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FALC Falconstor Software

Filed: 5 May 21, 4:12pm

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 March 31, 2021
or 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                                to                                
Commission File Number:  000-23970
FALCONSTOR SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
Delaware77-0216135
(State or other jurisdiction of incorporation or organization)(I.R.S. Employer Identification No.)
701 Brazos StreetSuite 400AustinTX78701
(Address of principal executive offices)(Zip Code)

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

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

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

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

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




The number of shares of common stock outstanding as of April 30, 2021 was 5,949,463.



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

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PART I.  FINANCIAL INFORMATION
Item 1. Financial Statements
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 March 31, 2021December 31, 2020
 (unaudited) 
Assets  
Current assets:  
Cash and cash equivalents$2,020,989 $1,920,656 
Accounts receivable, net of allowances2,954,033 2,836,571 
Prepaid expenses and other current assets2,063,111 1,837,596 
Contract assets380,119 254,483 
Inventory15,061 15,275 
Total current assets7,433,313 6,864,581 
Property and equipment, net of accumulated depreciation and amortization196,630 197,020 
Operating lease right-of-use assets, net202,495 536,272 
Deferred tax assets, net312,342 330,552 
Software development costs, net17,639 19,278 
Other assets862,515 863,964 
Goodwill4,150,339 4,150,339 
Other intangible assets, net84,052 100,134 
Long-term contract assets188,119 343,934 
Total assets$13,447,444 $13,406,074 
Liabilities and Stockholders' Deficit  
Current liabilities:  
Accounts payable$917,570 $453,791 
Accrued expenses2,374,705 2,293,765 
Current portion of lease liabilities235,962 665,074 
Short-term loan, net of debt issuance costs and discounts3,396,568 3,320,863 
Deferred revenue4,151,083 4,603,270 
Total current liabilities11,075,888 11,336,763 
Other long-term liabilities698,323 703,889 
Notes payable, net of debt issuance costs and discounts754,000 
Deferred tax liabilities520,905 513,027 
Deferred revenue, net of current portion2,303,675 1,765,859 
Total liabilities14,598,791 15,073,538 
Commitments and contingencies (Note 11)00
Series A redeemable convertible preferred stock, $0.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $13,623,747 and $13,346,577, respectively13,415,006 12,940,722 
Stockholders' deficit:  
Common stock - $0.001 par value, 30,000,000 shares authorized, 5,949,463 shares and 5,949,463 shares issued and outstanding, respectively5,949 5,949 
Additional paid-in capital109,637,357 110,107,170 
Accumulated deficit(122,308,096)(122,733,344)
Accumulated other comprehensive loss, net(1,901,563)(1,987,961)
Total stockholders' deficit(14,566,353)(14,608,186)
Total liabilities and stockholders' deficit$13,447,444 $13,406,074 
See accompanying notes to unaudited condensed consolidated financial statements.
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FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three Months Ended March 31,
 20212020
Revenue:  
Product revenue$2,139,729 $1,048,963 
Support and services revenue1,688,597 2,131,224 
Total revenue3,828,326 3,180,187 
Cost of revenue:  
Product222,834 139,460 
Support and service426,173 407,920 
Total cost of revenue649,007 547,380 
Gross profit3,179,319 2,632,807 
Operating expenses:  
Research and development costs659,940 674,924 
Selling and marketing1,396,640 981,191 
General and administrative837,867 1,093,169 
Restructuring costs302,313 287,460 
Total operating expenses3,196,760 3,036,744 
Operating income (loss)(17,441)(403,937)
Gain on debt extinguishment754,000 
Interest and other expense(266,695)(245,839)
Income (loss) before income taxes469,864 (649,776)
Income tax expense (benefit)44,616 70,064 
Net income (loss)$425,248 $(719,840)
Less: Accrual of Series A redeemable convertible preferred stock dividends277,170 285,760 
Less: Accretion to redemption value of Series A redeemable convertible preferred stock197,114 26,090 
Net income (loss) attributable to common stockholders$(49,036)$(1,031,690)
Basic net income (loss) per share attributable to common stockholders$(0.01)$(0.17)
Diluted net income (loss) per share attributable to common stockholders$(0.01)$(0.17)
Weighted average basic shares outstanding5,949,463 5,919,643 
Weighted average diluted shares outstanding5,949,463 5,919,643 

See accompanying notes to unaudited condensed consolidated financial statements.

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FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
Three Months Ended March 31,
 20212020
Net income (loss)$425,248 $(719,840)
Other comprehensive income (loss), net of applicable taxes  
Foreign currency translation86,398 (13,153)
Total other comprehensive income (loss), net of applicable taxes:86,398 (13,153)
Total comprehensive income (loss)$511,646 $(732,993)
Less: Accrual of Series A redeemable convertible preferred stock dividends277,170 285,760 
Less: Accretion to redemption value of Series A redeemable convertible preferred stock197,114 26,090 
Total comprehensive income (loss) attributable to common stockholders$37,362 $(1,044,843)

See accompanying notes to unaudited condensed consolidated financial statements.

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FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(UNAUDITED)

Common Stock OutstandingCommon StockAdditional Paid-In CapitalAccumulated DeficitAccumulated Other Comprehensive Loss, NetTotal Stockholders' Deficit
Balance at January 1, 20215,949,463 $5,949 $110,107,170 $(122,733,344)$(1,987,961)$(14,608,186)
Net income (loss)425,248 425,248 
Share-based compensation to employees4,471 4,471 
Restricted stock issued00
Accretion of Series A redeemable convertible preferred stock(197,114)(197,114)
Dividends on Series A redeemable convertible preferred stock(277,170)(277,170)
Foreign currency translation86,398 86,398 
Balance at March 31, 20215,949,463 $5,949 $109,637,357 $(122,308,096)$(1,901,563)$(14,566,353)
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FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(UNAUDITED)

Common Stock OutstandingCommon StockAdditional Paid-In CapitalAccumulated DeficitAccumulated Other Comprehensive Loss, NetTotal Stockholders' Deficit
Balance at January 1, 20205,918,733 $5,919 $111,727,888 $(123,871,853)$(1,893,260)$(14,031,306)
Net income (loss)(719,840)(719,840)
Share-based compensation to employees4,510 4,510 
Restricted stock issued1,104 (1)
Accretion of Series A redeemable convertible preferred stock(26,090)(26,090)
Dividends on Series A redeemable convertible preferred stock(285,760)(285,760)
Foreign currency translation(13,153)(13,153)
Balance at March 31, 20205,919,837 $5,920 $111,420,547 $(124,591,693)$(1,906,413)$(15,071,639)


