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EX-31.2 - EXHIBIT 31.2 - FALCONSTOR SOFTWARE INCex312-q32015.htm
EX-31.1 - EXHIBIT 31.1 - FALCONSTOR SOFTWARE INCex311-q32015.htm
EX-32.2 - EXHIBIT 32.2 - FALCONSTOR SOFTWARE INCex322-q32015.htm
EX-32.1 - EXHIBIT 32.1 - FALCONSTOR SOFTWARE INCex321-q32015.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
or 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                                 to                                
Commission File Number:  000-23970
FALCONSTOR SOFTWARE, INC.
(Exact name of registrant as specified in its charter)
 
 
DELAWARE
77-0216135
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
 
 
2 Huntington Quadrangle
Melville, New York
11747
(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)
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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
Large accelerated filer o
Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No ý
 
The number of shares of Common Stock outstanding as of October 28, 2015 was 41,182,567.




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


2



PART I.  FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
 
FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
September 30, 2015
 
December 31, 2014
 
 
(unaudited)
 
 
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
5,483,379

 
$
10,873,891

Marketable securities
 
10,582,030

 
10,900,722

Accounts receivable, net of allowances of $184,009 and $119,530, respectively
 
5,051,870

 
8,898,680

Prepaid expenses and other current assets
 
1,644,379

 
1,596,916

Inventory
 
156,871

 
352,493

Deferred tax assets, net
 
300,343

 
316,586

Total current assets
 
23,218,872

 
32,939,288

Property and equipment, net of accumulated depreciation of $17,668,588 and $16,867,911, respectively
 
1,821,390

 
2,147,188

Deferred tax assets, net
 
7,503

 
7,503

Software development costs, net
 
1,128,553

 
1,508,517

Other assets
 
1,154,717

 
1,373,964

Goodwill
 
4,150,339

 
4,150,339

Other intangible assets, net
 
260,004

 
196,037

Total assets
 
$
31,741,378

 
$
42,322,836

Liabilities and Stockholders' Deficit
 
 

 
 

Current liabilities:
 
 

 
 

Accounts payable
 
$
1,387,493

 
$
1,266,504

Accrued expenses
 
7,418,471

 
6,939,198

Deferred tax liabilities, net
 
23,307

 
23,307

Deferred revenue, net
 
15,502,480

 
23,380,012

Total current liabilities
 
24,331,751

 
31,609,021

Other long-term liabilities
 
717,200

 
630,444

Deferred tax liabilities, net
 
252,298

 
226,443

Deferred revenue, net
 
9,260,148

 
13,097,215

Total liabilities
 
34,561,397

 
45,563,123

Commitments and contingencies
 


 


Series A redeemable convertible preferred stock, $.001 par value, 2,000,000 shares authorized, 900,000 shares issued and outstanding, redemption value of $9,000,000
 
7,661,884

 
7,230,941

Stockholders' deficit:
 
 

 
 

Common stock - $.001 par value, 100,000,000 shares authorized, 56,710,637 and 56,360,222 shares issued, respectively and 41,182,567 and 40,924,313 shares outstanding, respectively
 
56,711

 
56,360

Additional paid-in capital
 
167,165,710

 
166,933,291

Accumulated deficit
 
(119,042,274
)
 
(119,054,530
)
Common stock held in treasury, at cost (15,528,070 and 15,435,909 shares, respectively)
 
(57,032,917
)
 
(56,895,059
)
Accumulated other comprehensive loss, net
 
(1,629,133
)
 
(1,511,290
)
Total stockholders' deficit
 
(10,481,903
)
 
(10,471,228
)
Total liabilities and stockholders' deficit
 
$
31,741,378

 
$
42,322,836


See accompanying notes to unaudited condensed consolidated financial statements.

3



FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Revenue:
 
 
 
 
 
 
 
 
Product revenue
 
$
3,756,579

 
$
3,940,479

 
$
21,377,450

 
$
13,156,024

Support and services revenue
 
5,926,647

 
7,234,961

 
17,798,241

 
21,323,582

Total revenue
 
9,683,226

 
11,175,440

 
39,175,691

 
34,479,606

Cost of revenue:
 
 

 
 

 
 

 
 

Product
 
510,861

 
834,628

 
1,619,142

 
2,107,974

Support and service
 
1,915,090

 
1,757,716

 
5,875,837

 
5,866,408

Total cost of revenue
 
2,425,951

 
2,592,344

 
7,494,979

 
7,974,382

Gross profit
 
$
7,257,275

 
$
8,583,096

 
$
31,680,712

 
$
26,505,224

Operating expenses:
 
 

 
 

 
 

 
 

Research and development costs
 
3,454,128

 
2,995,150

 
9,727,727

 
9,487,169

Selling and marketing
 
4,128,814

 
5,776,558

 
13,805,689

 
18,016,971

General and administrative
 
2,132,665

 
2,140,460

 
7,209,499

 
6,896,250

Investigation, litigation, and settlement related (benefits) costs
 

 
(22,502
)
 
8,842

 
(5,186,711
)
Restructuring costs
 
15,024

 
259,078

 
172,995

 
1,045,564

Total operating expenses
 
9,730,631

 
11,148,744

 
30,924,752

 
30,259,243

Operating (loss) income
 
(2,473,356
)
 
(2,565,648
)
 
755,960

 
(3,754,019
)
Interest and other income (loss), net
 
25,697

 
(504,124
)
 
(339,968
)
 
(484,998
)
(Loss) income before income taxes
 
(2,447,659
)
 
(3,069,772
)
 
415,992

 
(4,239,017
)
Provision for income taxes
 
134,280

 
162,627

 
403,736

 
464,233

Net (loss) income
 
$
(2,581,939
)
 
$
(3,232,399
)
 
$
12,256

 
$
(4,703,250
)
Less: Accrual of Series A redeemable convertible preferred stock dividends
 
190,786

 
186,904

 
568,476

 
560,712

Less: Accretion to redemption value of Series A redeemable convertible preferred stock
 
149,969

 
125,915

 
430,943

 
361,822

Net loss attributable to common stockholders
 
$
(2,922,694
)
 
$
(3,545,218
)
 
$
(987,163
)
 
$
(5,625,784
)
Basic net loss per share attributable to common stockholders
 
$
(0.07
)
 
$
(0.08
)
 
$
(0.02
)
 
$
(0.12
)
Diluted net loss per share attributable to common stockholders
 
$
(0.07
)
 
$
(0.08
)
 
$
(0.02
)
 
$
(0.12
)
Weighted average basic shares outstanding
 
41,113,431

 
45,158,184

 
41,004,976

 
47,025,887

Weighted average diluted shares outstanding
 
41,113,431

 
45,158,184

 
41,004,976

 
47,025,887


See accompanying notes to unaudited condensed consolidated financial statements.


4



FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(UNAUDITED)

 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Net (loss) income
 
$
(2,581,939
)
 
$
(3,232,399
)
 
$
12,256

 
$
(4,703,250
)
Other comprehensive (loss) income, net of taxes:
 
 

 
 

 
 

 
 

Foreign currency translation
 
(93,045
)
 
183,858

 
(124,023
)
 
45,388

Net unrealized gain on marketable securities
 
1,429

 
(3,900
)
 
6,105

 
(3,282
)
Net minimum pension liability
 
(5,733
)
 
(754
)
 
75

 
3,350

Total other comprehensive loss, net of taxes:
 
(97,349
)
 
179,204

 
(117,843
)
 
45,456

Total comprehensive loss
 
$
(2,679,288
)
 
$
(3,053,195
)
 
$
(105,587
)
 
$
(4,657,794
)
Less: Accrual of Series A redeemable convertible preferred stock dividends
 
190,786

 
186,904

 
568,476

 
560,712

Less: Accretion to redemption value of Series A redeemable convertible preferred stock
 
149,969

 
125,915

 
430,943

 
361,822

Total comprehensive loss attributable to common stockholders
 
$
(3,020,043
)
 
$
(3,366,014
)
 
$
(1,105,006
)
 
$
(5,580,328
)

See accompanying notes to unaudited condensed consolidated financial statements.


