Notes to Unaudited Condensed Consolidated Financial Statements
(1) Basis of Presentation
(a) The Company and Nature of Operations
FalconStor Software, Inc., a Delaware Corporation (the "Company"), is a leading storage software company offering a converged data services software platform that is hardware agnostic. The Company develops, manufactures and sells data migration, business continuity, disaster recovery, optimized backup and de-duplication solutions and provides the related maintenance, implementation and engineering services.
(b) Going Concern
A fundamental principle of the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") is the assumption that an entity will continue in existence as a going concern, which contemplates continuity of operations and the realization of assets and settlement of liabilities occurring in the ordinary course of business. This principle is applicable to all entities except for entities in liquidation or entities for which liquidation appears imminent. In accordance with this requirement, the Company has prepared its consolidated financial statements on a going concern basis.
The Company has incurred significant operating losses in the previous eight years and negative cash flow from operations in five of the previous eight years. The Company currently has a working capital deficiency of
$12.6 million
, which is inclusive of current deferred revenue of
$12.3 million
and a stockholders' deficit of
$22.5 million
. During the
nine months ended September 30, 2017
, the Company incurred a net loss of
$0.3 million
and cash flow used in operations of
$1.6 million
. The Company's total cash balance at
September 30, 2017
was
$1.8 million
, a
decrease
of
$1.6 million
as compared to
December 31, 2016
. In addition to these financial metrics, as of December 31, 2016, the Company was not in compliance with the financial covenants of the Series A redeemable convertible preferred stock, which were mutually agreed to annually, for two consecutive quarters. This breach provides the holder of the Series A redeemable convertible preferred stock with the right to require the Company to redeem any of the Series A redeemable convertible preferred stock at the greater of
100%
of the stated value plus accrued and unpaid dividends or the product of the number of shares of common stock underlying the Series A redeemable convertible preferred stock and the closing price of the Company's common stock as of December 31, 2016. To date, the holder of the Series A redeemable convertible preferred stock has neither exercised nor waived this right and accordingly this right may be exercised at any time. In addition, as of August 5, 2017, the holder of the Series A redeemable convertible preferred stock has the right to request a redemption of the Series A redeemable convertible preferred stock. If the holders request that the Series A redeemable convertible preferred stock be redeemed, the Company may not have sufficient liquidity or sufficient surplus as such term is defined under the Delaware General Business Corporation Law ("DGCL") to undertake the redemption. If the Company does not redeem the Series A redeemable convertible preferred stock, the holder of the Series A redeemable convertible preferred stock can pursue other remedies. Refer to Note (11)
Series A Redeemable Convertible Preferred Stock
for further discussion regarding these other remedies. As further described below, the Company's reduced cash balance and history of losses both in and of itself, and in combination with the redemption rights of the holders of the Series A redeemable convertible preferred stock, raise substantial doubt about the Company's ability to continue as a going concern within one year after November 20, 2017 (the date that these financial statements were issued).
The Company's ability to continue as a going concern, including in the event of a redemption request by the holder, depends on its ability to execute its business plan, increase revenue and billings and reduce expenditures. During 2016, the Company continued to focus on aligning its expense structure with revenue expectations which included tighter expense controls and overall operational efficiencies which better align the Company's current business plan on a run-rate basis. These efficiencies include among other items, stream-lined personnel related costs and global overhead costs and efficiencies realized on the Company's redesigned go-to-market coverage models. In June 2017, the Company's Board of Directors, approved a comprehensive plan to increase operating performance (the “2017 Plan”). The 2017 Plan will result in a realignment and reduction in workforce. The 2017 Plan was substantially completed as of June 30, 2017. These actions are anticipated to result in an annualized cost savings of approximately
$10.0 million
. In connection with the 2017 Plan, the Company incurred severance expense of
$1.0 million
. In making these changes, the Company prioritized customer support and development while consolidating operations and cutting direct sales resources, therefore allowing the Company to focus on its install base and develop more efficient market channels. The Company's worldwide headcount was
83
employees as of
September 30, 2017
, compared with
166
and
226
employees as of
December 31, 2016
and
2015
, respectively.
Although, the Company was able to reduce its operating expenses from the previous year, the Company's bookings, billings and revenue continued to decline which negatively impacts the Company's ability to continue as a going concern. As previously disclosed in the Company’s public filings, the Company’s failure to generate sufficient revenue, billing control or further reduce expenditures and/or the inability to obtain financing will result in an inability of the Company to continue as a going concern. While the Company was able to reduce expenditures and hence generated net income for the three months ended September 30, 2017 and the Company’s cash and cash equivalents increased slightly between June 30, 2017 and September 30, 2017, the Company’s revenues continued to decrease for such period both in comparison to the comparable period in the fiscal year ended December 31, 2016 as well as compared to the three months ended June 30, 2017. In addition, subsequent to September 30, 2017, the Company’s cash and cash equivalents has significantly decreased. Accordingly, to ensure that the Company could meet its operating cash flow needs and continue as a going concern, the Company entered into a short term secured loan in the principal amount of $500,000 (the “Short-Term Loan”) with HCP-FVA, LLC, an affiliate of Hale Capital Partners, LP (together “Hale Capital”) and secured a commitment (the “Commitment”) from Hale Capital to purchase up to $3 million of units from the Company (inclusive of units issued in satisfaction of the Company’s obligations under the Short-Term Loan). The Company has received the Short-Term Loan. The Company’s ability to continue as a going concern will depend on whether it receives the balance of the funds from the Commitment as well as its ability to increase revenues and/or further reduce expenditures of which there can be no assurance. The issuance of warrants in connection with the Short Term Loan and Commitment will have a substantial dilutive effect on all existing stockholders. Please see “Note 17 - Subsequent Event” and “Item 5. - Other Information” for more information on the Short-Term Loan and the Commitment.
To the extent the Company incurs losses and or is unable to receive the balance of the funds from the Commitment, the Company will need to seek additional financing to continue as a going concern and there can be no assurance that the Company will be able to obtain financing or that such financing will be on favorable terms. Similar to the Short Term Loan and the Commitment any such financing could be dilutive to our shareholders. Failure to generate sufficient revenue, billings, control or further reduce expenditures and/or the inability to obtain financing will result in an inability of the Company to continue as a going concern.
(c) 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.
(d) Use of Estimates
The preparation of financial statements in conformity with 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. 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.
(e) 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 present fairly the financial position of the Company at
September 30, 2017
, and the results of its operations for the
three and nine
months ended
September 30, 2017
and
2016
. 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, 2016
("
2016
Form 10-K").
(f) Recently Adopted Accounting Pronouncements
In March 2016, the Financial Accounting Standards Board ("FASB") issued new guidance on accounting for employee share-based payment awards to simplify the accounting related to several aspects of accounting for share-based payment transactions, including income tax consequences of share-based payment transactions, classification of awards as either equity or liabilities, forfeitures, and classification on the statement of cash flows. The Company adopted this guidance as of January 1, 2017. In accordance with this new guidance the Company has made an entity-wide accounting policy election to account for forfeitures when they occur. As a result of this election, the Company recognized additional stock-based compensation expense of approximately
$0.1 million
in the first quarter of 2017 to adjust for actual forfeitures on historical share-based payment awards.
In January 2017, the FASB issued new guidance on accounting for goodwill to simplify the goodwill impairment test by eliminating Step 2 of the goodwill impairment test. This new guidance also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The new standard is effective for the annual period beginning after December 15, 2019, including interim reporting periods within that period, which for the Company is the annual period ending December 31, 2020. Early adoption is permitted. The Company elected to adopt this guidance as of January 1, 2017, prospectively for impairment tests performed subsequent to January 1, 2017. The Company's single reporting unit for purposes of its goodwill impairment test had a negative carrying value and thus the Company determined there was no impairment of goodwill. During 2017 there have been no triggering events that would require a goodwill impairment test to be performed prior to the Company's annual goodwill impairment test. The adoption of this guidance did not have an impact on the Company's financial statements and related disclosures.