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FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 Three Months Ended March 31,
 20212020
Cash flows from operating activities:  
Net income (loss)$425,248 $(719,840)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:  
Depreciation and amortization57,486 33,563 
Amortization of debt discount on notes payable75,705 109,861 
Amortization of right of use assets333,777 353,715 
Gain on debt extinguishment(754,000)
Share-based payment compensation4,471 4,510 
Provision for (recovery of) returns and doubtful accounts(81,244)
Deferred income taxes (benefit)7,878 24,545 
Changes in operating assets and liabilities:  
Accounts receivable(129,714)1,720,163 
Prepaid expenses and other current assets(250,034)121,591 
Contract assets30,179 229,042 
Inventory15,539 
Other assets(1,031)(51)
Accounts payable536,721 (433,791)
Accrued expenses and other long-term liabilities114,335 (171,461)
Operating lease liabilities(429,112)(403,100)
Deferred revenue115,750 (1,201,373)
Net cash provided by (used in) operating activities137,659 (398,331)
Cash flows from investing activities:  
Purchases of property and equipment(41,121)0
Security deposits1,588 (82,908)
Purchase of intangible assets(11,360)
Net cash provided by (used in) investing activities(39,533)(94,268)
Effect of exchange rate changes on cash and cash equivalents2,207 (6,446)
Net increase (decrease) in cash and cash equivalents100,333 (499,045)
Cash and cash equivalents, beginning of period1,920,656 1,475,166 
Cash and cash equivalents, end of period$2,020,989 $976,121 
Supplemental disclosures:  
Cash paid for interest$75,816 $52,546 
Non-cash investing and financing activities:  
Undistributed Series A redeemable convertible preferred stock dividends$277,170 $285,760 
Accretion of Series A redeemable convertible preferred stock$197,114 $26,090 

See accompanying notes to unaudited condensed consolidated financial statements.
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FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements 

(1) Basis of Presentation

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

(b) Liquidity

As of March 31, 2021, the Company had a working capital deficiency of $3.6 million, which is inclusive of current deferred revenue of $4.2 million, and a stockholders' deficit of $14.6 million. During the three months ended March 31, 2021, the Company had net income of $0.4 million and positive cash flow from operations of $0.1 million. The Company's total cash balance at March 31, 2021 was $2.0 million, an increase of $100,333 compared to December 31, 2020.

The Company’s principal sources of liquidity at March 31, 2021 consisted of cash and future cash anticipated to be generated from operations. The Company generated positive net income and cash flows from operations during the three months ended March 31, 2021. Although the Company reported negative working capital as of March 31, 2021, it was primarily due to notes payable and deferred revenue. The Company is currently a party to the Amended and Restated Term Loan Credit Agreement, dated as of February 23, 2018, as amended December 27, 2019, by and among the company, HCP-FVA, LLC (“HCP-FVA”), EW Capital, LLC, the lenders party thereto and the other loan parties named therein (the “Amended and Restated Loan Agreement”). The maturity date of the Company’s obligations under the Amended and Restated Loan Agreement is June 30, 2021 and as of March 31, 2021, the Company is obligated to repay the loan parties $3.5 million, of which $2.2 million is owed to HCP-FVA. The Company also has outstanding Series A Redeemable Convertible Preferred Stock (the “Series A Preferred Stock”) which currently can be redeemed by the holders of the Series A Preferred Stock at July 30, 2021. If such Series A Preferred Stock was redeemed at March 31, 2021, the Company would be required to pay the holders of the Series A Preferred Stock $13.6 million. HCP-FVA is the majority holder of the Series A Preferred Stock and no Series A Preferred Stock can be redeemed without the consent of HCP-FVA.

HCP-FVA is an affiliated party of Hale Capital Partners and Hale Capital Partners and affiliated entities (“HCP”) have agreed if necessary to extend the maturity date of the indebtedness owed to HCP-FVA under the Amended and Restated Loan Agreement from June 30, 2021 to at least July 1, 2022. Similarly, HCP has agreed if necessary to extend the commencement of the optional redemption date of the Series A Preferred Stock from July 30, 2021 to at least July 1, 2022. The Company believes its current cash balances together with anticipated cash flows from operating activities, and its plans to extend the maturity of its borrowings from HCP-FVA and commencement of the optional redemption date of the Series A 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.

(c) 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.
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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, share-based payment compensation, valuation of derivatives, capitalizable software development costs, valuation of goodwill and other intangible assets and income taxes. During the first quarter of 2018, the Company also had significant estimates in the determination of the fair value of Series A Redeemable Convertible Preferred Stock ("Series A Preferred Stock"), notes payable and warrants issued. Actual results could differ from those estimates.
 
The financial market volatility in many countries where the Company operates has impacted and may continue to impact the Company’s business. Such conditions could have a material impact on the Company’s significant accounting estimates discussed above.
 
(f)  Unaudited Interim Financial Information
 
The accompanying unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements.
 
In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly state the financial position of the Company at March 31, 2021, and the results of its operations for the three months ended March 31, 2021 and 2020. The results of operations of any interim period are not necessarily indicative of the results of operations to be expected for the full fiscal year. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes set forth in the Company's Annual Report on Form 10-K for the year ended December 31, 2020 ("2020 Form 10-K").

(g)  Recently Issued Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board (the "FASB") issued Accounting Standards Update ("ASU") 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General: Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans. The objective of the guidance is to improve the effectiveness of disclosure requirements on defined benefit pension plans and other postretirement plans. The guidance is effective for fiscal years beginning after December 15, 2020. 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.

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

(2) Summary of Significant Accounting Policies

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

Revenue from Contracts with Customers and Associated Balances

Nature of Products and Services

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

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

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

Contract Balances

    Timing of revenue recognition may differ from the timing of invoicing to customers. The Company records a contract asset when revenue is recognized prior to invoicing, or unearned revenue when revenue is recognized subsequent to invoicing. For perpetual licenses with multi-year 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 March 31, 2021 and December 31, 2020, accounts receivable, net of allowance for doubtful accounts, was $3.0 million and $2.8 million, respectively. As of both March 31, 2021 and December 31, 2020, short and long-term contract assets, net of allowance for doubtful accounts, was $0.6 million.

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

    Changes in deferred revenue were as follows:
Three Months Ended March 31, 2021
Balance at December 31, 2020$6,369,129 
   Deferral of revenue3,915,390 
   Recognition of revenue(3,828,326)
   Change in reserves(1,435)
Balance at March 31, 2021$6,454,758 
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    Deferred revenue includes invoiced revenue allocated to remaining performance obligations that has not yet been recognized and will be recognized as revenue in future periods. Deferred revenue was $6.5 million as of March 31, 2021, of which the Company expects to recognize approximately 64% of such amount as revenue over the next 12 months and the remainder thereafter.