5



FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Cash flows from operating activities:
 
 
 
 
Net income (loss)
 
$
12,256

 
$
(4,703,250
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 

 
 

Depreciation and amortization
 
1,511,147

 
1,968,810

Share-based payment compensation
 
1,098,305

 
1,205,476

Non-cash professional services expenses
 
74,642

 
297

Gain on Estate litigation settlement
 

 
(5,293,319
)
Restructuring costs
 
172,995

 
832,149

Payment of restructuring costs
 
(469,247
)
 
(1,004,799
)
Loss on disposal of fixed assets
 
45,213

 

Benefit for returns and doubtful accounts
 
(20,004
)
 
(68,838
)
Deferred income tax provision (benefit)
 
41,208

 
(18,407
)
Changes in operating assets and liabilities:
 
 

 
 

Accounts receivable
 
3,837,502

 
3,976,230

Prepaid expenses and other current assets
 
(73,428
)
 
(188,627
)
Inventory
 
195,622

 
604,967

Other assets
 
15,978

 
210,587

Accounts payable
 
144,828

 
(160,432
)
Accrued expenses and other long-term liabilities
 
1,010,797

 
(1,733,806
)
Deferred revenue
 
(11,623,998
)
 
4,333,607

Net cash used in operating activities
 
(4,026,184
)
 
(39,355
)
Cash flows from investing activities:
 
 

 
 

Sales of marketable securities
 
11,116,000

 
31,901,030

Purchases of marketable securities
 
(10,916,401
)
 
(35,967,458
)
Purchases of property and equipment
 
(741,926
)
 
(688,579
)
Proceeds from sale of fixed assets
 
3,130

 

Capitalized software development costs
 
(14,100
)
 
(100,885
)
Security deposits
 
193,790

 
(44,247
)
Purchase of intangible assets
 
(177,826
)
 
(67,793
)
Net cash used in investing activities
 
(537,333
)
 
(4,967,932
)
Cash flows from financing activities:
 
 

 
 

Proceeds from exercise of stock options
 
59,242

 
24,684

Repurchase of common stock
 
(137,859
)
 

Dividends paid on Series A redeemable convertible preferred stock
 
(377,690
)
 
(590,187
)
Net cash used in financing activities
 
(456,307
)
 
(565,503
)
Effect of exchange rate changes on cash and cash equivalents
 
(370,688
)
 
(18,489
)
Net decrease in cash and cash equivalents
 
(5,390,512
)
 
(5,591,279
)
Cash and cash equivalents, beginning of period
 
10,873,891

 
19,288,340

Cash and cash equivalents, end of period
 
$
5,483,379

 
$
13,697,061

Supplemental disclosures:
 
 

 
 

Cash paid for income taxes, net
 
$
158,313

 
$
146,246

Non-cash financing activities:
 
 

 
 

Undistributed Series A redeemable convertible preferred stock dividends
 
$
377,690

 
$
186,904

The Company did not pay any interest for the nine months ended September 30, 2015 and 2014.
See accompanying notes to unaudited condensed consolidated financial statements.

6



FALCONSTOR SOFTWARE, INC. AND SUBSIDIARIES
Notes to Unaudited Condensed Consolidated Financial Statements 

(1) Basis of Presentation

(a)  The Company and Nature of Operations
 
FalconStor Software, Inc., a Delaware Corporation (the "Company"), is a leading software-defined storage 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)  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.
 
(c)  Use of Estimates
 
The preparation of financial statements in conformity with generally accepted accounting principles 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 to the Company’s significant accounting estimates discussed above.
 
(d)  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 accounting principles generally accepted in the United States of America 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, 2015, and the results of its operations for the three and nine months ended September 30, 2015 and 2014. 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, 2014 ("2014 Form 10-K").

(e)  Recently Issued Accounting Pronouncements

In November 2014, the Financial Accounting Standards Board (the "FASB") issued new guidance which requires an entity to determine whether the host contract in a hybrid financial instrument issued in the form of a share is more akin to debt or to equity by considering the economic characteristics and risks of the entire hybrid financial instrument, including the embedded derivative feature that is being evaluated for separate accounting from the host contract. The effects of initially adopting the amendments in this update should be applied on a modified retrospective basis to existing hybrid financial instruments issued in the form of a share as of the beginning of the fiscal year for which the amendments are effective. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, which for the Company will be the annual period ending December 31, 2016. 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 by the Company to have a significant impact on our financial results.


7



In August 2014, the FASB issued new guidance which requires an entity to evaluate whether there are conditions or events, in the aggregate, that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the financial statements are available to be issued when applicable), and to provide related footnote disclosures in certain circumstances. The new standard is effective for the annual period ending after December 15, 2016, and for annual and interim periods thereafter, which for the Company will be the annual period ending December 31, 2016. Early application is permitted. 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 our financial reporting or 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 Generally Accepted Accounting Principles in the United States when it becomes effective. The new standard is effective for the annual period ending after December 15, 2017, including interim reporting period within that period, which for the Company will be the annual period ending December 31, 2018. Early application as of January 1, 2017 is permitted. 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 not yet selected a transition method nor has it determined the effect of the standard on its financial reporting.
 
(2) Summary of Significant Accounting Policies

The Company's significant accounting policies were described in Note (1) "Summary of Significant Accounting Policies" of the 2014 Form 10-K. There have been no significant changes in the Company's significant accounting policies since December 31, 2014. The Company's revenue recognition accounting policy is included below. For a description of the Company's other significant accounting policies refer to the 2014 Form 10-K.

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 vendor-specific objective evidence (“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.


8



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 has 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 to 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. In 2013, the Company entered into a joint development agreement whereby final acceptance of the software delivered under the joint development agreement occurred on November 16, 2014. During 2014, the Company began to recognize the total committed fee as revenue ratably over a twenty-five and a half month period which began on November 16, 2014 which included a contractual twenty-four month maintenance period. During the first quarter of 2015, the customer elected to terminate its maintenance agreement and as such all unrecognized deferred revenue was accelerated and recognized as product revenue during the quarter. During the nine months ended September 30, 2015, the Company recorded total product revenue of approximately $11.3 million related to this agreement. There was no product revenue recorded during the three months ended September 30, 2015 related to this agreement. As of September 30, 2015, there is no deferred revenue or undelivered services remaining related to this agreement.
 
(3) Earnings Per Share

Basic 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, 2015 and 2014:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Stock options and restricted stock
 
7,948,021

 
8,453,854

 
7,948,021

 
8,453,854

Series A redeemable convertible preferred stock
 
8,781,516

 
8,781,516

 
8,781,516

 
8,781,516

Total anti-dilutive common stock equivalents
 
16,729,537

 
17,235,370

 
16,729,537

 
17,235,370



9



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,

 
2015
 
2014
 
2015
 
2014
Numerator
 
 
 
 
 
 
 
 
Net (loss) income
 
$
(2,581,939
)
 
$
(3,232,399
)
 
$
12,256

 
$
(4,703,250
)
Effects of Series A redeemable convertible preferred stock:
 
 

 
 

 
 

 
 

Less: Series A redeemable convertible preferred stock dividends
 
190,786

 
186,904

 
568,476

 
560,712

Less: Accretion to redemption value of Series A redeemable convertible preferred stock
 
149,969

 
125,915

 
430,943

 
361,822

Net loss attributable to common stockholders
 
$
(2,922,694
)
 
$
(3,545,218
)
 
$
(987,163
)
 
$
(5,625,784
)
Denominator
 
 

 
 

 
 

 
 

Weighted average basic shares outstanding
 
41,113,431

 
45,158,184

 
41,004,976

 
47,025,887

Effect of dilutive securities:
 
 

 
 

 
 

 
 

Stock options and restricted stock
 

 

 

 

Series A redeemable convertible preferred stock
 

 

 

 

Weighted average diluted shares outstanding
 
41,113,431

 
45,158,184

 
41,004,976

 
47,025,887

EPS
 
 

 
 

 
 

 
 

Basic net loss per share attributable to common stockholders
 
$
(0.07
)
 
$
(0.08
)
 
$
(0.02
)
 
$
(0.12
)
Diluted net loss per share attributable to common stockholders
 
$
(0.07
)
 
$
(0.08
)
 
$
(0.02
)
 
$
(0.12
)

(4) Inventories
 
At September 30, 2015 and December 31, 2014, inventories are as follows:
 
 
September 30, 2015
 
December 31, 2014
Finished systems
 
$
156,871

 
$
352,493

Total Inventory
 
$
156,871

 
$
352,493

 
As of September 30, 2015 and December 31, 2014, the Company has not recorded any reserve for excess and/or obsolete inventories in arriving at the estimated net realizable value of its inventory.
 
(5) Property and Equipment

The gross carrying amount and accumulated depreciation of property and equipment as of September 30, 2015 and December 31, 2014 are as follows:
 
 
September 30, 2015
 
December 31, 2014
Property and Equipment:
 
 
 
 
Gross carrying amount
 
$
19,489,978

 
$
19,015,099

Accumulated depreciation
 
(17,668,588
)
 
(16,867,911
)
Property and Equipment, net
 
$
1,821,390

 
$
2,147,188


For the three months ended September 30, 2015 and 2014, depreciation expense was $280,663 and $378,010, respectively. For the nine months ended September 30, 2015 and 2014, depreciation expense was $1,003,224 and $1,318,737, respectively.


10



During the three and nine months ended September 30, 2015, the Company wrote-off gross property and equipment of $53,511 and $191,936, respectively, and the associated accumulated depreciation of $19,374 and $144,614, respectively, related to assets that were no longer in use. During the three and nine months ended September 30, 2014, in connection with the Company's 2013 restructuring plan, the Company wrote-off gross property and equipment of $318,757 and $559,674, respectively, and the associated accumulated depreciation of $203,351 and $346,259, respectively, related to assets that were no longer in use as a result of the closure of a foreign facility. For further information, refer to Note (18) Restructuring Costs.

(6) Software Development Costs

The gross carrying amount and accumulated amortization of software development costs as of September 30, 2015 and December 31, 2014 are as follows:
 
 
September 30, 2015
 
December 31, 2014
Software development costs:
 
 
 
 
Gross carrying amount
 
$
2,917,215

 
$
2,903,115

Accumulated amortization
 
(1,788,662
)
 
(1,394,598
)
Software development costs, net
 
$
1,128,553

 
$
1,508,517


During the three months ended September 30, 2015 and 2014, the Company recorded $131,736 and $121,821, respectively, of amortization expense related to capitalized software costs. During the nine months ended September 30, 2015 and 2014, the Company recorded $394,064 and $345,945, respectively, of amortization expense related to capitalized software costs.