(g) Recently Issued Accounting Pronouncements
In May 2017, the FASB issued new guidance on stock-based compensation to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the stock-based compensation guidance to a change to the terms or conditions of a share-based payment award. The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. This new guidance requires application on a prospective basis. This update is effective for public entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted, which for the Company will be the annual period ending December 31, 2018. The Company has not yet adopted this guidance and currently does not expect the adoption of the new guidance by the Company to have a significant impact on the Company's financial statements and related disclosures.
In March 2017, the FASB issued new guidance on retirement benefits, which requires employers to disaggregate the service cost component from other components of net periodic benefit costs and to disclose the amounts of net periodic benefit costs that are included in each income statement line item. The standard requires employers to report the service cost component in the same line item as other compensation costs and to report the other components of net periodic benefit costs (which include interest costs, expected return on plan assets, amortization of prior service cost or credits and actuarial gains and losses) separately and outside a subtotal of operating income. The income statement guidance requires application on a retrospective basis. This update is effective for public entities for annual periods beginning after December 15, 2017, including interim periods, with early adoption permitted, which for the Company will be the annual period ending December 31, 2018. The Company has not yet adopted this guidance and currently does not expect the adoption of the new guidance by the Company to have a significant impact on the Company's financial statements and related disclosures.
In August 2016, the FASB issued new guidance on presentation and classification of eight specific items within the statement of cash flows, including (i) debt prepayment or debt extinguishment costs, (ii) settlement of zero-coupon debt instruments or other debt instruments with coupon rates that are insignificant in relation to the effective interest rate of the borrowing, (iii) contingent consideration payments made after a business combination, (iv) proceeds from the settlement of insurance claims, (v) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, (vi) distributions received from equity method investees, (vii) beneficial interests in securitization transactions, and (viii) separately identifiable cash flows and application of the predominance principle. This update is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2017, which for the Company will be the annual period ending December 31, 2018. Early adoption, including adoption in an interim period, is permitted. The Company has not yet adopted this guidance and currently does not expect the adoption of the new guidance to have a significant impact on the Company's financial statements and related disclosures.
In February 2016, the FASB issued new guidance on leases to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This new guidance will replace existing guidance on leases in accounting principles generally accepted in the United States when it becomes effective. The new standard is effective for the annual period beginning after December 15, 2018, including interim reporting periods within that period, which for the Company will be the annual period ending December 31, 2019. Early application is permitted. The standard requires the use of a modified retrospective transition method; however, certain optional practical expedients may be applied. The Company's preliminary analysis indicates that the Company will recognize a liability for remaining lease payments and a right-of-use asset related to the Company's operating lease covering its corporate office facility that expires in April 2021. Currently the Company's additional operating leases related to offices in foreign countries are set to expire prior to adoption of the new guidance. The Company is in the initial stages of evaluating the effect of the standard on the Company's financial statements.
In January 2016, the FASB issued new guidance on the recognition, measurement, presentation and disclosure of financial assets and financial liabilities. The standard (i) requires an entity to measure equity investments, except those accounted for under the equity method of accounting or those that result in consolidation of the investee, at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring an entity to perform a qualitative assessment to identify impairment, (iii) changes certain presentation and disclosure requirements related to financial assets and financial liabilities, and (iv) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets. The amendments in this update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, which for the Company will be the annual period ending December 31, 2018. Early adoption, including adoption in an interim period, is not permitted except for certain amendments in this update. The Company has not yet adopted this guidance and currently does not expect the adoption of the new guidance by the Company to have a significant impact on the Company's financial statements and related disclosures.
In May 2014, the FASB issued new guidance which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This new guidance will replace most existing revenue recognition guidance in GAAP in the United States when it becomes effective. The new standard is effective for the annual period beginning after December 15, 2017, including interim reporting periods within that period, which for the Company will be the annual period ending December 31, 2018. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that this new guidance will have on its consolidated financial statements and related disclosures. The Company has formed an implementation team to evaluate the standard's effect on the Company's financial statements. The Company has historically deferred revenue for certain deliverables in its multiple-element arrangements due to a lack of vendor-specific objective evidence (“VSOE”) for purposes of the allocation of the transaction consideration. The Company performed a preliminary analysis, which indicated that the Company will recognize revenue for these arrangements earlier under the new standard than under the existing guidance due to the elimination of the VSOE requirement. The Company has not yet determined what other impact may result from application of the new standard. The Company will use the cumulative effect transition method upon adoption of this guidance. The Company has not progressed beyond the initial stages of evaluating the effect of the standard on the Company's financial statements and currently has concerns about its ability to timely adopt this standard due to its current status and resources.
(2) Summary of Significant Accounting Policies
The Company's significant accounting policies were described in Note (1) "Summary of Significant Accounting Policies" of the
2016
Form 10-K. The Company's revenue recognition accounting policy is included below for reference. There have been no significant changes in the Company's significant accounting policies since
December 31, 2016
, other than those noted below in (b) and (c). For a description of the Company's other significant accounting policies refer to the
2016
Form 10-K.
(a) Revenue Recognition
The Company derives its revenue from sales of its products, support and services. Product revenue consists of the Company’s software integrated with industry standard hardware and sold as complete turn-key integrated solutions, as stand-alone software applications or sold on a subscription or consumption basis. Depending on the nature of the arrangement revenue, related to turn-key solutions and stand-alone software applications are generally recognized upon shipment and delivery of license keys. For certain arrangements revenue is recognized based on usage or ratably over the term of the arrangement. Support and services revenue consists of both maintenance revenues and professional services revenues. Revenue is recorded net of applicable sales taxes.
In accordance with the authoritative guidance issued by the FASB on revenue recognition, the Company recognizes revenue when persuasive evidence of an arrangement exists, the fee is fixed or determinable, delivery has occurred, and collection of the resulting receivable is deemed probable. Products delivered to a customer on a trial basis are not recognized as revenue until the trial period has ended and acceptance has occurred by the customer. Reseller and distributor customers typically send the Company a purchase order when they have an end user identified. For bundled arrangements that include either maintenance or both maintenance and professional services, the Company uses the residual method to determine the amount of product revenue to be recognized. Under the residual method, consideration is allocated to the undelivered elements based upon VSOE of the fair value of those elements, with the residual of the arrangement fee allocated to and recognized as product revenue. If VSOE does not exist for all undelivered elements of an arrangement, the Company recognizes total revenue from the arrangement ratably over the term of the maintenance agreement. The Company's long-term portion of deferred revenue consists of (i) payments received for maintenance contracts with terms in excess of one year as of the balance sheet date, and (ii) payments received for product sales bundled with multiple years of maintenance but for which VSOE did not exist for all undelivered elements of the arrangement. The Company provides an allowance for product returns as a reduction of revenue, based upon historical experience and known or expected trends.
When more than one element, such as hardware, software and services are contained in a single arrangement, the Company will first allocate revenue based upon the relative selling price into two categories: (1) non-software components, such as hardware and any hardware-related items, as required system software that functions with the hardware to deliver the essential functionality of the hardware and related post-contract customer support, and software as service subscriptions and (2) software components and applications, such as post-contract customer support and other services. The Company will then allocate revenue within the non-software category to each element based upon their relative selling price using a hierarchy of VSOE, third-party evidence of selling price (“TPE”) or estimated selling prices (“ESP”), if VSOE or TPE does not exist. The Company will allocate revenue within the software category to the undelivered elements based upon their fair value using VSOE with the residual revenue allocated to the delivered elements. If the Company cannot objectively determine the VSOE of the fair value of any undelivered software element, the Company will defer revenue for all software components until all elements are delivered and services have been performed, until fair value can objectively be determined for any remaining undelivered elements, or until software maintenance is the only undelivered element which the Company does not have VSOE for, in which case revenue is recognized over the maintenance term for all software elements.
Revenues associated with maintenance services are deferred and recognized as revenue ratably over the term of the contract. Revenues associated with software implementation and software engineering services are recognized when the services are performed. Costs of providing these services are included in cost of support and services.