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

    Payment terms and conditions vary by contract type, although terms generally include a requirement of payment within 30 to 90 days. In instances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined its contracts generally do not include a significant financing component. The primary purpose of the Company’s invoicing terms is to provide customers with simplified and predictable ways of purchasing its products and services, not to receive financing from our customers or to provide customers with financing. Examples include invoicing at the beginning of a subscription term with maintenance and support revenue recognized ratably over the contract period, and multi-year on-premises licenses that are invoiced annually with product revenue recognized upon delivery.
Significant Judgments
    The Company’s contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment.
    Judgment is required to determine the standalone selling price (“SSP”) for each distinct performance obligation. For products and services aside from maintenance and support, the Company estimates SSP by adjusting the list price by historical discount percentages. SSP for software and hardware maintenance and support fees is based on the stated percentages of the fees charged for the respective products.
    The Company’s perpetual and term software licenses have significant standalone functionality and therefore revenue allocated to these performance obligations are recognized at a point in time upon electronic delivery of the download link and the license keys.
    Product maintenance and support services are satisfied over time as they are stand-ready obligations throughout the support period. As a result, revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract.
    Revenues associated with professional services are recognized at a point in time upon customer acceptance.
Disaggregation of Revenue
    Please refer to the condensed consolidated statements of operations and Note (16), Segment Reporting and Concentrations, for discussion on revenue disaggregation by product type and by geography. The Company believes this level of disaggregation sufficiently depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors.

Assets Recognized from Costs to Obtain a Contract with a Customer

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

Leases

We have entered into operating leases for our various facilities. We determine if an arrangement is a lease at inception. Operating leases are included in Right-of-Use ("ROU") assets, and lease liability obligations in our condensed consolidated balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liability obligations
13


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

Right of Use Assets and Liabilities

    We have various operating leases for office facilities that expire through 2021. Below is a summary of our ROU assets and liabilities as of March 31, 2021.
Right of use assets$202,495 
Lease liability obligations, current235,962 
Lease liability obligations, less current portion
Total lease liability obligations$235,962 
Weighted-average remaining lease term0.54
Weighted-average discount rate5.74 %
Three Months Ended March 31,
20212020
Components of lease expense:
Operating lease cost$414,351 $489,043 
Sublease income(75,314)(199,055)
Net lease cost$339,037 $289,988 

    During the three months ended March 31, 2021 and 2020, operating cash flows from operating leases were approximately $354,968 and $547,623, respectively.

Approximate future minimum lease payments for our ROU assets over the remaining lease periods as of March 31, 2021, are as follows:
2021237,525 
Total minimum lease payments237,525 
Less interest1,563 
Present value of lease liabilities235,962 

(3) Earnings Per Share

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

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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 months ended March 31, 2021 and 2020:
 Three Months Ended March 31,
20212020
Stock options and restricted stock1,395,993 1,178,974 
Series A redeemable convertible preferred stock87,815 87,815 
Total anti-dilutive common stock equivalents1,483,808 1,266,789 

(4) Property and Equipment

The gross carrying amount and accumulated depreciation of property and equipment as of March 31, 2021 and December 31, 2020 are as follows:
March 31, 2021December 31, 2020
Gross carrying amount$18,813,944 $18,791,841 
Accumulated depreciation(18,617,314)(18,594,821)
Property and Equipment, net$196,630 $197,020 

For the three months ended March 31, 2021 and 2020, depreciation expense was $39,765 and $45,943, respectively.

(5) Software Development Costs

The gross carrying amount and accumulated amortization of software development costs as of March 31, 2021 and December 31, 2020 are as follows:
March 31, 2021December 31, 2020
Gross carrying amount$2,950,132 $2,950,132 
Accumulated amortization(2,932,493)(2,930,854)
Software development costs, net$17,639 $19,278 

During the three months ended March 31, 2021 and 2020, the Company recorded $1,639 and $2,791, respectively, of amortization expense related to capitalized software costs.

(6) Goodwill and Other Intangible Assets

The gross carrying amount and accumulated amortization of goodwill and other intangible assets as of March 31, 2021 and December 31, 2020 are as follows: 
March 31, 2021December 31, 2020
Goodwill$4,150,339 $4,150,339 
Other intangible assets:  
Gross carrying amount$4,027,912 $4,027,912 
Accumulated amortization(3,943,860)(3,927,778)
Net carrying amount$84,052 $100,134 

    For the three months ended March 31, 2021 and 2020, amortization expense was $16,082 and $(15,171), respectively.

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(7) Share-Based Payment Arrangements

On June 22, 2018, the Company's stockholders adopted the FalconStor Software, Inc. 2018 Incentive Stock Plan (the "2018 Plan"). The 2018 Plan is administered by the Compensation Committee and provides for the issuance of up to 1,471,997 shares of the Company's common stock upon the grant of shares with such restrictions as determined by the Compensation Committee to the employees and directors of, and consultants providing services to, the Company or its affiliates. Exercise prices of the options will be determined by the Compensation Committee of the Company's Board of Directors, subject to the consent of Hale Capital Partners, LP. The vesting terms shall be performance based and determined by the Compensation Committee, subject to the consent of Hale Capital Partners, LP, based on various factors, including (i) the return of capital to the holders of the Series A Preferred Stock and the Company’s Common Stock in the event of a Change of Control, (ii) the repayment of the Company’s obligations under its senior secured debt, and (iii) the Company’s free cash flow.

The following table summarizes the 2018 Plan, which was the only plan under which the Company was able to grant equity compensation as of March 31, 2021: 
 SharesShares AvailableShares
Name of PlanAuthorizedfor GrantOutstanding
FalconStor Software, Inc. 2018 Incentive Stock Plan1,471,997(31,368)1,442,828

The following table summarizes the Company’s equity plans that have terminated or expired but that still have equity awards outstanding as of March 31, 2021: 
Name of PlanShares Available for GrantShares Outstanding
FalconStor Software, Inc., 2016 Incentive Stock Plan03,850
FalconStor Software, Inc., 2006 Incentive Stock Plan05,930
 
The following table summarizes the share-based compensation expense for all awards issued under the Company’s stock equity plans in the following line items in the condensed consolidated statements of operations for the three months ended March 31, 2021 and 2020:
 Three Months Ended March 31,
 20212020
Cost of revenue - Product$227 $
Cost of revenue - support and service181 103 
Research and development costs428 
Selling and marketing2,677 184 
General and administrative1,386 3,795 
 $4,471 $4,510 

(8) Income Taxes
 
    The Company’s provision for income taxes consists principally of state and local, and foreign taxes, as applicable, in amounts necessary to align the Company’s year-to-date tax provision with the effective rate that it expects to achieve for the full year.