(7) Goodwill and Other Intangible Assets

The gross carrying amount and accumulated amortization of goodwill and other intangible assets as of September 30, 2015 and December 31, 2014 are as follows: 
 
 
September 30, 2015
 
December 31, 2014
Goodwill
 
$
4,150,339

 
$
4,150,339

Other intangible assets:
 
 

 
 

Gross carrying amount
 
$
3,572,850

 
$
3,395,024

Accumulated amortization
 
(3,312,846
)
 
(3,198,987
)
Net carrying amount
 
$
260,004

 
$
196,037


For the three months ended September 30, 2015 and 2014, amortization expense was $40,167 and $29,897, respectively. For the nine months ended September 30, 2015 and 2014, amortization expense was $113,859 and $90,713, respectively.

(8) Share-Based Payment Arrangements
 
The following table summarizes the plans under which the Company was able to grant equity compensation as of September 30, 2015
 
 
Shares
 
Shares Available
 
Shares
 
Last Date for Grant
Name of Plan
 
Authorized
 
for Grant
 
Outstanding
 
of Shares
FalconStor Software, Inc., 2006 Incentive Stock Plan
 
13,455,546
 
3,006,059
 
7,218,770
 
May 17, 2016
FalconStor Software, Inc., 2013 Outside Directors Equity Compensation Plan
 
400,000
 
210,000
 
137,200
 
May 9, 2016
 

11



On July 1, 2015, the total shares available for issuance under the FalconStor Software, Inc., 2006 Incentive Stock Plan (the “2006 Plan”) totaled 3,246,122. Pursuant to the 2006 Plan, as amended, if, on July 1st of any calendar year in which the 2006 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 2006 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 2006 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 2006 Plan in the aggregate exceed twenty million shares, subject to adjustment as provided in the 2006 Plan. On July 1, 2015, the total number of outstanding shares of the Company’s common stock totaled 40,920,192. Pursuant to the 2006 Plan, as amended, the total shares available for issuance under the 2006 Plan were not increased as of July 1, 2015.

The following table summarizes the Company’s equity plans that have expired but that still have equity awards outstanding as of September 30, 2015
Name of Plan
 
Shares Available for Grant
 
Shares Outstanding
 
 
 
 
 
FalconStor Software, Inc., 2000 Stock Option Plan
 
 
392,051
 
 
 
 
 
2004 Outside Directors Stock Option Plan
 
 
40,000
 
 
 
 
 
FalconStor Software, Inc., 2007 Outside Directors Equity Compensation Plan
 
 
160,000
 
The Company recognized 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, 2015 and 2014:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Cost of revenue - Product
 
$

 
$

 
$

 
$

Cost of revenue - Support and Service
 
26,653

 
20,563

 
80,357

 
74,900

Research and development costs
 
57,478

 
47,085

 
228,993

 
222,492

Selling and marketing
 
73,575

 
67,214

 
225,155

 
280,188

General and administrative
 
214,467

 
236,196

 
638,442

 
628,193

 
 
$
372,173

 
$
371,058

 
$
1,172,947

 
$
1,205,773

  
On July 28, 2015 the Company granted 500,000 shares of restricted stock to the President and Chief Executive Officer of the Company. The restricted shares have terms of ten years. The restrictions of the restricted stock lapse upon the Company's achievement of performance criteria related to the Company's Common Stock closing trading price. The fair value of the common stock price market condition was calculated using the Monte Carlo simulation model resulting in a weighted average fair value of $1.05 per share. Share-based compensation expense for the common stock price market condition is being recorded straight-line over the service period derived from the Monte Carlo simulation since the awards exercisability depends entirely on achieving a market condition. The explicit service period and the service period derived from the Monte Carlo simulation were the same for the grant.

(9) 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, 2015 and 2014, the Company recorded an income tax provision of $403,736 and $464,233, respectively, consisting primarily of state and local and foreign taxes. The effective tax rate for the nine months ended September 30, 2015 and September 30, 2014 was 97.1% and (11.0%), respectively. The change in the effective tax rate is attributable to the mix of foreign and domestic earnings as no tax expense or benefit is being recognized on domestic earnings or losses. As of September 30, 2015, 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 benefit for its expected net domestic deferred tax assets for the full year 2015 estimated annual effective tax rate. As of September 30, 2015, the valuation allowance totaled approximately $35.2 million.

12



 
The Company’s total unrecognized tax benefits, excluding interest, at both September 30, 2015 and December 31, 2014 were $224,637. At September 30, 2015, $326,436 of unrecognized tax benefits, including interest, if recognized, would reduce the Company’s effective tax rate. As of September 30, 2015 and December 31, 2014, the Company had $101,798 and $87,960, respectively, of accrued interest.
 
(10) Fair Value Measurements
 
The Company measures its cash equivalents, marketable securities 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, 2015 and December 31, 2014, 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, 2015 and December 31, 2014, the Level 2 category included government securities and corporate debt securities, which are included within cash and cash equivalents and marketable securities 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, 2015 and December 31, 2014, 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 or marketable securities categorized as Level 3 as of September 30, 2015 or December 31, 2014.

The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at September 30, 2015:
 
 
 
 
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
 
$
1,894,384

 
$
1,894,384

 
$

 
$

Corporate debt and government securities
 
549,915

 

 
549,915

 

Total cash equivalents
 
2,444,299

 
1,894,384

 
549,915

 

Marketable securities:
 
 

 
 

 
 

 
 

Corporate debt and government securities
 
10,582,030

 

 
10,582,030

 

Total marketable securities
 
10,582,030

 

 
10,582,030

 

Derivative liabilities:
 
 

 
 

 
 

 
 

Derivative Instruments
 
59,693

 

 

 
59,693

Total derivative liabilities
 
59,693

 

 

 
59,693

 
 
 
 
 
 
 
 
 
Total assets and liabilities measured at fair value
 
$
13,086,022

 
$
1,894,384

 
$
11,131,945

 
$
59,693



13



The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis at December 31, 2014
 
 
 
 
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
 
$
2,049,972

 
$
2,049,972

 
$

 
$

Total cash equivalents
 
2,049,972

 
2,049,972

 

 

Marketable securities:
 
 

 
 

 
 

 
 

Corporate debt and government securities
 
10,900,722

 

 
10,900,722

 

Total marketable securities
 
10,900,722

 

 
10,900,722

 

Derivative liabilities:
 
 
 
 
 
 
 
 
Derivative Instruments
 
137,171

 

 

 
137,171

Total derivative liabilities
 
137,171

 

 

 
137,171

 
 
 
 
 
 
 
 
 
Total assets and liabilities measured at fair value
 
$
13,087,865

 
$
2,049,972

 
$
10,900,722

 
$
137,171

 
The fair value of the Company’s investments in corporate debt and government securities have been determined utilizing third party pricing services and reviewed by the Company. The pricing services use inputs to determine fair value which are derived from observable market sources including reportable trades, benchmark curves, credit spreads, broker/dealer quotes, bids, offers, and other industry and economic events. These investments are included in Level 2 of the fair value hierarchy.

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, 2015 and September 30, 2014:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Beginning Balance
 
$
100,561

 
$
111,470

 
$
137,171

 
$
159,134

Total (gain) loss recognized in earnings
 
(40,868
)
 
66,727

 
(77,478
)
 
19,063

Ending Balance
 
$
59,693

 
$
178,197

 
$
59,693

 
$
178,197



14



(11) Marketable Securities
 
The Company’s marketable securities consist of available-for-sale securities, which are carried at fair value, with unrealized gains and losses reported as a separate component of stockholders’ equity. Unrealized gains and losses are computed on the specific identification method. Realized gains, realized losses and declines in value judged to be other-than-temporary, are included in interest and other income (loss), net. The cost of available-for-sale securities sold is based on the specific identification method and interest earned is included in interest and other income.
 
The cost and fair values of the Company’s available-for-sale marketable securities as of September 30, 2015, are as follows: 
 
 
Aggregate
Fair Value
 
Cost or Amortized
Cost
 
Net Unrealized
Gains/(losses)
Government securities
 
$
8,100,285

 
$
8,095,408

 
$
4,877

Corporate debt securities
 
2,481,745

 
2,481,925

 
(180
)
Marketable Securities
 
$
10,582,030

 
$
10,577,333

 
$
4,697


The cost and fair values of the Company’s available-for-sale marketable securities as of December 31, 2014, are as follows: 
 
 
Aggregate
Fair Value
 
Cost or Amortized
Cost
 
Net Unrealized
Losses
Government securities
 
$
6,740,825

 
$
6,741,466

 
$
(641
)
Corporate debt securities
 
4,159,897

 
4,160,664

 
(767
)
Marketable Securities
 
$
10,900,722

 
$
10,902,130

 
$
(1,408
)
 
(12) 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. The expiration dates for these leases range from 2015 through 2017. The following is a schedule of future minimum lease payments for all operating leases as of September 30, 2015
2015
$
575,858

2016
1,919,397

2017
1,572,262

2018
1,361,341

2019
1,402,181

Thereafter
1,935,267

 
$
8,766,306


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, 2015, the Company has not incurred any costs related to warranty obligations.
 
Under the terms of substantially all of its software license agreements, the Company has agreed to indemnify 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.
 