The Company has entered into various distribution, licensing and joint promotion agreements with OEMs, whereby the Company has provided the OEM a non-exclusive software license to install the Company’s software on certain hardware or to resell the Company’s software in exchange for payments based on the products distributed by these OEMs. Such payments from the OEM or distributor are recognized as revenue in the period reported by the OEM.
From time to time the Company will enter into funded software development arrangements. Under such arrangements, revenue recognition will not commence until final delivery and/or acceptance of the product. For arrangements where the Company has VSOE for the undelivered elements, the Company will follow the residual method and recognize product revenue upon final delivery and/or acceptance of the product. For arrangements where the Company does not have VSOE for the undelivered elements, the Company will recognize the entire arrangement fee ratably commencing at the time of final delivery and/or acceptance through the end of the service period in the arrangement. Certain arrangements, for which VSOE of fair value for the undelivered maintenance elements cannot be established, are accounted for as a single unit of account. The revenue recognized from single units of accounting are typically allocated and classified on the consolidated statements of operations as product revenue and support and services revenue. Since VSOE cannot be established, VSOE of similar maintenance offerings provides the basis for the support and services revenue classification, and the remaining residual consideration provides the basis for the product revenue classification.
(b) Share-Based Payments
The Company accounts for share-based payments in accordance with the authoritative guidance issued by the FASB on share-based compensation, which establishes the accounting for transactions in which an entity exchanges its equity instruments for goods or services. Under the provisions of the authoritative guidance, share-based compensation expense is measured at the grant date, based on the fair value of the award, and is recognized as an expense over the requisite employee service period (generally the vesting period), net of actual forfeitures. For share-based payment awards that contain performance criteria share-based compensation, expense is recorded when the achievement of the performance condition is considered probable of achievement and is recorded on a straight-line basis over the requisite service period. If such performance criteria are not met, no compensation cost is recognized and any recognized compensation cost is reversed. The Company estimates the fair value of share-based payments using the Black-Scholes option-pricing model or the Monte Carlo simulation model if a market condition exists. Share-based compensation expense for a share-based payment award with a market condition is recorded on a straight-line basis over the longer of the explicit service period or the service period derived from the Monte Carlo simulation. Additionally, share-based awards to non-employees are expensed over the period in which the related services are rendered at their fair value. All share-based awards are expected to be fulfilled with new shares of common stock.
|
|
(c)
|
Goodwill and Other Intangible Assets
|
Goodwill represents the excess of the purchase price over the estimated fair value of net tangible and identifiable intangible assets acquired in business combinations. The Company has not amortized goodwill related to its acquisitions, but instead tests the balance for impairment. The Company evaluates goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate that the carrying value may not be recoverable. The Company tests goodwill for impairment by comparing the book value of net assets to the fair value of the reporting unit. If the fair value is determined to be less than the book value, the computed difference represents the amount of impairment. The Company's single reporting unit for purposes of its goodwill impairment test has a negative carrying value and thus the Company has determined there was no impairment of goodwill. During the second and third quarters of 2017, there were no triggering events that would require a goodwill impairment test to be performed prior to the Company's annual goodwill impairment test.
(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
and the Series A redeemable convertible preferred stock outstanding.
The following represents the common stock equivalents that were excluded from the computation of diluted shares outstanding because their effect would have been anti-dilutive for the
three and nine
months ended
September 30, 2017
and
2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Stock options and restricted stock
|
|
2,309,950
|
|
|
6,677,895
|
|
|
2,786,418
|
|
|
6,677,895
|
|
Series A redeemable convertible preferred stock
|
|
8,781,516
|
|
|
8,781,516
|
|
|
8,781,516
|
|
|
8,781,516
|
|
Total anti-dilutive common stock equivalents
|
|
11,091,466
|
|
|
15,459,411
|
|
|
11,567,934
|
|
|
15,459,411
|
|
The following represents a reconciliation of the numerators and denominators of the basic and diluted EPS computation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Numerator
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
1,429,173
|
|
|
$
|
(1,976,173
|
)
|
|
$
|
(322,825
|
)
|
|
$
|
(9,807,667
|
)
|
Effects of Series A redeemable convertible preferred stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: Series A redeemable convertible preferred stock dividends
|
|
215,000
|
|
|
194,012
|
|
|
634,664
|
|
|
581,986
|
|
Less: Accretion to redemption value of Series A redeemable convertible preferred stock
|
|
—
|
|
|
178,619
|
|
|
—
|
|
|
513,269
|
|
Net income (loss) attributable to common stockholders
|
|
$
|
1,214,173
|
|
|
$
|
(2,348,804
|
)
|
|
$
|
(957,489
|
)
|
|
$
|
(10,902,922
|
)
|
Denominator
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average basic shares outstanding
|
|
44,552,892
|
|
|
43,488,448
|
|
|
44,362,367
|
|
|
42,847,038
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options and restricted stock
|
|
901,468
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Series A redeemable convertible preferred stock
|
|
8,781,516
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Weighted average diluted shares outstanding
|
|
54,235,876
|
|
|
43,488,448
|
|
|
44,362,367
|
|
|
42,847,038
|
|
EPS
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per share attributable to common stockholders
|
|
$
|
0.03
|
|
|
$
|
(0.05
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.25
|
)
|
Diluted net income (loss) per share attributable to common stockholders
|
|
$
|
0.02
|
|
|
$
|
(0.05
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.25
|
)
|
(4) Property and Equipment
The gross carrying amount and accumulated depreciation of property and equipment as of
September 30, 2017
and
December 31, 2016
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
Property and Equipment:
|
|
|
|
|
Gross carrying amount
|
|
$
|
19,233,492
|
|
|
$
|
19,755,489
|
|
Accumulated depreciation
|
|
(18,479,643
|
)
|
|
(18,580,547
|
)
|
Property and Equipment, net
|
|
$
|
753,849
|
|
|
$
|
1,174,942
|
|
For the
three months ended September 30, 2017
and
2016
, depreciation expense was
$107,812
and
$154,948
, respectively. For the
nine months ended September 30, 2017
and
2016
, depreciation expense was
$429,566
and
$560,324
, respectively.
(5) Software Development Costs
The gross carrying amount and accumulated amortization of software development costs as of
September 30, 2017
and
December 31, 2016
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
Software development costs:
|
|
|
|
|
Gross carrying amount
|
|
$
|
2,917,215
|
|
|
$
|
2,917,215
|
|
Accumulated amortization
|
|
(2,579,193
|
)
|
|
(2,369,657
|
)
|
Software development costs, net
|
|
$
|
338,022
|
|
|
$
|
547,558
|
|
During the
three months ended September 30, 2017
and
2016
, the Company recorded
$58,608
and
$99,654
, respectively, of amortization expense related to capitalized software costs. During the
nine months ended September 30, 2017
and
2016
, the Company recorded
$209,536
and
$360,017
, respectively, of amortization expense related to capitalized software costs.
(6) Goodwill and Other Intangible Assets
The gross carrying amount and accumulated amortization of goodwill and other intangible assets as of
September 30, 2017
and
December 31, 2016
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
Goodwill
|
|
$
|
4,150,339
|
|
|
$
|
4,150,339
|
|
Other intangible assets:
|
|
|
|
|
|
|
Gross carrying amount
|
|
$
|
3,789,435
|
|
|
$
|
3,725,437
|
|
Accumulated amortization
|
|
(3,637,288
|
)
|
|
(3,515,981
|
)
|
Net carrying amount
|
|
$
|
152,147
|
|
|
$
|
209,456
|
|
For the
three months ended September 30, 2017
and
2016
, amortization expense was
$40,533
and
$39,186
, respectively. For the
nine months ended September 30, 2017
and
2016
, amortization expense was
$121,306
and
$121,421
, respectively.
