Note (12) Series A Redeemable Convertible Preferred Stock to our unaudited condensed consolidated financial statements.

(d) Our agreements with the holders of the Series A Preferred Stock provide that such holders will receive quarterly dividends on the Series A Preferred Stock at prime rate plus 5%, subject to a maximum dividend rate of 10%. We also have the ability to accrue and roll over dividends. Due to the lack of sufficient surplus to pay dividends as required by the Delaware General Corporation Law, the Company was not permitted to pay the fourth quarter 2016 dividend in cash or common stock and has been accruing its quarterly dividends since then. This amount represents our potential liability to pay preferred stock dividends in cash on July 30, 2023, which is the earliest date in which the holders of our Series A Preferred Stock can redeem their shares for cash. For further information, see Note (12) Series A Redeemable Convertible Preferred Stock to our unaudited condensed consolidated financial statements.

Critical Accounting Policies and Estimates

We describe our significant accounting policies in Note (1) Summary of Significant Accounting Policies of our ~~2020~~2021 Form 10-K. We discuss our critical accounting estimates in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our ~~2020~~2021 Form 10-K. There have been no significant changes in our significant accounting policies or critical accounting estimates since December 31, ~~2020.~~2021.

Impact of Recently Issued Accounting Pronouncements

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

Off-Balance Sheet Arrangements

As of ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020,~~2021, we had no off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

~~Foreign Currency Risk~~.

We ~~have several offices outside~~are not required to provide the ~~United States. Accordingly,~~information required by this item as we are ~~subject to exposure from adverse movements~~considered a smaller reporting company, as defined in ~~foreign currency exchange rates. For the nine months ended September 30, 2021 and 2020, approximately 57% and 63%, respectively,~~Section 229.10(f)(1) 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, 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.Regulation S-K.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

The Company maintains “disclosure controls and procedures,” as such term is defined in Rules 13a-15e and 15d-15e of the Exchange Act, that are designed to ensure that information required to be disclosed in its reports, pursuant to the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial

Officer, as appropriate, to allow timely decisions regarding the required disclosures. In designing and evaluating the disclosure controls and procedures, management has recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost benefit relationship of possible controls and procedures.

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

Internal Control Over Financial Reporting

Management’s Report on Internal Control Over Financial Reporting

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company; as such term is defined in Rules 13a-15(f) under the Exchange Act, as amended. To evaluate the effectiveness of the Company’s internal control over financial reporting, the Company’s management uses the Integrated Framework (2013) adopted by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

The Company’s management has assessed the effectiveness of the Company’s internal control over financial reporting as of ~~September 30, 2021,~~March 31, 2022, using the COSO framework (2013). The Company’s management has determined that the Company’s internal control over financial reporting is effective as of that date.

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

Changes in Internal Control over Financial Reporting

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

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PART II. OTHER INFORMATION

~~None.~~Item 1. Legal Proceedings

From time to time we are party to legal proceedings that we believe to be ordinary, routine litigation incidental to the business of present or former operations. While the outcome of any such matters cannot be predicted with certainty, such matters are not expected to have a material adverse effect on the Company’s financial condition or operating results.

Item 1A. Risk Factors

We are affected by risks specific to us as well as factors that affect all businesses operating in a global market. The significant factors known to us that could materially adversely affect our business, financial condition, or operating results are set forth in Item 1A to our ~~2020~~2021 Form 10-K.

Unknown Factors

Additional risks and uncertainties of which we are unaware or which currently we deem immaterial also may become important factors that affect us.

Item 2. Unregistered Sales of Equity Securities and use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

None.

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, 2021,~~March 31, 2022, formatted in XBRL (eXtensible Business Reporting Language):


			(i)			unaudited Condensed Consolidated Balance Sheets – ~~September 30, 2021~~March 31, 2022 and December 31, ~~2020.~~2021.

			(ii)			unaudited Condensed Consolidated Statement of Operations – Three ~~and Nine~~ Months Ended ~~September 30, 2021~~March 31, 2022 and ~~2020.~~2021.

			(iii)			unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) – Three ~~and Nine~~ Months Ended ~~September 30, 2021~~March 31, 2022 and ~~2020.~~2021.

			(iv)			unaudited Condensed Consolidated Statements of Stockholder's Deficit - Three ~~and Nine~~ Months Ended ~~September 30, 2021~~March 31, 2022 and ~~2020.~~2021.

			(v)			unaudited Condensed Consolidated Statement of Cash Flows – Three and ~~Nine~~ Months Ended ~~September 30, 2021~~March 31, 2022 and ~~2020.~~2021.

			(vi)			Notes to unaudited Condensed Consolidated Financial Statements – ~~September 30, 2021.~~March 31, 2022.


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

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


			/s/ Todd Brooks
			Todd Brooks
			President & Chief Executive Officer
~~November 10, 2021~~May 11, 2022			(principal executive officer)

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