15



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. 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. As of September 30, 2015, there were no triggering events that would allow the Series A redeemable convertible preferred stockholders to require the Company to redeem any of the Series A redeemable convertible preferred stock and the Company does not expect to incur any triggering events in fiscal 2015. As of September 30, 2015, the Company did not fail any financial or non-financial covenants related to the Company's Series A redeemable convertible preferred stock, though the Company did not meet certain required targets for the three months ended September 30, 2015. If the Company does not meet these required targets for the fourth quarter of 2015, the Company will not be in compliance with the financial covenants of the Series A redeemable convertible preferred stock. In such event, the Company would attempt to remedy the failed covenants and obtain waivers from the holders of the Series A redeemable convertible preferred stock. As described under Note (13) Series A Redeemable Convertible Preferred Stock, the Company obtained a waiver on April 20, 2015 to enable it to pay the required quarterly dividends on the Series A redeemable convertible preferred stock in cash for the fourth quarter of 2014 and the first quarter of 2015. The fourth quarter of 2014 and the first quarter of 2015 dividends were paid in cash in April 2015. In addition, as described below, the Company accrued its dividend payments for the required quarterly dividends on the Series A redeemable convertible preferred stock for the second and third quarters of 2015.

On July 24, 2015, the Company renewed its Employment Agreement (“Quinn Employment Agreement”) with Gary Quinn. Pursuant to the Quinn Employment Agreement, the Company agreed to continue to employ Mr. Quinn as President and Chief Executive Officer of the Company effective July 24, 2015, at an annual salary of $475,000 per annum, which will automatically renew every twelve (12) months unless either party gives notice to the other that it will not renew at least sixty (60) days prior to the end of the term. Among other items, The Quinn Employment Agreement also provided for the grant of 500,000 restricted shares which vest 50% and 50% based upon the achievement of two predetermined milestones of the Company’s Common Stock closing trading price for ninety (90) consecutive trading days. The 500,000 restricted shares were granted to Mr. Quinn by the Company’s Compensation Committee on July 28, 2015.

On July 23, 2013, the Company entered into an Employment Agreement (“2013 Quinn Employment Agreement”) with Gary Quinn. The 2013 Quinn Employment Agreement provided for the grant of 500,000 restricted shares which vested over a two-year period at 50% and 50% annually. On July 23, 2015, the final 250,000 restricted shares vested.

From time to time, the Company has undertaken restructuring and expense control measures to support its business performance and to align the Company’s cost structure with its resources. 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 expects 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, 2015 the restructuring accrual totaled $0.7 million. 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, 2015, our liability for uncertain tax positions totaled $326,436. At this time, the settlement period for the positions, including related accrued interest, cannot be determined.
 
(13) 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.
 

16



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 sale able by the redeemable convertible preferred stockholders, the Company can convert the 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 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.
 
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. 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 holders 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 holders 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 holders of the Series A redeemable convertible preferred stock control of the Company. As of September 30, 2015, there were no triggering events that would allow the Series A redeemable convertible preferred stockholders to require the Company to redeem any of the Series A redeemable convertible preferred stock and the Company does not expect to incur any triggering events in fiscal 2015. As of September 30, 2015, the Company did not fail any financial or non-financial covenants related to the Company's Series A redeemable convertible preferred stock, though the Company did not meet certain required targets for the three months ended September 30, 2015. If the Company does not meet these required targets for the fourth quarter of 2015, the Company will not be in compliance with the financial covenants of the Series A redeemable convertible preferred stock. In such event, the Company would attempt to remedy the failed covenants and obtain waivers from the holders of the Series A redeemable convertible preferred stock. As described below, the Company obtained a waiver on April 20, 2015 to enable it to pay the required quarterly dividends on the Series A redeemable convertible preferred stock in cash for the fourth quarter of 2014 and the first quarter of 2015 and accrued its dividend payments for the required quarterly dividends on the Series A redeemable convertible preferred stock for the second and third quarters of 2015.

Holders of the Series A redeemable convertible preferred stock are 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, 2014, due to the lack of sufficient surplus to pay dividends as required by the Delaware General Business Corporation Law, the Company was not permitted to pay the fourth quarter dividend in cash and accrued its fourth quarter 2014 dividend. As of March 31, 2015, the Company had sufficient surplus to pay dividends as required by the Delaware General Business Corporation law; however, the Company was not in compliance with the positive cash flow requirement to pay dividends in cash which would have required the Company to pay these dividends in kind through additional shares of this Series A redeemable convertible preferred stock. As a result, on April 20, 2015, the Company obtained a waiver from the holders to allow the Company to pay the fourth quarter 2014 and first quarter 2015 quarterly dividends in cash. These dividends were paid in cash in April 2015. As of June 30, 2015 and September 30, 2015, due to the lack of sufficient surplus to pay dividends as required by the Delaware General Business Corporation Law, the Company was not permitted to pay the second and third quarter dividends in cash and accrued its second and third quarter dividends.


17



Each share of Series A redeemable convertible preferred stock has a vote equal to the number of shares of common stock into which the 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, holders of a majority 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; 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 were bifurcated from the Series A redeemable convertible preferred stock and recorded as a liability. As of September 30, 2015 and December 31, 2014, the fair value of these derivative instruments was $59,693 and $137,171, respectively. The (gain) loss on the change in fair values of these derivative instruments for the three months ended September 30, 2015 and 2014, of ($40,868) and $66,727, respectively, and for the nine months ended September 30, 2015 and 2014, of ($77,478) and $19,063, respectively, was included in “Interest and other income (loss), net” within the consolidated statement of operations.
  
At the time of issuance the Company recorded transaction costs of $268,323, the beneficial conversion feature of $2.0 million and fair value allocated to the embedded derivatives of $170,337. These amounts were recorded as discounts to the Series A redeemable convertible preferred stock and are 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. The Company included deductions of $149,969 and $125,915 for the three months ended September 30, 2015 and 2014, respectively, and $430,943 and $361,822 for the nine months ended September 30, 2015 and 2014, respectively, as accretion adjustments to net loss attributable to common stockholders on the statement of operations and in determining loss per share for each period. The Company also included deductions of $190,786 and $186,904 for the three months ended September 30, 2015 and 2014, respectively, and $568,476 and $560,712 for the nine months ended September 30, 2015 and 2014, respectively, as adjustments to net loss attributable to common shareholders on the statement of operations and in determining loss per share for each period for accrued dividends on the Series A redeemable convertible preferred stock during the period. The fourth quarter of 2014 and the first quarter of 2015 dividends were paid in cash in April 2015 and the second and third quarters of 2015 dividends were accrued.

(14) Accumulated Other Comprehensive Loss 

The changes in Accumulated Other Comprehensive (Loss) Income, net of tax, for the three months ended September 30, 2015 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, 2015
 
$
(1,567,473
)
 
$
3,268

 
$
32,421

 
$
(1,531,784
)
Other comprehensive (loss) income
 
 

 
 

 
 

 
 

Other comprehensive (loss) income before reclassifications
 
(93,045
)
 
1,511

 
(7,348
)
 
(98,882
)
Amounts reclassified from accumulated other comprehensive (loss) income
 

 
(82
)
 
1,615

 
1,533

Total other comprehensive (loss) income
 
(93,045
)
 
1,429

 
(5,733
)
 
(97,349
)
Accumulated other comprehensive (loss) income at September 30, 2015
 
$
(1,660,518
)
 
$
4,697

 
$
26,688

 
$
(1,629,133
)

18




The changes in Accumulated Other Comprehensive (Loss) Income, net of tax, for the nine months ended September 30, 2015 are as follows:
 
 
Foreign Currency
Translation
 
Net Unrealized
Gains (Losses) on Marketable
Securities
 
Net Minimum
Pension Liability
 
Total
Accumulated other comprehensive (loss) income at December 31, 2014
 
$
(1,536,495
)
 
$
(1,408
)
 
$
26,613

 
$
(1,511,290
)
Other comprehensive (loss) income
 
 

 
 

 
 

 
 

Other comprehensive (loss) income before reclassifications
 
(124,023
)
 
6,536

 
(4,898
)
 
(122,385
)
Amounts reclassified from accumulated other comprehensive (loss) income
 

 
(431
)
 
4,973

 
4,542

Total other comprehensive (loss) income
 
(124,023
)
 
6,105

 
75

 
(117,843
)
Accumulated other comprehensive (loss) income at September 30, 2015
 
$
(1,660,518
)
 
$
4,697

 
$
26,688

 
$
(1,629,133
)

The changes in Accumulated Other Comprehensive (Loss) Income, net of tax, for the three months ended September 30, 2014 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, 2014
 
$
(1,832,375
)
 
$
4,028

 
$
(67,788
)
 
$
(1,896,135
)
Other comprehensive (loss) income
 
 

 
 

 
 

 
 

Other comprehensive (loss) income before reclassifications
 
183,858

 
(3,900
)
 
(3,986
)
 
175,972

Amounts reclassified from accumulated other comprehensive (loss) income
 

 

 
3,232

 
3,232

Total other comprehensive (loss) income
 
183,858

 
(3,900
)
 
(754
)
 
179,204

Accumulated other comprehensive (loss) income at September 30, 2014
 
$
(1,648,517
)
 
$
128

 
$
(68,542
)
 
$
(1,716,931
)
 
The changes in Accumulated Other Comprehensive (Loss) Income, net of tax, for the nine months ended September 30, 2014 are as follows:
 
 
Foreign Currency
Translation
 
Net Unrealized
Gains (Losses) on Marketable
Securities
 
Net Minimum
Pension Liability
 
Total
Accumulated other comprehensive (loss) income at December 31, 2013
 
$
(1,693,905
)
 
$
3,410

 
$
(71,892
)
 
$
(1,762,387
)
Other comprehensive (loss) income
 
 

 
 

 
 

 
 

Other comprehensive (loss) income before reclassifications
 
45,388

 
(3,282
)
 
(6,303
)
 
35,803

Amounts reclassified from accumulated other comprehensive (loss) income
 

 

 
9,653

 
9,653

Total other comprehensive (loss) income
 
45,388

 
(3,282
)
 
3,350

 
45,456

Accumulated other comprehensive (loss) income at September 30, 2014
 
$
(1,648,517
)
 
$
128

 
$
(68,542
)
 
$
(1,716,931
)


19



For the three and nine months ended September 30, 2015 and 2014, the amounts reclassified to net loss related to the Company’s defined benefit plan and sale of marketable securities. These amounts are included within “Operating (loss) income” within the condensed consolidated statements of operations.
 