(7) Share-Based Payment Arrangements
On
September 30, 2017
, the total shares available for issuance under the FalconStor Software, Inc. 2016 Incentive Stock Plan (the "2016 Plan") totaled
3,161,300
. Pursuant to the 2016 Plan, if, on July 1
st
of any calendar year in which the 2016 Plan is in effect, the number of shares of stock as to which options, restricted shares and restricted stock units may be granted under the 2016 Plan is less than five percent (
5%
) of the number of outstanding shares of stock, then the number of shares of stock available for issuance under the 2016 Plan is automatically increased so that the number equals five percent (
5%
) of the shares of stock outstanding. In no event shall the number of shares of stock subject to the 2016 Plan in the aggregate exceed
twenty million
shares, subject to adjustment as provided in the 2016 Plan. On July 1, 2017, the total number of outstanding shares of the Company’s common stock totaled
44,525,990
. Pursuant to the 2016 Plan, the total shares available for issuance under the 2016 Plan thus increased
2,081,080
to
2,226,300
shares available for issuance as of July 1, 2017.
The following table summarizes the plans under which the Company was able to grant equity compensation as of
September 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
Shares
|
|
Shares Available
|
|
Shares
|
|
Last Date for Grant
|
Name of Plan
|
|
Authorized
|
|
for Grant
|
|
Outstanding
|
|
of Shares
|
FalconStor Software, Inc., 2016 Incentive Stock Plan
|
|
2,166,606
|
|
3,161,300
|
|
565,000
|
|
April 27, 2026
|
FalconStor Software, Inc., 2016 Outside Directors Equity Compensation Plan
|
|
1,000,000
|
|
583,532
|
|
409,868
|
|
April 27, 2019
|
The following table summarizes the Company’s equity plans that have expired but that still have equity awards outstanding as of
September 30, 2017
:
|
|
|
|
|
|
Name of Plan
|
|
Shares Available for Grant
|
|
Shares Outstanding
|
FalconStor Software, Inc., 2006 Incentive Stock Plan
|
|
—
|
|
1,714,850
|
FalconStor Software, Inc., 2013 Outside Directors Equity Compensation Plan
|
|
—
|
|
10,200
|
FalconStor Software, Inc., 2000 Stock Option Plan
|
|
—
|
|
31,500
|
Related to the aforementioned 2017 Plan, many share-based compensation awards were forfeited and the related expense reversed accordingly, resulting in negative expense in the period. The following table summarizes the share-based compensation expense for all awards issued under the Company’s stock equity plans in the following line items in the condensed consolidated statements of operations for the
three and nine
months ended
September 30, 2017
and
2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Cost of revenue - Product
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Cost of revenue - Support and Service
|
|
(9,752
|
)
|
|
16,684
|
|
|
55,533
|
|
|
85,521
|
|
Research and development costs
|
|
28,382
|
|
|
80,310
|
|
|
212,910
|
|
|
1,652,107
|
|
Selling and marketing
|
|
(23,560
|
)
|
|
88,907
|
|
|
40,178
|
|
|
231,979
|
|
General and administrative
|
|
(255,647
|
)
|
|
88,305
|
|
|
(26,629
|
)
|
|
422,555
|
|
|
|
$
|
(260,577
|
)
|
|
$
|
274,206
|
|
|
$
|
281,992
|
|
|
$
|
2,392,162
|
|
On March 7, 2016, the Company issued an aggregate of
507,070
shares of the Company's common stock to Cumulus Logic, LLC, as a milestone payment pursuant to the terms of a Software License and Development Agreement between the Company and Cumulus Logic, LLC. The shares have an aggregate value of
$765,000
based on the 30 day trading day average of the Company's common stock immediately prior to July 29, 2015, the date that the License and Development Agreement was executed. The Company recognized share-based compensation expense of
$699,757
related to this transaction based on the fair value per share of the common stock on the date of issue of
$1.38
. This expense was included in "research and development costs" in the accompanying consolidated statements of operations.
On April 1, 2016, the Company issued an aggregate of
591,582
shares of the Company's common stock to Cumulus Logic, LLC, as the final milestone payment pursuant to the terms of a Software License and Development Agreement between the Company and Cumulus Logic, LLC. The shares have an aggregate value of
$892,500
based on the 30 day trading day average of the Company's common stock immediately prior to July 29, 2015, the date that the License and Development Agreement was executed. On April 1, 2016, the Company recognized share-based compensation expense of
$786,804
related to this transaction based on the fair value per share of the common stock on the date of issue of
$1.33
.
(8) Income Taxes
The Company’s provision for income taxes consists of state and local, and foreign taxes, as applicable, in amounts necessary to align the Company’s year-to-date tax provision with the effective rate that it expects to achieve for the full year.
For the
nine months ended September 30, 2017
and
2016
, the Company recorded an income tax provision of
$207,352
and
$375,338
, respectively, consisting primarily of state and local and foreign taxes. The effective tax rate for the
nine months ended September 30, 2017
and
September 30, 2016
was
(179.6%)
and
(4.0%)
, respectively. The difference in the Company’s effective tax from the statutory rate of 35% is primarily attributable to the mix of foreign and domestic earnings as no tax benefit is being recognized on domestic losses. During the
three months ended September 30, 2017
the Company recorded and income tax benefit of
$0.0 million
related to the reversal of uncertain tax positions. As of
September 30, 2017
, 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 benefit attributable to domestic losses in connection with forecasting the
2017
estimated annual effective tax rate. As of
September 30, 2017
, the valuation allowance totaled approximately
$39.2 million
. The Company’s total unrecognized tax benefits, excluding interest, at
September 30, 2017
and
December 31, 2016
were
$164,292
and
$217,461
, respectively.
At
September 30, 2017
,
$241,287
of unrecognized tax benefits, including interest, if recognized, would reduce the Company’s effective tax rate. As of
September 30, 2017
and
December 31, 2016
, the Company had
$76,995
and
$111,278
, respectively, of accrued interest.
(9) Fair Value Measurements
The Company measures its cash equivalents and derivative instruments at fair value. Fair value is an exit price, representing the amount that would be received on the sale of an asset or that would be paid to transfer a liability in an orderly transaction between market participants. As a basis for considering such assumptions, the Company utilizes a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value.
The methodology for measuring fair value specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs) or reflect the Company’s own assumptions of market participant valuation (unobservable inputs). As a result, observable and unobservable inputs have created the following fair value hierarchy:
|
|
•
|
Level 1
– Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities. At
September 30, 2017
the Company did not have any Level 1 category assets included in the condensed consolidated balance sheets. At
December 31, 2016
, the Level 1 category included money market funds, which are included within cash and cash equivalents in the condensed consolidated balance sheets.
|
|
|
•
|
Level 2 –
Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly. At
September 30, 2017
and
December 31, 2016
, the Company did not have any Level 2 category assets included in the condensed consolidated balance sheets.
|
|
|
•
|
Level 3
– Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable. At
September 30, 2017
and
December 31, 2016
, 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, cash equivalents categorized as Level 3 as of
September 30, 2017
or
December 31, 2016
.