For the three months ended March 31, 2021, the Company recorded an income tax provision of $44,616. The effective tax rate for the three months ended March 31, 2021 was 7.0%. The effective tax rate differs from the statutory rate of 21% due to the mix of foreign and domestic earnings and the application of valuation allowances. As of March 31, 2021, the Company’s conclusion did not change with respect to the realizability of its domestic deferred tax assets and therefore, the Company has not recorded any income tax benefit as such amounts are fully offset with a valuation allowance.

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

The Company’s total unrecognized tax benefits, excluding interest, at both March 31, 2021 and December 31, 2020 were $75,506. As of March 31, 2021 and December 31, 2020, the Company had $37,207 and $35,340, respectively, of accrued interest reflected in accrued expenses. The Company expects approximately $8,000 of tax benefits during the next twelve months due due to expiring statute of limitations, which will impact the Company's effective tax rate.

(9) Notes Payable

    The notes payable balance consists of the following:
Total notes payable, net at December 31, 2020$4,074,863 
Accretion of discount75,705 
PPP loan forgiveness(754,000)
Total notes payable, net at March 31, 2021$3,396,568 


Senior Secured Debt

    The $4 million senior secured debt bears interest at prime plus 0.75% and matures on June 30, 2021. As of March 31, 2021, the Company was in compliance with the financial covenants contained in the Amended and Restated Term Loan Credit Agreement.
Loan under the Paycheck Protection Program
On April 28, 2020, the Company entered into a loan with Peapack-Gladstone Bank in an aggregate principal amount of $754,000, pursuant to the Paycheck Protection Program (the "PPP") under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act").
The PPP Loan is evidenced by a promissory note dated April 28, 2020. The PPP Loan matures two years from the disbursement date and bears interest at a rate of 1.000% per annum, with the first six months of interest deferred. Principal and interest are payable monthly commencing six months after the disbursement date and may be prepaid by the Company at any time prior to maturity with 0 prepayment penalties.
Under the terms of the CARES Act, PPP loan recipients can apply for and be granted forgiveness for all or a portion of loans granted under the PPP. The PPP Loan is subject to forgiveness to the extent proceeds are used for payroll costs, including payments required to continue group health care benefits, and certain rent, utility, and mortgage interest expenses (collectively, “Qualifying Expenses”), pursuant to the terms and limitations of the PPP. The Company has used a significant majority of the Loan amount for Qualifying Expenses.

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

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

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

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at March 31, 2021:
  Fair Value Measurements at Reporting Date Using
TotalQuoted Prices in Active Markets for Identical Assets
(Level 1)
Significant other Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Derivative liabilities:    
Derivative Instruments470,222 470,222 
Total derivative liabilities470,222 470,222 
Total assets and liabilities measured at fair value$470,222 $$$470,222 

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at December 31, 2020: 
  Fair Value Measurements at Reporting Date Using
TotalQuoted Prices in Active Markets for Identical Assets
(Level 1)
Significant other Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Derivative liabilities:
Derivative Instruments472,851 472,851 
Total derivative liabilities472,851 472,851 
Total assets and liabilities measured at fair value$472,851 $$$472,851 
 
The fair value of the Company’s derivatives were valued using the Black-Scholes pricing model adjusted for probability assumptions, with all significant inputs, except for the probability and volatility assumptions, derived from or corroborated by observable market data such as stock price and interest rates. The probability and volatility assumptions are both significant to the fair value measurement and unobservable. These embedded derivatives are included in Level 3 of the fair value hierarchy.

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

The following table presents a reconciliation of the beginning and ending balances of the Company's liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2021 and March 31, 2020:
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Three Months Ended March 31,
20212020
Beginning Balance$472,851 $483,804 
Total income recognized in earnings(2,629)(2,752)
Ending Balance$470,222 $481,052 

(11) Commitments and Contingencies
 
    The Company’s headquarters are located in Austin, Texas.  The Company has an operating lease covering its Melville, New York office facility that expires in April 2021. The Company has sublet a portion of this lease. The Company also has several additional operating leases related to offices in foreign countries. The expiration dates for these leases occur in 2021. The following is a schedule of future minimum lease payments as well as sublease income for all operating leases as of March 31, 2021:
PaymentsSublease IncomeNet Commitments
2021237,525 (25,105)212,420 
 $237,525 $(25,105)$212,420 


The Company typically provides its customers a warranty on its software products for a period of no more than 90 days. Such warranties are accounted for in accordance with the authoritative guidance issued by the FASB on contingencies. For the three months ended March 31, 2021, the Company has not incurred any costs related to warranty obligations.
 
Under the terms of substantially all of its software license agreements, the Company indemnifies its customers for all costs and damages arising from claims against such customers based on, among other things, allegations that the Company’s software infringes on the intellectual property rights of a third party. In most cases, in the event of an infringement claim, the Company retains the right to (i) procure for the customer the right to continue using the software; (ii) replace or modify the software to eliminate the infringement while providing substantially equivalent functionality; or (iii) if neither (i) nor (ii) can be reasonably achieved, the Company may terminate the license agreement and refund to the customer a pro-rata portion of the license fee paid to the Company. Such indemnification provisions are accounted for in accordance with the authoritative guidance issued by the FASB on guarantees. From time to time, in the ordinary course of business, the Company receives claims for indemnification, typically from OEMs. The Company is not currently aware of any material claims for indemnification.
 
As described under Note (12), the holders of the Series A Preferred Stock have redemption rights upon certain triggering events. As of March 31, 2021, the Company did not fail any non-financial covenants related to the Company's Series A Preferred Stock.

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

    In connection with the appointment of Brad Wolfe as the Company's Chief Financial Officer, the Board approved an offer letter to Mr. Wolfe (the “Wolfe Offer Letter”), which was executed on April 4, 2018. The Wolfe Offer Letter provides that Mr. Wolfe is entitled to receive an annualized base salary of $240,000, payable in regular installments in accordance with the Company’s general payroll practices. Mr. Wolfe will also be eligible for a cash bonus of $10,000 for any quarter which has net
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working capital cash that exceeds the prior quarter and additional incentive compensation of an annual bonus of up to $70,000, subject to attainment of performance objectives to be mutually agreed upon and established.

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

In addition, as of March 31, 2021, the Company's liability for uncertain tax positions totaled $112,712. At this time, the settlement period for this liability, including related accrued interest, cannot be determined.
 