(15) 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 months ended September 30, 2015, the Company did not repurchase any shares of its common stock. During the nine months ended September 30, 2015, the Company repurchased 92,161 shares of its common stock at an aggregate purchase price of $137,859 or $1.50 per share. During the three and nine months ended September 30, 2014, the Company did not repurchase any shares of its common stock. As of September 30, 2015, the Company had the authorization to repurchase 4,907,839 shares of its common stock based upon its judgment and market conditions.

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 will be issued based on certain milestone achievements and/or transactions over a twenty-four month period. The issuance of the restricted Company common stock will be made pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended, and the rules promulgated there under.

(16)  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.

Stockholder Litigation
 
Company stockholders filed actions in the Suffolk County Division of the Supreme Court of the State of New York, putatively derivatively on behalf of the Company, against the Company, each of the Company’s Directors, Mr. Weber, the former Chief Financial Officer and Vice President of Operations of the Company, Wayne Lam, a former Vice president of the Company, the estate of Mr. Huai, the former Chairman, President and Chief Executive Officer of the Company, and Jason Lin, a former employee of the Company (the “Derivative Action”). The consolidated amended Derivative Action complaint alleged that the defendants breached their duties to the Company by: (1) causing or allowing the dissemination of false and misleading information; (2) failing to maintain internal controls; (3) failing to manage the Company properly; (4) unjustly enriching themselves; (5) abusing their control of the Company; and (6) wasting Company assets.


20



On March 5, 2013, the Suffolk County Division of the Supreme Court of the State of New York granted a motion made by all of the defendants in the Derivative Action, except Mr. Lin, and dismissed the Derivative Action as to all defendants other than Mr. Lin. The stockholders appealed the dismissal of the Derivative Action and on March 18, 2015, the Appellate Division, Second Department unanimously affirmed the New York Supreme Court’s decision dismissing the Derivative Action. The Plaintiffs have not timely sought leave to appeal the Appellate Division’s decision to the New York Court of Appeals, and thus the Company believes this matter has been finally resolved.

 The Company has insurance policies that were purchased to cover, among other things, lawsuits like the Derivative Action and a class action lawsuit that has been settled by the Company (the "Class Action"). The Company’s Directors and Officers (“D&O”) Insurance, is composed of more than one layer, with each layer written by a different insurance company. However, the events that gave rise to the claims in the Derivative Action and the Class Action caused the Company’s insurers to reserve their rights to disclaim, rescind, or otherwise not be obligated to provide coverage to the Company and certain other insureds under the policies. In light of these uncertainties, the Company entered into settlements with two of its insurers. Pursuant to these settlements, the Company will not receive repayment of all amounts it might otherwise have received.
 
Since October 1, 2012, the Company has recorded $7.3 million of total costs associated with the Class Action and the Derivative Actions. As a result of the agreement reached with the insurer carriers of the Company’s D&O insurance, the Company recorded insurance recoveries of $5.7 million since October 1, 2012 of which $5.7 million have been reimbursed by the Company's insurance carriers as of September 30, 2015.

 During the three months ended September 30, 2015, the Company did not record any expense and for the nine months ended September 30, 2015 the Company recorded expense of $8,842, of investigation, litigation and settlement related legal costs, net of expected recoveries, related to expenses related to the Class Action and Derivative Action lawsuits and other settlement related activities that are not recoverable through insurance. During the three and nine months ended September 30, 2014, the Company recorded benefits of $22,502 and $5.2 million, respectively, of investigation, litigation and settlement related legal costs, net of expected recoveries, related to expenses related to the Class Action and Derivative Action lawsuits, the Estate settlement and other settlement related activities that are not recoverable through insurance.

 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.
 
The Company continues to assess certain litigation and claims to determine the amounts, if any, that the Company believes may be paid as a result of such claims and litigation and, therefore, additional losses may be accrued and paid in the future, which could materially adversely impact the Company’s financial results, its cash flows and its cash reserves.
 
(17) Segment Reporting
 
The Company is organized in a single operating segment for purposes of making operating decisions and assessing performance. Revenues from the United States to customers in the following geographical areas for the three and nine months ended September 30, 2015 and 2014, and the location of long-lived assets as of September 30, 2015 and December 31, 2014, are summarized as follows:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,

 
2015
 
2014
 
2015
 
2014
Revenue:
 
 
 
 
 
 
 
 
Americas
 
$
2,980,427

 
$
3,814,197

 
$
20,613,518

 
$
12,693,541

Asia Pacific
 
3,441,168

 
3,537,043

 
9,547,455

 
10,676,928

Europe, Middle East, Africa and Other
 
3,261,631

 
3,824,200

 
9,014,718

 
11,109,137

Total Revenue
 
$
9,683,226

 
$
11,175,440

 
$
39,175,691

 
$
34,479,606

 


21



 
 
September 30, 2015
 
December 31, 2014
Long-lived assets:
 
 
 
 
Americas
 
$
7,717,111

 
$
8,327,602

Asia Pacific
 
600,267

 
822,277

Europe, Middle East, Africa and Other
 
205,128

 
233,669

Total long-lived assets
 
$
8,522,506

 
$
9,383,548

 
For the three months ended September 30, 2015, the Company had one customer that accounted for 15% of total revenue. For the three months ended September 30, 2014, the Company did not have any customers that accounted for 10% or more of total revenue.  As of September 30, 2015, the Company had two customers that accounted for 10% or more of the gross accounts receivable balance. As of December 31, 2014, the Company had one customer that accounted for 11% of the gross accounts receivable balance.

(18) Restructuring Costs
 
From time to time, the Company has undertaken restructuring and expense control measures to support its business performance and to align the Company’s cost structure with its resources. 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 expects 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 related to restructuring liabilities recorded in connection with the Company's 2013 Plan:
 
 
Severance related costs
 
Facility and other costs
 
Total
Original charge
 
$
3,179,131

 
$
426,889

 
$
3,606,020

Utilized/Paid
 
(2,067,554
)
 
(231,973
)
 
(2,299,527
)
Balance at December 31, 2013
 
$
1,111,577

 
$
194,916

 
$
1,306,493

Provisions/Additions
 
365,174

 
770,136

 
1,135,310

Utilized/Paid
 
(653,325
)
 
(759,563
)
 
(1,412,888
)
Balance at December 31, 2014
 
$
823,426

 
$
205,489

 
$
1,028,915

Provisions/Additions
 
58,755

 
75,721

 
134,476

Utilized/Paid
 
(33,688
)
 
(147,967
)
 
(181,655
)
Balance at March 31, 2015
 
$
848,493

 
$
133,243

 
$
981,736

Provisions/Additions
 
(3,228
)
 
26,723

 
23,495

Utilized/Paid
 
(102,159
)
 
(139,054
)
 
(241,213
)
Balance at June 30, 2015
 
$
743,106

 
$
20,912

 
$
764,018

Provisions/Additions
 

 
15,024

 
15,024

Utilized/Paid
 
(25,466
)
 
(20,913
)
 
(46,379
)
Balance at September 30, 2015
 
$
717,640

 
$
15,023

 
$
732,663

 
  
The severance related liabilities and facility and other liabilities are included within “accrued expenses” and "accounts payable" 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.


22



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
 
2015 continues to be a year of innovation and introduction of new product offerings to our customers. During the third quarter, we announced that we acquired an exclusive source code and distribution license from Cumulus Logic for a next-generation intelligent cloud-based predictive analytics monitoring system for FreeStor®. The exclusive source code license will provide the FreeStor product with core intelligence to the Software Defined Data Center - Intelligent Abstraction® and Intelligent Predictive Analytics that work in real-time for visualization, analysis and action as well as “smart rules” based tools for performance monitoring, capacity planning, and other insights to maximize storage resources - which many hardware vendors lack - the cloud-based engine will also enable secure multi-tenancy for service providers that manage their customers’ data and infrastructure, and support private cloud infrastructures.