|
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at
September 30, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
|
Total
|
|
Quoted Prices in Active Markets for Identical Assets
(Level 1)
|
|
Significant other Inputs
(Level 2)
|
|
Significant Unobservable Inputs
(Level 3)
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
Money market funds
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Total cash equivalents
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Derivative liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative Instruments
|
|
424,636
|
|
|
—
|
|
|
—
|
|
|
424,636
|
|
Total derivative liabilities
|
|
424,636
|
|
|
—
|
|
|
—
|
|
|
424,636
|
|
|
|
|
|
|
|
|
|
|
Total assets and liabilities measured at fair value
|
|
$
|
424,636
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
424,636
|
|
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
|
Total
|
|
Quoted Prices in Active Markets for Identical Assets
(Level 1)
|
|
Significant other Inputs
(Level 2)
|
|
Significant Unobservable Inputs
(Level 3)
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
Money market funds and commercial paper
|
|
$
|
1,133,280
|
|
|
$
|
1,133,280
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Total cash equivalents
|
|
1,133,280
|
|
|
1,133,280
|
|
|
—
|
|
|
—
|
|
Derivative liabilities:
|
|
|
|
|
|
|
|
|
Derivative Instruments
|
|
336,862
|
|
|
—
|
|
|
—
|
|
|
336,862
|
|
Total derivative liabilities
|
|
336,862
|
|
|
—
|
|
|
—
|
|
|
336,862
|
|
|
|
|
|
|
|
|
|
|
Total assets and liabilities measured at fair value
|
|
$
|
1,470,142
|
|
|
$
|
1,133,280
|
|
|
$
|
—
|
|
|
$
|
336,862
|
|
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 following table presents a reconciliation of the beginning and ending balances of the Company's liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the
three and nine
months ended
September 30, 2017
and
September 30, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Beginning Balance
|
|
$
|
419,560
|
|
|
$
|
164,670
|
|
|
$
|
336,862
|
|
|
$
|
82,024
|
|
Total loss recognized in earnings
|
|
5,076
|
|
|
8,997
|
|
|
87,774
|
|
|
91,643
|
|
Ending Balance
|
|
$
|
424,636
|
|
|
$
|
173,667
|
|
|
$
|
424,636
|
|
|
$
|
173,667
|
|
(10) Commitments and Contingencies
The Company has an operating lease covering its corporate office facility that expires in April 2021. The Company also has several additional operating leases related to offices in foreign countries with expiration dates ranging from 2017 through 2019. The following is a schedule of future minimum lease payments for all operating leases as of
September 30, 2017
:
|
|
|
|
|
2017
|
$
|
648,816
|
|
2018
|
1,967,248
|
|
2019
|
1,614,843
|
|
2020
|
1,444,247
|
|
2021
|
491,020
|
|
Thereafter
|
—
|
|
|
$
|
6,166,174
|
|
The Company typically provides its customers a warranty on its software products for a period of no more than
90
days. Such warranties are accounted for in accordance with the authoritative guidance issued by the FASB on contingencies. For the
three and nine
months ended
September 30, 2017
, 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 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.
Upon certain triggering events, such as bankruptcy, insolvency or a material adverse effect, failure to achieve minimum financial covenants or failure of the Company to issue shares upon conversion of the Series A redeemable convertible preferred stock in accordance with its obligations, the Series A redeemable convertible preferred stockholders may require the Company to redeem all or some of the Series A redeemable convertible preferred stock at a price equal to the greater of
100%
of the stated value plus accrued and unpaid dividends or the product of the number of shares of common stock underlying the Series A redeemable convertible preferred stock and the closing price as of the occurrence of the triggering event. Commencing after August 5, 2017, each Series A redeemable convertible preferred stockholder can require the Company to redeem its Series A redeemable convertible preferred stock in cash at a price equal to
100%
of the stated value being redeemed plus accrued and unpaid dividends. As of December 31, 2016, the Company was not in compliance with the financial covenants of the Series A redeemable convertible preferred stock for two consecutive quarters, which provides the Series A redeemable convertible preferred stockholders the right to require the Company to redeem any of the Series A redeemable convertible preferred stock at the greater of
100%
of the stated value plus accrued and unpaid dividends or the product of the number of shares of common stock underlying the Series A redeemable convertible preferred stock and the closing price of the Company's common stock as of December 31, 2016. To date, the holders of the Series A redeemable convertible preferred stock have neither exercised nor waived this right and accordingly this right may be exercised at any time. As of
September 30, 2017
, the Company did not fail any non-financial covenants related to the Company's Series A redeemable convertible preferred stock.
On July 24, 2015, the Company entered into an Independent Marketing Agreement with RFN Prime Marketing Inc., to provide among other items, certain sales and marketing deliverables to the Company in exchange for up to
2.55 million
shares of restricted Company common stock which was to be issued based on certain milestone achievements and/or transactions over a
twenty-four
month period. The Independent Marketing Agreement with RFN Prime Marketing Inc., was terminated effective March 31, 2017 and none of the performance milestones had been met, and therefore
no
restricted Company common stock was issued.
On June 14, 2017, the Company accepted the resignation of Gary Quinn from his position as Chief Executive Officer and President and as a Director of the Company effective July 1, 2017. In connection with Mr. Quinn’s departure, on June 14, 2017 the Company and Mr. Quinn entered into a Separation Agreement and General Release (the “Quinn Separation Agreement”). Under the terms of the Quinn Separation Agreement, the Company paid Mr. Quinn his current salary through July 24, 2017 and any COBRA expenses through January 31, 2019 to the extent that Mr. Quinn’s health insurance is not covered by the health insurance plan of another entity.
On August 15, 2017, the Company accepted the resignation of Todd Oseth from his position as Chief Executive Officer and President of the Company. In connection with Mr. Oseth’s departure, on August 15, 2017 the Company and Mr. Oseth entered into a Separation Agreement and General Release (the “Oseth Separation Agreement”). Under the terms of the Oseth Separation Agreement, the Company will, among other things, pay Mr. Oseth his current salary through March 1, 2018 and any COBRA expenses through February 15, 2018 to the extent that Mr. Oseth’s health insurance is not covered by the health insurance plan of another entity.
As of August 14, 2017, the Board appointed Todd Brooks as Chief Executive Officer effective August 14, 2017.
In connection with Mr. Brooks’ appointment 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 Offer Letter 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. Pursuant to the Brooks Agreement, it is the intention of the Company to create an equity plan for all employees subject to stockholder approval, for up to 15% of the equity of the Company on a fully diluted basis, plus potentially two additional tranches of 2.5% of the equity of the Company on a fully diluted basis, at the time the equity plan is adopted following stockholder approval. Vesting of the equity issued under the plan would occur only upon a sale of the Company’s assets or capital stock at a premium to the valuation of the Company at the time the equity plan is adopted. Mr. Brooks’ employment can be terminated at will. 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.
On August 14, 2017, the Board appointed Patrick McClain to serve as the Company’s Executive Vice President, Chief Financial Officer and Treasurer. Mr. McClain also assumed the roles of principal financial officer and principal accounting officer of the Company. In connection with Mr. McClain’s appointment as Chief Financial Officer, the Board approved an offer letter to Mr. McClain (the “McClain Agreement”), which was executed on August 17, 2017. The McClain Agreement provides that Mr. McClain 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. McClain will also be eligible for a cash bonus of $10,000 for any quarter that is free cash flow positive on an operating basis and additional incentive compensation of an annual bonus of up to $80,000, subject to attainment of performance objectives to be mutually agreed upon and established. Mr. McClain’s employment can be terminated at will. If Mr. McClain’s employment is terminated by the Company other than for cause he is entitled to receive severance equal to six (6) 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. McClain’s employment. Except as set forth in the preceding sentence, Mr. McClain is entitled to receive severance equal to three (3) 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. McClain is also entitled to vacation and other employee benefits in accordance with the Company’s policies.
During the third quarter of 2013, the Company adopted a restructuring plan intended 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 “2013 Plan”). In connection with the 2013 Plan, the Company eliminated over
100
positions worldwide, implemented tighter expense controls, ceased non-core activities and closed or downsized several facilities. As of
September 30, 2017
, the restructuring accrual totaled
$648,399
. The 2013 Plan was substantially completed by December 31, 2014; however, the Company expects the majority of the remaining accrued severance related costs to be paid once final settlement litigation is completed, which can be at various times over the next
three
to
twenty-four
months.
In addition, as of
September 30, 2017
, the Company's liability for uncertain tax positions totaled
$241,287
. At this time, the settlement period for the positions, including related accrued interest, cannot be determined.
(11) Series A Redeemable Convertible Preferred Stock
On September 16, 2013, the Company issued to Hale Capital Partners, LP (“Hale”)
900,000
shares of the Company’s Series A redeemable convertible preferred stock, par value
$0.001
per share, at a price of
$10
per share, for an aggregate purchase consideration of
$9.0 million
, which was subsequently transferred to HCP-FVA LLC. Each share of Series A redeemable convertible preferred stock is convertible into common stock equivalents, at the option of the holder and upon certain mandatory conversion events described below, at a conversion rate of
$1.02488
(as adjusted for stock splits, stock dividends, reverse stock splits, stock combinations, reclassifications and similar events). The Company received net proceeds of approximately
$8.7 million
from the issuance of the redeemable convertible preferred stock in 2013, net of transaction costs.