(12) Series A Redeemable Convertible Preferred Stock
 
The Company has 900,000 shares of Series A Preferred Stock outstanding. Pursuant to the Amended and Restated  Certificate of Designations, Preferences and Rights  for the Series A Preferred Stock (the "Certificate of Designations"), each share of Series A Preferred Stock can be converted into shares of the Company’s common stock, at an initial conversion price of $102.488 per share, subject to appropriate adjustments for any stock dividend, stock split, stock combination, reclassification or similar transaction, (i) at any time at the option of the holder or (ii) by the Company if, following the first anniversary of the issuance of the Series A Preferred Stock (subject to extension under certain circumstances), the volume weighted average trading price per share of the Company’s common stock for sixty (60) consecutive trading days exceeds 250% of the conversion price and continues to exceed 225% of the conversion price through the conversion date, subject at all times to the satisfaction of, and the limitations imposed by, the equity conditions set forth in the Certificate of Designations (including, without limitation, the volume limitations set forth therein).
Pursuant to the Certificate of Designations, the holders of the Series A Preferred Stock are entitled to receive quarterly dividends at the prime rate (provided in the Wall Street Journal Eastern Edition) plus 5% (up to a maximum dividend rate of 10%), payable in cash or in kind (i.e., through the issuance of additional shares of Series A Preferred Stock), except that the Company is not permitted to pay such dividends in cash while any indebtedness under the Company’s Amended and Restated Term Loan and Credit Agreement remains outstanding without the consent of the holders of the Series A Preferred Stock. In addition, the declaration and payment of dividends is subject to compliance with applicable law and unpaid dividends will accrue. A holder’s right to convert its shares of Series A Preferred Stock and receive dividends in the form of common stock is subject to certain limitations including, among other things, that the shares of common stock issuable upon conversion or as dividends will not, prior to receipt of stockholder approval, result in any holder beneficially owning greater than 9.99% of the Company’s currently outstanding shares of common stock.
The Series A Preferred Stock dividends shall accrue whether or not the declaration or payment of such Series A Preferred Stock dividends are prohibited by applicable law, whether or not the Company has earnings, whether or not there are funds legally available for the payment of such dividends and whether or not such dividends are authorized or declared.
Upon certain triggering events, such as bankruptcy, insolvency or a material adverse effect or failure of the Company to issue shares of common stock upon conversion of the Series A Preferred Stock in accordance with its obligations, the holders may require the Company to redeem all or some of the Series A Preferred Stock at a price per share equal to the greater of (i) the sum of 100% of the stated value of a share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto, and (ii) the product of the number of shares of common stock underlying a share of Series A Preferred Stock and the closing price as of the occurrence of the triggering event. On or after July 30, 2021, subject to the approval of HCP-FVA, each holder of Series A Preferred Stock can also require the Company to redeem its Series A Preferred Stock in cash at a per share price equal to 100% of the stated value of a share of Series A Preferred Stock plus accrued and unpaid dividends with respect thereto. Notwithstanding the forgoing, no holder of Series A Preferred Stock is permitted to exercise any rights or remedies upon a Breach Event or to exercise any redemption rights under the Certificate of Designations, unless approved by the holders of a majority of the then outstanding shares of Series A Preferred Stock. As described under Note (1), HCP-FVA has agreed to extend if necessary the commencement of the optional redemption date of the Series A Preferred Stock from July 30, 2021 to July 1, 2022.
Upon consummation of a fundamental sale transaction, the Series A Preferred Stock shall be redeemed at a per share redemption price equal to the greater of (y) 250% of the per share purchase price of the Series A Preferred Stock and (z) the price payable in respect of such share of Series A Preferred Stock if such share of Series A Preferred Stock had been converted into such number of shares of common stock in accordance with the Certificate of Designations (but without giving effect to any limitations or restrictions contained therein) immediately prior to such fundamental sale transaction; provided however that the 250% threshold is changed to 100% if the fundamental sale transaction is approved by the two Series A Directors (as defined in the Certificate of Designations). In addition, if the Company consummates an equity or debt financing that results in more than $5.0 million of net proceeds to the Company and/or its subsidiaries, the holders of Series A Preferred Stock will have
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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 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 March 31, 2021 and December 31, 2020, the fair value of these derivative instruments was $470,222 and $472,851, respectively, and were included in "other long-term liabilities" within the consolidated balance sheets. The loss on the change in fair value of these derivative instruments for the three months ended March 31, 2021 and March 31, 2020 of $2,629 and 2,752, respectively, were included in “interest and other loss, net” within the consolidated statement of operations.

The fair value of these derivative instruments and the loss recorded on the change in the fair value of these derivative instruments, which was included in “Interest and other income, net” within the condensed consolidated statement of operations, for the three months ended March 31, 2021 and 2020, were as follows:
Three Months Ended March 31,
20212020
Beginning Balance$472,851 $483,804 
Total income recognized in earnings(2,629)(2,752)
Ending Balance$470,222 $481,052 

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The Company’s derivatives were valued using the Black-Scholes pricing model adjusted for probability assumptions, with all significant inputs, except for the probability and volatility assumptions, derived from or corroborated by observable market data such as stock price and interest rates. The probability and volatility assumptions are as follows:
Probability of redemption as part of a fundamental sale transaction0.5%
Probability of redemption absent a fundamental sale transaction4.75%
Annual volatility65%

At the time of issuance, the Company recorded transaction costs, a beneficial conversion feature and the fair value allocated to the embedded derivatives as discounts to the Series A Preferred Stock. These costs were being accreted to the Series A Preferred Stock using the effective interest method through the stated redemption date of August 5, 2017, which represents the earliest redemption date of the instrument. This accretion was accelerated as of December 31, 2016 due to the failure of the financial covenants and the redemption right of the holders at that time. In connection with the Commitment, Hale Capital Partners, LP, which was the sole holder of the Series A Preferred Stock, agreed to the Series A mandatory extension of the mandatory redemption right and waived prior breaches of the terms of the Series A Preferred Stock. The Company included deductions for accretion, deemed and accrued dividends on the Series A Preferred Stock as adjustments to net income (loss) attributable to common stockholders on the statement of operations and in determining income (loss) per share for the three months ended March 31, 2021 and 2020, respectively. The following represents a reconciliation of net loss attributable to common stockholders for the three months ended March 31, 2021 and 2020, respectively:
 Three Months Ended March 31,
20212020
Net income (loss)$425,248 $(719,840)
Effects of Series A redeemable convertible preferred stock:  
Less: Accrual of Series A redeemable convertible preferred stock dividends277,170 285,760 
Less: Accretion to redemption value of Series A redeemable convertible preferred stock197,114 26,090 
Net income (loss) attributable to common stockholders$(49,036)$(1,031,690)

The Series A Preferred Stock consists of the following:
Total Series A redeemable convertible preferred stock, net at December 31, 2020$12,940,722 
Accrued dividends$277,170 
Accretion of preferred stock$197,114 
Total Series A redeemable convertible preferred stock, net at March 31, 2021$13,415,006 