During the second quarter of 2015, we released for general availability, FreeStor, a horizontal software-defined storage platform inclusive of converged data services which are an agnostic solution to any server hardware or storage hardware manufacturer. FreeStor addresses heterogeneous storage portfolios, all-flash array and hybrid flash array hardware manufacturers which do not have a software stack or do not have an enterprise-ready software stack, and solutions for managed service providers. FreeStor provides management, monitoring, reporting and provisioning through a web browser, tablet or smartphone which gives end-users or storage administrators the ability to be completely mobile when managing their virtual storage portfolio. Additionally, during the first quarter of 2015, we announced the general availability of our Continuous Data Protection (“CDP") and Network Storage Server (“NSS”) version 8.0. CDP/NSS v. 8.0 includes re-architecting the IPStor™ core engine, IO paths, HA logic, a new IP Cluster engine, and overall data management and change tracking. This redesign was done in part to support the efforts of our previous joint-development agreement, as well as to create the framework for our next generation platform, FreeStor.

As we stated since the beginning of 2015, one of the key indicators of the initial success of our new product offerings will be our ability to secure new OEM all-flash array manufacturers, managed service providers and finally enterprise-class customers by the end of 2015. During the first half of 2015, we added six new OEM all-flash array manufacturers and four new service providers who are implementing our FreeStor technology into their services portfolios. During the third quarter of 2015, we added one enterprise-class customer and two service providers who will be implementing FreeStor into their service portfolios. Generally, the new OEM partners have contractual annual minimum revenue commitments associated with their agreements.

2015 is the second full year whereby we offer more flexibility in licensing and payment structures, and as a result the product revenue for some transactions are being recognized ratably over the contractual maintenance term. We expect to continue this flexibility going forward, and also expect that the number of transactions with flexible sales terms will increase over time, which could result in variable periods for recognizing the revenue. Furthermore, our new FreeStor platform is sold on a subscription based offering with ratable revenue recognition recorded over the term of the subscription. Our support and maintenance revenue has always been recognized ratably over the term of the support and maintenance agreement and this will not change. Our professional services revenue will continue to be recognized upon delivery of the professional services unless it is sold as part of a bundled arrangement for which we have not established fair value for all undelivered elements which would require the revenue from the entire arrangement be recognized over the longest service term which would be the maintenance term.

One consequence of offering the flexibility in licensing, payment structures and subscription based offerings, which result in ratable revenue recognition, is that our GAAP revenue number will likely show greater fluctuations on a quarterly basis. Some transactions that would have been recognized into revenue in one quarter, will now be recognized over a longer period of time. For this reason, we look to our quarterly and our annual bookings, rather than to our quarterly and our annual revenue numbers, to gauge our progress.

We believe that the flexibility in licensing, payment structures and subscription based offerings has made and will continue to make us more competitive in the marketplace by allowing us more flexibility to work with end users to design licensing and payment terms that meet their needs.

23




For the third quarter of 2015, total revenue was $9.7 million, compared with $11.2 million in the third quarter of 2014. Bookings for the third quarter of 2015 totaled $8.8 million, compared with $8.9 million in the third quarter of 2014 and $8.3 million in the second quarter of 2015. Additionally, revenue was negatively impacted by foreign currency fluctuations of approximately 12%-15% as compared with the three months ended September 30, 2014.

Product revenue from our OEM partners remained consistent quarter over quarter. The decline in product revenue from our non-OEM partners of $0.1 million was primarily due to the pause in customer purchasing habits related to our legacy product offerings in anticipation of our new product refresh and FreeStor platform. During the third quarter of 2015, Hitachi Data Systems accounted for 15% of our total revenue.

Excluding the impact of our joint-development agreement, deferred revenue as of September 30, 2015 totaled $24.8 million, an increase of 5% compared with September 30, 2014, and a decrease of 2% compared with December 31, 2014.

Support and services revenue decreased 18% from $7.2 million for the three months ended September 30, 2014 to $5.9 million for the three months ended September 30, 2015. The decline was due primarily from the softness in our legacy product portfolio sales over the past twelve months prior to the release of new product offerings during the first nine months of 2015, and the continued wind-down in maintenance revenue from certain legacy OEM partners.

Overall, our operating expenses decreased 13% or $1.4 million to $9.7 million for the three months ended September 30, 2015 from $11.1 million in the same period in 2014. Net loss for the three months ended September 30, 2015 was $2.6 million, compared with $3.2 million for the three months ended September 30, 2014.

RESULTS OF OPERATIONS – FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2015 COMPARED WITH THE THREE MONTHS ENDED SEPTEMBER 30, 2014.
 
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. Product revenue consists of both integrated solutions and stand-alone software revenues. Support and services revenue consists of both maintenance revenue and professional services revenue.
 
Total revenue for the three months ended September 30, 2015 decreased 13% to $9.7 million, compared with $11.2 million for the three months ended September 30, 2014. Our cost of revenue decreased 6% to $2.4 million for the three months ended September 30, 2015, compared with $2.6 million for the three months ended September 30, 2014. Included in the operating results for the three months ended September 30, 2015 and 2014 were; (i) $0.4 million of share-based compensation expense in both periods; and (ii) less than $0.1 million and $0.3 million, respectively, of restructuring costs. Net loss for the three months ended September 30, 2015 was $2.6 million, compared with $3.2 million for the three months ended September 30, 2014. Net loss attributable to common stockholders, which includes the effects of Series A redeemable convertible preferred stock dividends (including accrued dividends) and accretion of the discounts related to the issuance of the Series A redeemable convertible preferred stock, was $2.9 million for the three months ended September 30, 2015, compared with $3.5 million for the three months ended September 30, 2014.

Overall, our total operating expenses decreased $1.4 million, or 13%, to $9.7 million for the three months ended September 30, 2015, compared with $11.1 million for the same period in 2014. This decrease was primarily attributable to our tighter expense controls and overall operational efficiencies which better align our current business plan on a run-rate basis. These efficiencies include among other items, a stream-lined personnel related costs, global overhead costs and efficiencies realized on our redesigned go-to-market coverage models. In addition, the decrease is attributable to a decrease in professional fees primarily related to an investment made in 2014 to penetrate certain market verticals under a one-year arrangement, which ended at March 31, 2015. Our worldwide headcount was 237 employees as of September 30, 2015, compared with 273 employees as of September 30, 2014. We will continue to evaluate the appropriate headcount levels to properly align our resources with our current and long-term outlook and to take actions in areas of the Company that are not performing.


24



Revenue 
 
 
Three Months Ended September 30,
 
 
2015
 
2014
Revenue:
 
 
 
 
Product revenue
 
$
3,756,579

 
$
3,940,479

Support and services revenue
 
5,926,647

 
7,234,961

Total Revenue
 
$
9,683,226

 
$
11,175,440

Year-over-year percentage change
 
 

 
 

Product revenue
 
(5)%
 
(40)%
Support and services revenue
 
(18)%
 
(11)%
Total percentage change
 
(13)%
 
(24)%

Product revenue
 
Product revenue is comprised of sales of both licenses for our software solutions and sales of the platforms on which the software is installed. This includes stand-alone software applications and software integrated with industry standard hardware, sold as one complete integrated solution or sold on a subscription or consumption basis. The products are sold through our OEMs, and through (i) value-added resellers, (ii) distributors, and/or (iii) directly to end-users (collectively “non-OEMs”). These revenues are recognized when all the applicable criteria under Generally Accepted Accounting Principles in the United States are met. Product revenue decreased 5% from $3.9 million for the three months ended September 30, 2014, to $3.8 million for the three months ended September 30, 2015. These amounts are net of a sales return benefit of less than $0.1 million recognized during the three months ended September 30, 2015 and 2014, resulting from the impact of our collection efforts of previously reserved accounts receivable. Product revenue represented 39% and 35% of our total revenue for the three months ended September 30, 2015 and 2014, respectively.

Product revenue from our OEM partners remained consistent, while product revenue from our non-OEM partners decreased $0.1 million for the three months ended September 30, 2015, compared with the same period in 2014. The decline in product revenue from our non-OEM channel was primarily due to, (i) a decrease in the volume of sales from our legacy product line(s) as partners and customers evaluate and plan for the transition to our re-architectured version 8.0 suite of products and the recently released FreeStor platform, (ii) challenges in obtaining new customer acquisitions, and (iii) the mix of deals where revenue is recognized ratably over the term of the associated maintenance agreement, rather than upon transaction completion and product delivery. Product revenue from our non-OEM partners represented 83% of our total product revenue for both the three months ended September 30, 2015 and 2014. Product revenue from our OEM partners represented 17% of our total product revenue for both the three months ended September 30, 2015 and 2014.

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

Support and services revenue

Support and services revenue is comprised of revenue from (i) maintenance and technical support services, (ii) professional services primarily related to the implementation of our software, and (iii) engineering services. Revenue derived from maintenance and technical support contracts are deferred and recognized ratably over the contractual maintenance term. Professional services revenue is recognized in the period that the related services are performed or over the contractual term if VSOE does not exist for all undelivered elements. Engineering services are recognized upon customer acceptance or over the remaining contract term if VSOE does not exist for the remaining deliverables upon acceptance. Support and services revenue decreased 18% from $7.2 million for the three months ended September 30, 2014 to $5.9 million for the three months ended September 30, 2015. The decrease in support and services revenue was attributable to a decrease in maintenance and technical support services revenue.