If the volume weighted average price of common stock for each trading day of any
60
consecutive trading days exceeds
250%
of the conversion price and exceeds
225%
of the conversion price through the conversion date, and certain equity conditions are met such that shares of common stock issued upon conversion can be immediately salable by the Series A redeemable convertible preferred stockholders, the Company can convert the Series A redeemable convertible preferred stock up to an amount equal to the greater of
25%
of the daily trading volume for the
20
consecutive trading days immediately preceding the conversion date or the amount of an identified bona fide block trade at a price reasonably acceptable to the applicable Series A redeemable convertible preferred stockholder, but which price is not less than the arithmetic average of the weighted average prices of the common stock for the five trading days immediately preceding such sale.
The holder of the Series A redeemable convertible preferred stock has veto power over certain future financings, and certain rights to participate in any subsequent financing, whether through debt or equity (subject to certain exclusions). In addition, the Company's agreement with the holder of the Series A redeemable convertible preferred stock provide that if, at the time of certain future debt or equity financings, the proceeds of which exceed
$5.0 million
, the holder of the Series A redeemable convertible preferred stock still has outstanding Series A redeemable convertible preferred stock, then the Company must offer to repurchase their Series A redeemable convertible preferred stock. The holder of the Series A redeemable convertible preferred stock has the right to accept the offer or to retain their Series A redeemable convertible preferred stock. If the Company does a financing, and the holder of the Series A redeemable convertible preferred stock elects to have their Series A redeemable convertible preferred stock repurchased, then the capital raised in excess of
$5.0 million
will go to repurchase the holders’ Series A redeemable convertible preferred stock, instead of being able to be used for our business.
The Company cannot consummate a liquidation or a fundamental sale transaction in which the consideration is stock or a combination of cash and stock without the consent of the holder of the Series A redeemable convertible preferred stock.
In addition to the veto rights set forth in the preceding paragraph, upon consummation of a fundamental sale transaction in which the consideration is cash and is not approved by the holder of the Series A redeemable convertible preferred stock, the Series A redeemable convertible preferred stock shall be redeemed at a per share redemption price equal to the greater of (i)
250%
of the stated value of the Series A redeemable convertible preferred stock (which is currently equal to
$22.5 million
or
$2.56
per share of common stock held by the holder of the Series A redeemable convertible preferred stock on an as converted basis as of
September 30, 2017
) and (ii) the price such holder would receive in the transaction on an as converted basis. In addition in the event of the liquidation of the Company or a Fundamental Transaction of the Company (which includes a merger or sale of the Company), the holders of the Series A redeemable convertible preferred stock shall be entitled to receive from the proceeds of the transaction, prior to the holders of the Common Stock, an amount equal to
100%
of the stated value plus accrued and unpaid dividends. The stated value and accrued and unpaid dividends of the Series A redeemable convertible preferred stock at
September 30, 2017
is
$9.8 million
.
Upon certain triggering events, such as bankruptcy, insolvency or a material adverse effect, failure to achieve minimum financial covenants or failure of the Company to issue shares upon conversion of the Series A redeemable convertible preferred stock in accordance with its obligations, the Series A redeemable convertible preferred stockholder may require the Company to redeem all or some of the Series A redeemable convertible preferred stock at a price equal to the greater of
100%
of the stated value plus accrued and unpaid dividends or the product of the number of shares of common stock underlying the Series A redeemable convertible preferred stock and the closing price as of the occurrence of the triggering event. On or after August 5, 2017, each Series A redeemable convertible preferred stockholder can require the Company to redeem its Series A redeemable convertible preferred stock in cash at a price equal to
100%
of the stated value being redeemed plus accrued and unpaid dividends. If the Company does not have the funds necessary to redeem the Series A redeemable convertible preferred stock, the dividends accruing on any outstanding Series A redeemable convertible preferred stock will increase to prime plus
10%
(from prime plus
5%
). For each
six months
that the Series A redeemable convertible preferred stock remains unredeemed, the dividend rate increases by
1%
, subject to a maximum dividend rate of
19%
. In addition, the Company's failure to redeem the Series A redeemable convertible preferred stock would be considered a “Breach Event” under the agreements with the holder of the Series A redeemable convertible preferred stock. If a Breach Event were to occur and the Company is in default under or has breached any provision in respect of its obligations to redeem the Series A redeemable convertible preferred stock, then, under the agreements with the holder of our Series A redeemable convertible preferred stock, the Company's Board of Directors would automatically be increased, with the holders of the Series A redeemable convertible preferred stock having the right to appoint the new directors, so that the holders of the Series A redeemable convertible preferred stock would have appointed a majority of the Board of Directors. This would give the holder of the Series A redeemable convertible preferred stock control of the Company. As of December 31, 2016, the Company was not in compliance with the financial covenants of the Series A redeemable convertible preferred stock for two consecutive quarters, which provides the Series A redeemable convertible preferred stockholder the right to require the Company to redeem any of the Series A redeemable convertible preferred stock at the greater of
100%
of the stated value plus accrued and unpaid dividends or the product of the number of shares of common stock underlying the Series A redeemable convertible preferred stock and the closing price of the Company's common stock as of December 31, 2016. To date, the holder of the Series A redeemable convertible preferred stock has neither exercised nor waived this right and accordingly this right may be exercised at any time. As of
September 30, 2017
, the Company did not fail any non-financial covenants related to the Company's Series A redeemable convertible preferred stock.
The
holder of the Series A redeemable convertible preferred stock is entitled to receive quarterly dividends at the Prime Rate (Wall Street Journal Eastern Edition) plus 5% (up to a maximum amount of 10%)
, payable in cash, provided, that if the Company will not have at least
$1.0 million
in positive cash flow for any calendar quarter after giving effect to the payment of such dividends, the Company, at its election, can pay such dividends in whole or in part in cash, provided that cash flow from operations is not negative, and the remainder can be accrued or paid in common stock to the extent certain equity conditions are satisfied. As of December 31, 2016, March 31, 2017, June 30, 2017 and September 30, 2017, due to the lack of sufficient surplus to pay dividends as required by the DGCL, the Company was not permitted to pay the fourth quarter 2016 and first, second and third quarter 2017 dividends in cash or through the issuance of the Company's common stock and accrued the aforementioned dividends. As of
September 30, 2017
, the Company's liability for dividends to the holder of the Series A redeemable convertible preferred stock totaled
$830,568
.
Each share of Series A redeemable convertible preferred stock has a vote equal to the number of shares of common stock into which the Series A redeemable convertible preferred stock would be convertible as of the record date of September 13, 2013. The Company’s closing stock price on the record date was
$1.23
per share, which results in voting power of an aggregate of
7,317,073
shares. In addition, holder of the Series A redeemable convertible preferred stock must approve certain actions, including any amendments to the Company's charter or bylaws that adversely affects the voting powers, preferences or other rights of the Series A redeemable convertible preferred stock; payment of dividends or distributions; any liquidation, capitalization, reorganization or any other fundamental transaction of the Company, other than as set forth above; issuance of certain equity securities senior to or in parity with the Series A redeemable convertible preferred stock as to dividend rights, redemption rights, liquidation preference and other rights; issuances of equity below the conversion price; incur 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 capital stock of the Company.
The Company has classified the Series A redeemable convertible 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 redeemable convertible preferred stock, the contingent redemption put options in the Series A redeemable convertible 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 redeemable convertible preferred stock and recorded as a liability.