(13) Accumulated Other Comprehensive Loss
 
The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended March 31, 2021 are as follows:
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 Foreign Currency
Translation
Net Minimum
Pension Liability
Total
Accumulated other comprehensive income (loss) at December 31, 2020$(1,995,680)$7,719 $(1,987,961)
Other comprehensive income (loss)   
Other comprehensive income (loss) before reclassifications86,398 86,398 
Total other comprehensive income (loss)86,398 86,398 
Accumulated other comprehensive income (loss) at March 31, 2021$(1,909,282)$7,719 $(1,901,563)

The changes in Accumulated Other Comprehensive Loss, net of tax, for the three months ended March 31, 2020 are as follows:
 Foreign Currency
Translation
Net Minimum
Pension Liability
Total
Accumulated other comprehensive income (loss) at December 31, 2019$(1,926,826)$33,566 $(1,893,260)
Other comprehensive income (loss)   
Other comprehensive income (loss) before reclassifications(13,153)(13,153)
Total other comprehensive income (loss)(13,153)(13,153)
Accumulated other comprehensive income (loss) at March 31, 2020$(1,939,979)$33,566 $(1,906,413)
 
(14) Stockholders' Equity

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

(15)  Litigation
 
In view of the inherent difficulty of predicting the outcome of litigation, particularly where the claimants seek very large or indeterminate damages, the Company generally cannot predict what the eventual outcome of the pending matters will be, what the timing of the ultimate resolution of these matters will be, or what the eventual loss, fines or penalties related to each pending matter may be.
 
In accordance with the authoritative guidance issued by the FASB on contingencies, the Company accrues anticipated costs of settlement, damages and losses for claims to the extent specific losses are probable and estimable. The Company records a receivable for insurance recoveries when such amounts are probable and collectable. In such cases, there may be an exposure to loss in excess of any amounts accrued. If, at the time of evaluation, the loss contingency related to a litigation is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable and, the Company will expense these costs as incurred. If the estimate of a probable loss is a range and no amount within the range is more likely, the Company will accrue the minimum amount of the range.

The Company is subject to various legal proceedings and claims, asserted or unasserted, which arise in the ordinary course of business. While the outcome of any such matters cannot be predicted with certainty, such matters are not expected to have a material adverse effect on the Company’s financial condition or operating results.
 
(16) Segment Reporting and Concentrations
 
The Company is organized in a single operating segment for purposes of making operating decisions and assessing performance. Revenue from the United States to customers in the following geographical areas for the three months ended March 31, 2021 and 2020, and the location of long-lived assets as of March 31, 2021 and December 31, 2020, are summarized as follows:
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Three Months Ended March 31,
20212020
Revenue:
Americas$1,708,177 $1,094,904 
Asia Pacific509,293 983,795 
Europe, Middle East, Africa and Other1,610,856 1,101,488 
Total Revenue$3,828,326 $3,180,187 
 
March 31, 2021December 31, 2020
Long-lived assets:
Americas$1,253,841 $1,735,986 
Asia Pacific485,147 502,344 
Europe, Middle East, Africa and Other40,752 52,690 
Total long-lived assets$1,779,740 $2,291,020 
 
For the three months ended March 31, 2021, the Company had 2 customers that accounted for 10% or more of total revenue, respectively. For the three months ended March 31, 2020, the Company had 2 customers that accounted for 10% or more of total revenue, respectively.

As of March 31, 2021, the Company had 2 customers that accounted for 10% or more of the gross accounts receivable balance. As of December 31, 2020, the Company had 1 customer that accounted for 10% or more of the gross accounts receivable balance.

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

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

    Given the commercial uncertainty caused by the novel coronavirus pandemic, or COVID-19, the Company developed and implemented an even more aggressive expense control plan in March 2020, that it is prepared to keep in place for the remainder of 2020 (the "2020 Plan"). The 2020 Plan reduced the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 20 of these positions were reinstated by December 31, 2020. During the three months ended March 31, 2021, the Company has not yet incurred severance expense as a result of this action.

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The following table summarizes the activity during 2020 and 2021 related to restructuring liabilities recorded in connection with the 2017, 2019 and 2020 Plans:
Severance Related CostsFacility and Other CostsTotal
Balance at December 31, 2019$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 Adjustment4,674 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 Adjustment9,554 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 Adjustment11,124 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 
Translation Adjustment(10,393)(10,393)
Utilized/Paid(357,184)(357,184)
Balance at March 31, 2021$229,051 $20,595 $249,646 

    The severance and facility related liabilities are included within “accrued expenses” in the accompanying condensed consolidated balance sheets. The expenses under the 2017, 2019 and 2020 Plans are included within “restructuring costs” in the accompanying condensed consolidated statements of operations.
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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 is a data protection technology company enabling enterprises to modernize their data backup and archival operations across multiple sites and public clouds. We deliver increased data security and provide fast recovery from ransomware attacks, while driving down an enterprise’s data storage footprint by up to 90%. As an established technology leader with 47 patents and patent applications, we have over an exabyte of data under management and offer products that are used by more than 600 enterprise customers. Our products are offered through and supported by a worldwide network of leading service providers, systems integrators, resellers, managed services providers (“MSPs”) and original equipment manufacturers (“OEMs”).

Our products are utilized by enterprises and managed service providers to address two key areas of enterprise data protection: (i) long-term data retention and recovery, and (ii) data replication to preserve business continuity. Our innovative integration with modern cloud-based data storage environments, such as Amazon Web Services (“AWS”) and Microsoft Azure, enables our enterprise customers to significantly reduce costs and improve the portability, security and accessibility of their enterprise data. 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 are software-defined and can be used regardless of the underlying hardware, cloud and source-data, which enables our enterprise customers to maximize their existing hardware and software investments.

In 2020, we 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. We increased our go-to-market investment within our core regions of the Americas, EMEA, Japan, Korea, and Southeast Asia, and we released StorSafeTM, the next generation of our Virtual Tape Library (“VTL”) product family built for the cloud, while carefully managing operating expenses.
    
During first quarter of 2021, we delivered 20% year-over-year total revenue growth despite the economic turmoil caused by the global COVID-19 pandemic. While uncertainties continue to exist as a result of COVID-19, we have seen our customers and prospects continue to invest in the business critical area of data production in which we sell our solutions.

GAAP revenue increased by $0.6 million during the first quarter of 2021, compared to first quarter of 2020. We delivered $0.4 million of net income in the first quarter of 2021, compared to a net loss of $0.7 million in first quarter of 2020. The $0.4 million in net income in the first quarter of 2021 includes a gain on debt extinguishment of $0.7 million which resulted from the forgiveness of the Paycheck Protection Loan we received under the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") loan program (the "PPP Loan"). Our improved profitability has allowed us to make additional targeted investments, primarily related to Sales, R&D, and Support personnel, while maintaining a profitable expense base.