25



Maintenance and technical support services revenue decreased from $6.9 million for the three months ended September 30, 2014 to $5.7 million for the three months ended September 30, 2015. 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. During the three months ended September 30, 2015, the decline in maintenance and technical support services revenue was primarily attributable to a decrease of $1.2 million in maintenance revenue from our non-OEM partners primarily driven by the softness in our legacy product portfolio sales over the past twelve months prior to the release of our new product offerings during the first half of 2015 and the continued wind-down in maintenance revenue from certain legacy OEM partners which decreased $0.1 million.
 
Professional services revenue decreased less than $0.1 million, to $0.2 million for the three months ended September 30, 2015, compared with $0.3 million for the same period in 2014. Professional services revenue varies 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
 
 
Three Months Ended September 30,
 
 
2015
 
2014
Cost of revenue:
 
 
 
 
Product
 
$
510,861

 
$
834,628

Support and service
 
1,915,090

 
1,757,716

Total cost of revenue
 
$
2,425,951

 
$
2,592,344

Total Gross Profit
 
$
7,257,275

 
$
8,583,096

Gross Margin:
 
 

 
 

Product
 
86%
 
79%
Support and service
 
68%
 
76%
Total gross margin
 
75%
 
77%

 Cost of revenue, gross profit and gross margin
 
Cost of product revenue consists primarily of industry standard hardware we purchase and integrate with our software for turn-key integrated solutions, personnel costs, amortization of capitalized software and shipping and logistics costs. 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 product revenue for the three months ended September 30, 2015 decreased $0.3 million, or 39%, to $0.5 million, compared with $0.8 million for the same period in 2014. Product gross margin increased to 86% for the three months ended September 30, 2015, compared with 79% for the same period in 2014. The increase in product gross margin was primarily attributable to an increase in the percentage of our product revenue from sales of our stand-alone software applications, which have higher gross margins than sales of our fully integrated solutions with hardware appliances, compared with the same period in 2014. Our cost of support and service revenue for the three months ended September 30, 2015 increased $0.2 million, or 9%, to $1.9 million, compared with $1.7 million for the same period in 2014. Support and service gross margin decreased to 68% for the three months ended September 30, 2015 from 76% for the same period in 2014. The decrease in support and service gross margin was primarily attributable to the decrease in our support and services revenues.
 
Total gross profit decreased $1.3 million, or 15%, to $7.3 million for the three months ended September 30, 2015 from $8.6 million for the same period in 2014. Total gross margin decreased to 75% for the three months ended September 30, 2015, from 77% for the same period in 2014. The decrease in our total gross margin was primarily due to the decrease in revenue and the mix of sales. 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.


26



Operating Expenses
 
Research and Development Costs
 
Research and development costs consist primarily of personnel costs for product development, share-based compensation expense, and other related costs associated with the development of new products, enhancements to existing products, quality assurance and testing. Research and development costs increased $0.5 million, or 15%, to $3.5 million for the three months ended September 30, 2015, from $3.0 million in the same period in 2014. The increase in research and development costs was primarily related to cost associated with our exclusive source code license and distribution agreement we entered into during the quarter as we continue to re-invest in research and development by adding new and innovative functionalities to our product portfolio, which totaled approximately $0.8 million. We expect to continue to incur additional costs associated with our exclusive source code license and distribution agreement over the next twelve months as part of our investment strategy. This increase was partly offset by a decrease in personnel related costs during the third quarter of 2015 as compared with the same period in 2014, as a result of the on-going new product development that was performed throughout 2014. We believe we continue to provide adequate levels of 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. Share-based compensation expense included in research and development costs was $0.1 million for each of the three months ended September 30, 2015 and September 30, 2014.
 
Selling and Marketing
 
Selling and marketing expenses consist primarily of sales and marketing personnel and related costs, share-based compensation expense, travel, public relations expense, marketing literature and promotions, commissions, trade show expenses, and the costs associated with our foreign sales offices. Selling and marketing expenses decreased $1.6 million, or 29%, to $4.1 million for the three months ended September 30, 2015, from $5.8 million for the same period in 2014. The decrease in selling and marketing expenses was primarily attributable to a decrease in personnel related costs as well as a decrease in our sales and marketing headcount as we continue to define our optimized go-to-market coverage models around the world. In addition, the decrease is attributable to a decrease in professional fees of $0.8 million primarily related to an investment made in 2014 to penetrate certain market verticals under a one-year arrangement, which ended at March 31, 2015. Share-based compensation expense included in selling and marketing was $0.1 million for each of the three months ended September 30, 2015 and September 30, 2014.
 
General and Administrative
 
General and administrative expenses consist primarily of personnel costs of general and administrative functions, share-based compensation expense, public company related costs, directors’ and officers’ insurance, legal and professional fees, bad debt expense, and other general corporate overhead costs. General and administrative expenses remained flat at $2.1 million for both the three months ended September 30, 2015 and 2014. Share-based compensation expense included in general and administrative expenses was $0.2 million for each of the three months ended September 30, 2015 and September 30, 2014.

Investigation, Litigation and Settlement Related Costs
 
During the three months ended September 30, 2015, we did not incur any investigation, litigation, and settlement related costs. During the three months ended September 30, 2014, our investigation, litigation, and settlement related costs totaled a benefit of less than $0.1 million. For further information, refer to Note (16) Litigation, to our unaudited condensed consolidated financial statements.

Restructuring costs
 
From time to time, we have undertaken restructuring and expense control measures to support our business performance and to align our cost structure with our resources. In the third quarter of 2013, we adopted a restructuring plan intended to better align our cost structure with the skills and resources required to more effectively execute our long-term growth strategy and to support revenue levels we expect to achieve on a go forward basis. In connection with the 2013 Plan, we eliminated over 100 positions worldwide, implemented tighter expense controls, ceased non-core activities and closed or downsized several facilities. Restructuring costs incurred during the three months ended September 30, 2015 and 2014, under the 2013 Plan were less than $0.1 million and $0.3 million, respectively. For further information, refer to Note (18) Restructuring Costs, to our unaudited condensed consolidated financial statements.
 

27



Interest and Other Income (Loss), net
 
We invest our cash primarily in money market funds, commercial paper, government securities, and corporate bonds. As of September 30, 2015, our cash, cash equivalents, and marketable securities totaled $16.1 million, compared with $26.6 million as of September 30, 2014. Interest and other income (loss), net, increased $0.5 million to income of less than $0.1 million for the three months ended September 30, 2015 compared with a loss of $0.5 million for the same period in 2014. The change in interest and other income (loss), net, was primarily due to other income of less than $0.1 million recorded during the three months ended September 30, 2015, compared with a foreign currency loss of $0.5 million for the same period in 2014.

Income Taxes
 
Our provision for income taxes consists of federal, state and local, and foreign taxes. For the three months ended September 30, 2015 and 2014, the Company recorded an income provision of $0.1 million and $0.2 million, respectively, consisting primarily of federal, state and local and foreign taxes. Our domestic deferred tax assets are not realizable on a more-likely-than-not basis and, therefore, we have recorded a full valuation allowance against our domestic deferred tax assets. During the three months ended September 30, 2015, our conclusion did not change with respect to our domestic deferred tax assets and therefore, we have not recorded any benefit for our expected net domestic deferred tax assets for the full year 2015 estimated annual effective tax rate.

RESULTS OF OPERATIONS – FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015 COMPARED WITH THE NINE MONTHS ENDED SEPTEMBER 30, 2014.
 
Total revenue for the nine months ended September 30, 2015 increased 14% to $39.2 million, compared with $34.5 million for the nine months ended September 30, 2014. This increase was mainly attributable to the accelerated revenue recorded associated with our joint development agreement. Excluding $9.9 million of accelerated revenue related to our joint development agreement, total revenue decreased 15% to $29.3 million for the nine months ended September 30, 2015, compared with $34.5 million for the nine months ended September 30, 2014. Our cost of revenue decreased 6% to $7.5 million for the nine months ended September 30, 2015, compared with $8.0 million for the nine months ended September 30, 2014. Our operating expenses increased 2% from $30.3 million for the nine months ended September 30, 2014 to $30.9 million for the nine months ended September 30, 2015. Our operating expenses for the nine months ended September 30, 2014, benefited from a litigation settlement of $5.3 million associated with our then outstanding lawsuit with the estate of our former Chief Executive Officer, as compared with expense of less than $0.1 million during the same period in 2015. Also included in the operating results for the nine months ended September 30, 2015 and 2014 were; (i) $1.2 million of share-based compensation expense for both periods; and (ii) $0.2 million and $1.0 million, respectively, of restructuring costs. Net income for the nine months ended September 30, 2015 was less than $0.1 million, compared with a net loss of $4.7 million for the nine months ended September 30, 2014. Net loss attributable to common stockholders, which includes the effects of Series A redeemable convertible preferred stock dividends (including accrued dividends) and accretion of the discounts related to the issuance of the Series A redeemable convertible preferred stock, was $1.0 million for the nine months ended September 30, 2015, compared with $5.6 million for the nine months ended September 30, 2014.

Overall, our total operating expenses, excluding the $5.3 million gain recorded on the Estate litigation settlement for the nine months ended September 30, 2014, decreased $4.6 million, or 13%, to $30.9 million for the nine months ended September 30, 2015, compared with $35.6 million for the same period in 2014. This decrease was primarily attributable to our tighter expense controls and overall operational efficiencies which better align our current business plan on a run-rate basis. These efficiencies include among other items, a stream-lined personnel related costs, global overhead costs and efficiencies realized on our redesigned go-to-market coverage models. In addition, the decrease is attributable to a decrease in professional fees primarily related to an investment made in 2014 to penetrate certain market verticals under a one-year arrangement, which ended at March 31, 2015, as well as a decrease in our restructuring costs of $0.9 million compared with the nine months ended September 30, 2014. Our worldwide headcount was 237 employees as of September 30, 2015, compared with 273 employees as of September 30, 2014.