The fair value of these derivative instruments and the loss recorded on the change in the fair value of these derivative instruments, which was included in “Interest and other income, net” within the condensed consolidated statement of operations, for the
three and nine
months ended
September 30, 2017
and
2016
, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Beginning Balance
|
|
$
|
419,560
|
|
|
$
|
164,670
|
|
|
$
|
336,862
|
|
|
$
|
82,024
|
|
Total loss recognized in earnings
|
|
5,076
|
|
|
8,997
|
|
|
87,774
|
|
|
91,643
|
|
Ending Balance
|
|
$
|
424,636
|
|
|
$
|
173,667
|
|
|
$
|
424,636
|
|
|
$
|
173,667
|
|
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 redeemable convertible preferred stock. These costs were being accreted to the Series A redeemable convertible 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 as noted above. The Company included deductions for accretion and accrued dividends as adjustments to net loss attributable to common stockholders on the condensed consolidated statement of operations for the
three and nine
months ended
September 30, 2017
and
2016
. The following represents a reconciliation of net loss attributable to common stockholders for the
three and nine
months ended
September 30, 2017
and
2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Net loss
|
|
$
|
1,429,173
|
|
|
$
|
(1,976,173
|
)
|
|
$
|
(322,825
|
)
|
|
$
|
(9,807,667
|
)
|
Effects of Series A redeemable convertible preferred stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
Less: Series A redeemable convertible preferred stock dividends
|
|
215,000
|
|
|
194,012
|
|
|
634,664
|
|
|
581,986
|
|
Less: Accretion to redemption value of Series A redeemable convertible preferred stock
|
|
—
|
|
|
178,619
|
|
|
—
|
|
|
513,269
|
|
Net gain (loss) attributable to common stockholders
|
|
$
|
1,214,173
|
|
|
$
|
(2,348,804
|
)
|
|
$
|
(957,489
|
)
|
|
$
|
(10,902,922
|
)
|
(12) Accumulated Other Comprehensive (Loss) Income
The changes in Accumulated Other Comprehensive (Loss) Income, net of tax, for the
three months ended September 30, 2017
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency
Translation
|
|
Net Unrealized Gains (Losses) on Marketable
Securities
|
|
Net Minimum
Pension Liability
|
|
Total
|
Accumulated other comprehensive (loss) income at June 30, 2017
|
|
$
|
(2,046,484
|
)
|
|
$
|
—
|
|
|
$
|
28,675
|
|
|
$
|
(2,017,809
|
)
|
Other comprehensive (loss) income
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive (loss) income before reclassifications
|
|
104,917
|
|
|
—
|
|
|
—
|
|
|
104,917
|
|
Amounts reclassified from accumulated other comprehensive (loss) income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total other comprehensive (loss) income
|
|
104,917
|
|
|
—
|
|
|
—
|
|
|
104,917
|
|
Accumulated other comprehensive (loss) income at September 30, 2017
|
|
$
|
(1,941,567
|
)
|
|
$
|
—
|
|
|
$
|
28,675
|
|
|
$
|
(1,912,892
|
)
|
The changes in Accumulated Other Comprehensive (Loss) Income, net of tax, for the
nine months ended September 30, 2017
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency
Translation
|
|
Net Unrealized (Losses) Gains on Marketable
Securities
|
|
Net Minimum
Pension Liability
|
|
Total
|
Accumulated other comprehensive (loss) income at December 31, 2016
|
|
$
|
(1,866,388
|
)
|
|
$
|
—
|
|
|
$
|
28,675
|
|
|
$
|
(1,837,713
|
)
|
Other comprehensive (loss) income
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive (loss) income before reclassifications
|
|
(75,179
|
)
|
|
—
|
|
|
—
|
|
|
(75,179
|
)
|
Amounts reclassified from accumulated other comprehensive (loss) income
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Total other comprehensive (loss) income
|
|
(75,179
|
)
|
|
—
|
|
|
—
|
|
|
(75,179
|
)
|
Accumulated other comprehensive (loss) income at September 30, 2017
|
|
$
|
(1,941,567
|
)
|
|
$
|
—
|
|
|
$
|
28,675
|
|
|
$
|
(1,912,892
|
)
|
The changes in Accumulated Other Comprehensive (Loss) Income, net of tax, for the
three months ended September 30, 2016
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency
Translation
|
|
Net Unrealized
Gains (Losses) on Marketable
Securities
|
|
Net Minimum
Pension Liability
|
|
Total
|
Accumulated other comprehensive (loss) income at June 30, 2016
|
|
$
|
(2,288,570
|
)
|
|
$
|
350
|
|
|
$
|
31,040
|
|
|
$
|
(2,257,180
|
)
|
Other comprehensive (loss) income
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive (loss) income before reclassifications
|
|
59,527
|
|
|
(1,289
|
)
|
|
2,616
|
|
|
60,854
|
|
Amounts reclassified from accumulated other comprehensive (loss) income
|
|
—
|
|
|
1,010
|
|
|
1,258
|
|
|
2,268
|
|
Total other comprehensive (loss) income
|
|
59,527
|
|
|
(279
|
)
|
|
3,874
|
|
|
63,122
|
|
Accumulated other comprehensive (loss) income at September 30, 2016
|
|
$
|
(2,229,043
|
)
|
|
$
|
71
|
|
|
$
|
34,914
|
|
|
$
|
(2,194,058
|
)
|
The changes in Accumulated Other Comprehensive (Loss) Income, net of tax, for the
nine months ended September 30, 2016
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign Currency
Translation
|
|
Net Unrealized (Losses) Gains on Marketable
Securities
|
|
Net Minimum
Pension Liability
|
|
Total
|
Accumulated other comprehensive (loss) income at December 31, 2015
|
|
$
|
(1,726,994
|
)
|
|
$
|
(3,406
|
)
|
|
$
|
27,186
|
|
|
$
|
(1,703,214
|
)
|
Other comprehensive (loss) income
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive (loss) income before reclassifications
|
|
(502,049
|
)
|
|
1,224
|
|
|
4,039
|
|
|
(496,786
|
)
|
Amounts reclassified from accumulated other comprehensive (loss) income
|
|
—
|
|
|
2,253
|
|
|
3,689
|
|
|
5,942
|
|
Total other comprehensive (loss) income
|
|
(502,049
|
)
|
|
3,477
|
|
|
7,728
|
|
|
(490,844
|
)
|
Accumulated other comprehensive (loss) income at Sept 30, 2016
|
|
$
|
(2,229,043
|
)
|
|
$
|
71
|
|
|
$
|
34,914
|
|
|
$
|
(2,194,058
|
)
|
For the
three and nine
months ended
September 30, 2017
, the amounts reclassified to net loss related to the Company’s defined benefit plan and maturity of marketable securities. These amounts are included within “
Operating loss
” within the condensed consolidated statements of operations.
(13) Stockholders' Equity
Stock Repurchase Activity
On April 22, 2015, the Company’s Board of Directors (the "Board") approved a new stock buy-back program (the "Repurchase Program"). The Repurchase Program authorizes management to repurchase in the aggregate up to
five million
shares of the Company's common stock. Repurchases may be made by the Company from time to time in open-market or privately-negotiated transactions as permitted by securities laws and other legal requirements, and subject to market conditions and other factors. The Repurchase Program superseded and replaced the Company's prior stock buy-back program. The Repurchase Program does not obligate the Company to make repurchases at any specific time or situation. The Company was required to obtain approvals from the Series A redeemable convertible preferred stockholders for the Repurchase Program. The Repurchase Program does not have an expiration date and may be amended or terminated by the Board at any time without prior notice.
During the
three and nine
months ended
September 30, 2017
and
2016
, the Company did not repurchase any shares of its common stock. As of
September 30, 2017
, the Company had the authorization to repurchase
4,907,839
shares of its common stock based upon its judgment and market conditions.
(14) 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.
Other Claims
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.