During the first quarter of 2021, our strategy was to continue focus within our core regions of the Americas, EMEA, Japan, Korea, and Southeast Asia. As result of this strategy, we delivered:

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

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

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

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

Beyond our long-term archive retention and reinstatement products, our NSS and CDP business continuity driven data replication products give our customers the ability to move workloads to the right destination, on-premise or in the cloud, with advanced insight. These products are designed for organizations with complex, heterogeneous IT environments and the full spectrum of data management use cases, including but not limited to large enterprises, universities, health care entities and governmental institutions. These products are modern, comprehensive and easy-to-use software solutions that enable IT professionals to have complete insight into and control over their organization’s data. Data is an organization’s most precious resource which, if managed and protected properly, can help an enterprise unlock competitive advantage, whether by gaining a better understanding of customers, uncovering ways to improve operations and reduce costs, or inventing new products, services and business models.

To provide for greater ease of use for all our products, we also made significant enhancements to our central data management console, now called StorSightTM, to interface with each of our products to provide a holistic view of an enterprise’s entire data protection environment - whether legacy data centers, hyper-converged infrastructure, cloud and/or hybrids.

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

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

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

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

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

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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 March 31, 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.
Three Months Ended March 31, Change
Period to Period
(amounts in dollars)
20212020
Revenue:
Product revenue$2,139,729 56 %$1,048,963 33 %$1,090,766 104 %
Support and services revenue1,688,597 44 %2,131,224 67 %(442,627)(21)%
Total revenue3,828,326 100 %3,180,187 100 %648,139 20 %
Cost of revenue:  
Product222,834 %139,460 %83,374 60 %
Support and service426,173 11 %407,920 13 %18,253 %
Total cost of revenue649,007 17 %547,380 17 %101,627 19 %
Gross profit3,179,319 83 %2,632,807 83 %546,512 21 %
Operating expenses:  
Research and development costs659,940 17 %674,924 21 %(14,984)(2)%
Selling and marketing1,396,640 36 %981,191 31 %415,449 42 %
General and administrative837,867 22 %1,093,169 34 %(255,302)(23)%
Restructuring costs302,313 %287,460 %14,853 %
Total operating expenses3,196,760 84 %3,036,744 95 %160,016 %
Operating income (loss)(17,441)— %(403,937)(13)%386,496 96 %
Gain on debt extinguishment754,000 20 %— — %754,000 — %
Interest and other expense(266,695)(7)%(245,839)(8)%(20,856)(8)%
Income (loss) before income taxes469,864 12 %(649,776)(20)%1,119,640 172 %
Income tax expense (benefit)44,616 %70,064 %(25,448)(36)%
Net income (loss)$425,248 11 %$(719,840)(23)%$1,145,088 159 %
Less: Accrual of Series A redeemable convertible preferred stock dividends277,170 %285,760 %(8,590)(3)%
Less: Accretion to redemption value of Series A redeemable convertible preferred stock197,114 %26,090 %171,024 656 %
Net income (loss) attributable to common stockholders$(49,036)(1)%$(1,031,690)(32)%$982,654 95 %

Revenue

Our primary sales focus is on selling software solutions and platforms which includes stand-alone software applications, software integrated with industry standard hardware and sold as one complete integrated solution or sold on a subscription or consumption basis. As a result, our revenue is classified as either: (i) product revenue, or (ii) support and services revenue. During the three months ended March 31, 2021, we recognized revenue of $3.8 million, compared with $3.2 million in the prior year period.

Product revenue
 
Product revenue is comprised of sales of both licenses for our software solutions and sales of the platforms on which the software is installed. This includes stand-alone software applications and, on occasion, software integrated with industry standard hardware. We no longer primarily source or sell hardware, 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 March 31, 2021 and 2020, product revenue represented 56% and 33% of our total revenue, respectively. Product revenue of $2.1 million for the three months ended March 31, 2021 increased $1.1 million, or 104%, from $1.0 million in the prior year period.

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

Support and services revenue

Support and services revenue is comprised of revenue from (i) maintenance and technical support services, (ii) professional services primarily related to the implementation of our software, and (iii) engineering services. Revenue derived from maintenance and technical support contracts are deferred and recognized ratably over the contractual maintenance term. 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 March 31, 2021 decreased to $1.6 million, compared to $2.0 million in the prior year period. Our maintenance and technical support service revenue results primarily from (i) the purchase of maintenance and support contracts by our customers, and (ii) the renewal of maintenance and support contracts by our existing and new customers after their initial contracts expire. The decrease in maintenance and technical support service revenue over the previous year reflects a decline in maintenance renewal revenue as a result of conversion to subscription contracts and customer attrition.
 
Professional services revenue for the three months ended March 31, 2021 decreased to $0.1 million, compared to $0.2 million in the prior year period. Professional services revenue can vary from period to period based upon (i) the number of solutions sold during the existing and previous periods, (ii) the number of our customers who elect to purchase professional services, (iii) the number of professional services contracts that are performed during the period, and (iv) the number of customers who elect to purchase engineering services. We expect professional services revenue to continue to vary from period to period based upon the number of customers who elect to utilize our professional services upon purchasing any of our solutions.

Cost of Revenue, Gross Profit and Gross Margin

Total cost of revenue for the three months ended March 31, 2021 increased 19% to $0.6 million, compared with $0.5 million in the prior year period. Total gross profit increased $0.5 million, or 21%, to $3.2 million for the three months ended March 31, 2021, compared with $2.6 million for the prior year period. Total gross margin remained the same at 83% for the three months ended March 31, 2021, compared with the prior year period. The increase in our total gross profit, in absolute dollars, was primarily due to product mix, and as a result of an intentional shift away from selling hardware, which yields significantly lower profit margins, compared to our key proprietary software license offerings. Generally, our total gross profits and total gross margins fluctuate based on several factors, including (i) revenue growth levels, (ii) changes in personnel headcount and related costs, and (iii) our product offerings and mix of sales.

Cost of Product Revenue, Gross Profit and Gross Margin

Cost of product revenue consists primarily of personnel costs and amortization of capitalized software. Cost of product revenue for the three months ended March 31, 2021 increased to $0.2 million, compared with $0.1 million in the prior year period. Product gross margin for the three months ended March 31, 2021 increased, year over year, to 90% from 87% for the same period in 2020. The increase in cost of product revenue and increase in gross margin for the current year was primarily due to an intentional shift away from hardware sales in the current period, compared to the prior year period.
 
Cost of Support and Service Revenue, Gross Profit and Gross Margin

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

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Operating Expenses

Our operating expenses for the three months ended March 31, 2021 increased $0.2 million to $3.2 million from $3.0 million, for the previous year period.

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

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

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

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

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

    Given the commercial uncertainty caused by the novel coronavirus pandemic, or COVID-19, the Company developed and implemented an even more aggressive expense control plan in March 2020, that it is kept in place for the remainder of 2020 (the "2020 Plan"). The 2020 Plan reduced the Company's annual cash expense run rate by $4.0 million or 29%. The Company has furloughed 21 positions worldwide, and 20 of these positions were reinstated by December 31, 2020. We believe the reduced expense level will enable FalconStor to remain profitable during the remainder of 2020, even with continued revenue challenges throughout. During the three months ended March 31, 2021, the Company has not yet incurred severance expense as a result of this action.
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Restructuring expense increased $14,853 for the three months ended March 31, 2021 to $302,313, compared to a restructuring expense of $287,460 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 three months ended March 31, 2021, compared to $0 in the prior year period. The Company's loan under the Paycheck Protection Program was forgiven on March 30, 2021. For further information, refer to Note (9) Notes Payable, to our unaudited condensed consolidated financial statements.

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

Income Taxes
 
Our provision for income taxes consists of state and local, and foreign taxes. For the three months ended March 31, 2021 and 2020, the Company recorded income tax expense of $44,616 and $70,064, respectively, consisting primarily of state and local, and foreign taxes. 

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

COVID-19

    While our Q1 2021 results were an improvement compared to Q1 2020 results, 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.


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 March 31, 2021 and December 31, 2020 totaled $2.0 million and $1.9 million, respectively.

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

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

The restrictions in the Amended and Restated Term Loan Agreement may prevent us from taking actions that we believe would be in the best interests of our business, and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted. In addition, our ability to comply with the financial and other covenants and restrictions in the Amended and Restated Term 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 Term 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 Term Loan Agreement, which could result in an acceleration of our indebtedness.

HCP-FVA is an affiliated party of Hale Capital Partners and Hale Capital Partners and affiliated entities (“HCP”) have agreed if necessary to extend the maturity date of the indebtedness owed to HCP-FVA under the Amended and Restated Loan Agreement from June 30, 2021 to at least July 1, 2022. Similarly, HCP has agreed if necessary to extend the commencement of the optional redemption date of the Series A Preferred Stock from July 31, 2021 to at least July 1, 2022. Under the terms of the Series A Preferred Stock, no holder of Series A Preferred Stock can exercise their redemption right without the consent of HCP-FVA.

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

Liquidity

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

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

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

Given the commercial uncertainty caused by the novel coronavirus pandemic, or COVID-19, the Company 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.

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Based on its projected cash flows from operations, commitments from HCP, ongoing 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 May 5, 2022.

Cash Flow Analysis

Cash flow information is as follows:
 Three Months Ended March 31,
 20212020
Cash provided by (used in):  
Operating activities137,659 (398,331)
Investing activities(39,533)(94,268)
Financing activities— — 
Effect of exchange rate changes2,207 (6,446)
Net increase (decrease) in cash and cash equivalents$100,333 $(499,045)

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

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

Net cash used in financing activities totaled $0.0 million for the three months ended March 31, 2021, compared with net cash used in financing activities of $0.0 million in the prior year period.
 
Total cash and cash equivalents increased $0.1 million to $2.0 million at March 31, 2021 compared to December 31, 2020.

Contractual Obligations

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

    The following is a schedule summarizing our significant obligations to make future payments under contractual obligations as of March 31, 2021:
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Operating LeasesNote Payable (a)Interest Payments (a)Long-Term Income Tax Payable (b)Series A Preferred Stock Mandatory RedemptionDividends on Series A Preferred Stock
2021237,525 3,510,679 35,107 — — — 
2022— — — — — — 
Other— — — 112,712 9,000,000 5,002,282 
Total contractual obligations$237,525 $3,510,679 $35,107 $112,712 $9,000,000 $5,002,282 
Sublease income$(25,105)$— $— $— $— $— 
Net contractual obligations$212,420 $3,510,679 $35,107 $112,712 $9,000,000 $5,002,282 

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

(b) Represents our liability for uncertain tax positions. We are unable to make a reasonably reliable estimate of the timing of payments due to uncertainties in the timing of tax audit outcomes.
 
Critical Accounting Policies and Estimates
 
We describe our significant accounting policies in Note (1), "Summary of Significant Accounting Policies" of our 2020 Form 10-K. We discuss our critical accounting estimates in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our 2020 Form 10-K. There have been no significant changes in our significant accounting policies or critical accounting estimates since December 31, 2020.

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 March 31, 2021 and December 31, 2020, we had no off-balance sheet arrangements.

Item 3.     Quantitative and Qualitative Disclosures About Market Risk
 
Foreign Currency Risk.

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

If foreign currency exchange rates were to change adversely by 10% from the levels at March 31, 2021, the effect on our results before taxes from foreign currency fluctuations on our balance sheet would be approximately $1.7 million. The above analysis disregards the possibility that rates for different foreign currencies can move in opposite directions and that losses from one currency may be offset by gains from another currency.
 
Item 4.     Controls and Procedures
 
Disclosure Controls and Procedures

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,
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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 March 31, 2021, 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 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 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. 

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Item 6.     Exhibits
31.1
31.2
32.1
32.2
101.1The following financial statements from FalconStor Software, Inc’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2021, formatted in XBRL (eXtensible Business Reporting Language):
(i)unaudited Condensed Consolidated Balance Sheets – March 31, 2021 and December 31, 2020.
(ii)unaudited Condensed Consolidated Statement of Operations – Three Months Ended March 31, 2021 and 2020.
(iii)unaudited Condensed Consolidated Statement of Comprehensive Income (Loss) – Three Months Ended March 31, 2021 and 2020.
(iv)unaudited Condensed Consolidated Statements of Stockholder's Deficit - Three Months Ended March 31, 2021 and 2020.
(v)unaudited Condensed Consolidated Statement of Cash Flows – Three Months Ended March 31, 2021 and 2020.
(vi)Notes to unaudited Condensed Consolidated Financial Statements – March 31, 2021.
.
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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 FALCONSTOR SOFTWARE, INC.
 (Registrant)
  
 /s/ Brad Wolfe
 Brad Wolfe
 Executive Vice President, Chief Financial Officer and Treasurer
 (principal financial and accounting officer)
 
 
/s/ Todd Brooks
 Todd Brooks
 President & Chief Executive Officer
May 5, 2021(principal executive officer)

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