(15) Segment Reporting
The Company is organized in a single operating segment for purposes of making operating decisions and assessing performance. Revenue from the United States to customers in the following geographical areas for the
three and nine
months ended
September 30, 2017
and
2016
, and the location of long-lived assets as of
September 30, 2017
and
December 31, 2016
, are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2017
|
|
2016
|
|
2017
|
|
2016
|
Revenue:
|
|
|
|
|
|
|
|
|
Americas
|
|
$
|
1,742,556
|
|
|
$
|
1,856,175
|
|
|
$
|
5,384,051
|
|
|
$
|
6,909,801
|
|
Asia Pacific
|
|
2,243,820
|
|
|
2,958,989
|
|
|
6,940,306
|
|
|
8,645,233
|
|
Europe, Middle East, Africa and Other
|
|
2,119,057
|
|
|
2,511,646
|
|
|
6,554,517
|
|
|
7,272,058
|
|
Total Revenue
|
|
$
|
6,105,433
|
|
|
$
|
7,326,810
|
|
|
$
|
18,878,874
|
|
|
$
|
22,827,092
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2017
|
|
December 31, 2016
|
Long-lived assets:
|
|
|
|
|
Americas
|
|
$
|
5,920,211
|
|
|
$
|
6,525,612
|
|
Asia Pacific
|
|
831,464
|
|
|
890,051
|
|
Europe, Middle East, Africa and Other
|
|
261,025
|
|
|
218,316
|
|
Total long-lived assets
|
|
$
|
7,012,700
|
|
|
$
|
7,633,979
|
|
For both the
three and nine
months ended
September 30, 2017
, the Company had no customers that accounted for
10%
or more of total revenue. For both the
three and nine
months ended
September 30, 2016
, the Company had one customer that accounted for
15%
of total revenue.
As of
September 30, 2017
, the Company had one customer that accounted for
16%
of the gross accounts receivable balance. As of
December 31, 2016
, the Company had three customers that accounted for
15%
,
14%
and
12%
, respectively, of the gross accounts receivable balance.
(16) Restructuring Costs
In the third quarter of 2013, the Company adopted the 2013 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 2013 Plan, the Company eliminated over
100
positions worldwide, implemented tighter expense controls, ceased non-core activities and closed or downsized several facilities. The 2013 Plan was substantially completed by December 31, 2014; however, we expect the majority of the severance related costs to be paid once final settlement litigation is completed, which can be at various times over the next
three
to
twenty-four
months. The following table summarizes the activity during 2017 related to restructuring liabilities recorded in connection with the 2013 Plan:
|
|
|
|
|
|
|
|
Severance related costs
|
Balance at December 31, 2016
|
|
$
|
846,337
|
|
Additions (Reductions)
|
|
(236,302
|
)
|
Utilized/Paid
|
|
—
|
|
Balance at March 31, 2017
|
|
$
|
610,035
|
|
Additions (Reductions)
|
|
—
|
|
Utilized/Paid
|
|
(38,341
|
)
|
Balance at June 30, 2017
|
|
$
|
571,694
|
|
Additions (Reductions)
|
|
76,705
|
|
Utilized/Paid
|
|
—
|
|
Balance at September 30, 2017
|
|
$
|
648,399
|
|
In June 2017, the Board approved a comprehensive plan to increase operating performance (the “2017 Plan”).
The 2017 Plan will result in a realignment and reduction in workforce. When substantially completed by the end of the Company’s fiscal year ending December 31, 2017, the Company expects that the 2017 Plan when combined with previous workforce reductions in the second quarter of Fiscal 2017 will have reduced the Company’s workforce to approximately 80 employees. These actions are anticipated to result in an annualized cost savings of approximately
$10.0 million
. In connection with the 2017 Plan, the Company expects to incur total estimated charges of up to
$1.0 million
, consisting primarily of severance. In making these changes, the Company prioritized customer support and development while consolidating operations and cutting direct sales resources allowing the company to focus on the install base and develop alternate channels to the market.
The severance related liabilities are included within “accrued expenses” in the accompanying condensed consolidated balance sheets. The expenses under the 2013 Plan are included within “restructuring costs” in the accompanying condensed consolidated statements of operations.
(17) Subsequent Events
On November 17, 2017, HCP-FVA, LLC (the “Lender”) provided a commitment letter to the Company agreeing to finance up to
$3 million
to the Company (the “Commitment”) on the terms, and subject to the conditions, set forth in that certain commitment letter, as further described below. As part of that Commitment, on November 17, 2017, the Company entered into a Loan and Security Agreement (the “Loan Agreement”) with Lender and certain other loan parties named therein, pursuant to which the Lender made a short term loan to the Company in the principal amount of
$500,000
(the “Short Term Loan”). The Lender is an affiliate of Hale Capital Partners, LP (together, “Hale Capital”), the Company’s largest stockholder through its ownership of Series A Redeemable Preferred Stock , and an affiliate of FalconStor director, Martin Hale.
Pursuant to the terms of the Loan Agreement, the Short Term Loan is secured by all of the assets of the Company and guaranteed by each of the Company’s domestic subsidiaries. The Short Term Loan bears interest at a rate equal to the prime rate plus
0.75%
, which will be increased by an additional
5%
during the continuance of a Default or Event of Default (as each term is defined in the Loan Agreement). The Short Term Loan will be due and payable on May 17, 2018, unless prepaid or satisfied through the issuance by the Company of units in a proposed private placement which will be offered to certain eligible stockholders existing on the date of the Loan Agreement (the “Proposed Offering”). Such units would consist of senior secured debt in the aggregate principal amount of the Short Term Loan and nominal warrants to purchase approximately
61,165,134
shares of the Company’s common stock, as further described below.
In the event the Short Term Loan is prepaid, such prepayment will be subject to the payment of a premium in an amount equal to
5%
of the principal amount of the Short Term Loan prepaid. The Short Term Loan must be repaid in the event of certain fundamental events, incurrence of any additional indebtedness, other than permitted indebtedness (as defined in the Loan Agreement), upon a change of control and with any insurance proceeds not reinvested in the Company. The Loan Agreement has customary representations, warranties and affirmative and negative covenants. In addition, the Company is required to maintain a minimum total liquidity of
$2 million
and cannot permit a variance of more than
10%
of net cash flow from the amounts set forth in a rolling weekly detailed budget agreed upon at the signing of the Loan Agreement.
In consideration for making the Short Term Loan and Commitment, the Company issued a warrant to purchase
13,859,128
shares of common stock at an exercise price of
$0.001
per share, which warrant has customary terms and conditions and permits cashless exercises (the “Initial Backstop Warrant”). Upon the funding of all or any portion of the Commitment, the Company will issue an additional warrant (the “Additional Backstop Warrant” and, together with the Initial Backstop Warrant, the “Backstop Warrants”) to purchase
41,577,382
shares of common stock at an exercise price of
$0.001
per share, which warrant shall be in substantially the same form as the Initial Backstop Warrant. Fifty percent (
50%
) of the Backstop Warrants (or the shares of common stock issuable upon exercise thereof on a post-cashless exercise basis) are subject to cancellation in the event that more than half of the units in the Proposed Offering are purchased by eligible stockholders (other than Hale Capital). The Backstop Warrants are in addition to the nominal warrants to be issued upon purchase of any units in the Proposed Offering.
As part of the Commitment, the Proposed Offering contemplates the private placement of approximately
$14.08 million
of units, which assumes year end closing, with each unit consisting of senior secured debt, nominal warrants and shares of the Company’s Series A Preferred Stock held by Hale Capital. If the Proposed Offering is fully subscribed,
$4 million
of the total offering proceeds would be paid to the Company in exchange for the portion of the units consisting of secured debt and warrants and approximately
$10.08 million
of the total offering proceeds (less any portion attributable to the units purchased by Hale Capital) would be paid to Hale Capital for the purchase of its Series A Preferred Stock. Pursuant to the terms of the Commitment, the Lender has committed to purchase
75%
of the total number of the portion of the units to be issued by the Company in the Proposed Offering to ensure the Company receives at least
$3 million
of total offering proceeds, inclusive of the units issuable upon conversion of the Short Term Loan.
The issuance of warrants in connection with the Short Term Loan and Commitment, will have a substantial dilutive effect on all existing stockholders of the Company. For example, if Lender funds the full Commitment, Hale Capital will beneficially own, when combined with Hale Capital’s current ownership, and the warrants issued in connection with the Short Term Loan and shares set aside for management, approximately
73%
of the Company, on an as-converted basis. If Lender funds only
25%
of the total number of units to be issued in the Proposed Offering due to purchases of units by eligible stockholders of the Company electing to partially draw on the Commitment, Hale Capital will beneficially own, when combined with Hale Capital’s current ownership, the warrants issued in connection with the Short Term Loan and shares set aside for management, approximately
21.5%
of the Company, on an as-converted basis.