28



Revenue 
 
 
Nine Months Ended September 30, 2015
 
 
2015
 
2014
Revenue:
 
 
 
 
Product revenue
 
$
21,377,450

 
$
13,156,024

Support and services revenue
 
17,798,241

 
21,323,582

Total Revenue
 
$
39,175,691

 
$
34,479,606

Year-over-year percentage change
 
 

 
 

Product revenue
 
62%
 
(37)%
Support and services revenue
 
(17)%
 
(8)%
Total percentage change
 
14%
 
(22)%

Product revenue
 
Product revenue increased 62% from $13.2 million for the nine months ended September 30, 2014, to $21.4 million for the nine months ended September 30, 2015 primarily due to a total of $11.3 million of product revenue recognized related to our joint development agreement, of which $9.9 million was accelerated during the nine months ended September 30, 2015. These amounts are net of a sales return benefit of less than $0.1 million recognized during the nine months ended September 30, 2015 and $0.1 million recognized during the nine months ended September 30, 2014, resulting from the impact of our collection efforts of previously reserved accounts receivable. Product revenue represented 55% and 38% of our total revenue for the nine months ended September 30, 2015 and 2014, respectively. Excluding the accelerated product revenue recognized related to our joint development agreement, product revenue decreased $3.1 million or 23% to $10.1 million for the nine months ended September 30, 2015 compared with the same period in 2014.

Excluding the joint development agreement revenue, product revenue from our OEM partners decreased $0.6 million, while product revenue from our non-OEM partners decreased $2.4 million for the nine months ended September 30, 2015, compared with the same period in 2014. The decrease in OEM product revenue was due to a decrease in sales volume from one of our largest OEM partners in China. The decline in product revenue from our non-OEM partners was primarily due to, (i) a decrease in the volume of sales from our legacy product line(s) as partners and customers evaluate and plan for the transition to our re-architectured version 8.0 suite of products and the recently released FreeStor platform, (ii) challenges in obtaining new customer acquisitions, and (iii) the mix of deals where revenue is recognized ratably over the term of the associated maintenance agreement, rather than upon transaction completion and product delivery. Product revenue from our non-OEM partners represented 38% and 81% of our total product revenue for the nine months ended September 30, 2015 and 2014, respectively. Product revenue from our OEM partners represented 62% and 19% of our total product revenue for the nine months ended September 30, 2015 and 2014, respectively. Excluding the joint development agreement product revenue, our non-OEM partners and OEM partners represented 81% and 19%, respectively, of our total product revenue for the nine months ended September 30, 2015.

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

Support and services revenue

Support and services revenue decreased 17% from $21.3 million for the nine months ended September 30, 2014 to $17.8 million for the nine months ended September 30, 2015. The decrease in support and services revenue was attributable to a decrease in both maintenance and technical support services revenue and professional services revenue.

Maintenance and technical support services revenue decreased from $20.2 million for the nine months ended September 30, 2014 to $17.0 million for the nine months ended September 30, 2015. 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. During the nine months ended September 30, 2015, the decline in maintenance and technical support services revenue was primarily attributable to a decrease of $2.4 million in maintenance revenue from our non-OEM partners primarily driven by the softness in our legacy product portfolio sales over the past twelve months prior to the release of our new product offerings during the first half of 2015 and the continued wind-down in maintenance revenue from certain legacy OEM partners which decreased $0.7 million.
 

29



Professional services revenue decreased $0.4 million, to $0.7 million for the nine months ended September 30, 2015, compared with $1.1 million for the same period in 2014. Professional services revenue varies 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
 
 
Nine Months Ended September 30, 2015
 
 
2015
 
2014
Cost of revenue:
 
 
 
 
Product
 
$
1,619,142

 
$
2,107,974

Support and service
 
5,875,837

 
5,866,408

Total cost of revenue
 
$
7,494,979

 
$
7,974,382

Total Gross Profit
 
$
31,680,712

 
$
26,505,224

Gross Margin:
 
 

 
 

Product
 
92%
 
84%
Support and service
 
67%
 
72%
Total gross margin
 
81%
 
77%

 Cost of revenue, gross profit and gross margin
 
Cost of product revenue for the nine months ended September 30, 2015 decreased $0.5 million, or 23%, to $1.6 million, compared with $2.1 million for the same period in 2014. Product gross margin increased to 92% for the nine months ended September 30, 2015, compared with 84% for the same period in 2014. The increase in product gross margin was primarily attributable to the product revenue recorded in 2015 related to our joint development agreement. Excluding the joint development agreement revenue, product gross margin remained consistent at 84% for the nine months ended September 30, 2015. Our cost of support and service revenue for the nine months ended September 30, 2015 was consistent at $5.9 million, compared with the same period in 2014. Support and service gross margin decreased to 67% for the nine months ended September 30, 2015 from 72% for the same period in 2014. The decrease in support and service gross margin was primarily attributable to the decrease in our support and services revenues.
 
Total gross profit increased $5.2 million, or 20%, to $31.7 million for the nine months ended September 30, 2015 from $26.5 million for the same period in 2014. Total gross margin increased to 81% for the nine months ended September 30, 2015, from 77% for the same period in 2014. Total gross margin excluding the joint development agreement revenue was 73% for the nine months ended September 30, 2015. The decrease in our total gross margin, excluding the joint development agreement revenue, was primarily due to the decrease in revenue, excluding the joint development agreement revenue and the mix of sales. 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.


30



Operating Expenses
 
Research and Development Costs
 
Research and development costs increased $0.2 million, or 3%, to $9.7 million for the nine months ended September 30, 2015, from $9.5 million in the same period in 2014. The increase in research and development costs was primarily related to costs associated with our exclusive source code license and distribution agreement we entered into during the quarter as we continue to re-invest in research and development by adding new and innovative functionalities to our product portfolio, which totaled approximately $0.8 million. We expect to continue to incur additional costs associated with our exclusive source code license and distribution agreement over the next twelve months as part of our investment strategy. This increase was partly offset by a decrease in personnel related costs during the nine months ended September 30, 2015 as compared with the same period in 2014, as a result of the on-going new product development that was performed throughout 2014. We believe we continue to provide adequate levels of 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. Share-based compensation expense included in research and development costs was $0.2 million for each of the nine months ended September 30, 2015 and September 30, 2014.
 
Selling and Marketing
 
Selling and marketing expenses decreased $4.2 million, or 23%, to $13.8 million for the nine months ended September 30, 2015, from $18.0 million for the same period in 2014. The decrease in selling and marketing expenses was primarily attributable to a decrease in personnel related costs, including commission expense as a result of decreased bookings for the nine months ended September 30, 2015 compared with the same period in 2014 as well as a decrease in our sales and marketing headcount as we continue to define our optimized go-to-market coverage models around the world. In addition, the decrease is attributable to a decrease in professional fees of $0.9 million primarily related to an investment made in 2014 to penetrate certain market verticals under a one-year arrangement, which ended at March 31, 2015. Share-based compensation expense included in selling and marketing was $0.2 million for the nine months ended September 30, 2015 compared with $0.3 million for the nine months ended September 30, 2014.
 
General and Administrative
 
General and administrative expenses increased $0.3 million, or 5%, to $7.2 million for the nine months ended September 30, 2015, compared with $6.9 million for the same period in 2014. The increase in general and administrative expenses was primarily related to $0.5 million of termination costs incurred by the Company during the nine months ended September 30, 2015 due to the termination of a contract with an internet communication provider, partly offset by a decrease in personnel related costs. Share-based compensation expense included in general and administrative expenses was $0.6 million for each of the nine months ended September 30, 2015 and September 30, 2014.

Investigation, Litigation and Settlement Related Costs
 
During the nine months ended September 30, 2015, our investigation, litigation, and settlement related costs totaled less than $0.1 million, which was comprised of legal expenses, net of expenses expected to be recoverable through insurance, related to the derivative lawsuit. During the nine months ended September 30, 2014, our investigation, litigation, and settlement related costs totaled a benefit of $5.2 million primarily related to the settlement of the Estate litigation. For further information, refer to Note (16) Litigation, to our unaudited condensed consolidated financial statements.

Restructuring costs
 
In the third quarter of 2013, we adopted a restructuring plan intended to better align our cost structure with the skills and resources required to more effectively execute our long-term growth strategy and to support revenue levels we expect to achieve on a go forward basis. In connection with the 2013 Plan, we eliminated over 100 positions worldwide, implemented tighter expense controls, ceased non-core activities and closed or downsized several facilities. Restructuring costs incurred during the nine months ended September 30, 2015 and 2014, under the 2013 Plan were $0.2 million and $1.0 million, respectively. For further information, refer to Note (18) Restructuring Costs, to our unaudited condensed consolidated financial statements.
 

31



Interest and Other Income (Loss), net
 
We invest our cash primarily in money market funds, commercial paper, government securities, and corporate bonds. As of September 30, 2015, our cash, cash equivalents, and marketable securities totaled $16.1 million, compared with $26.6 million as of September 30, 2014. Interest and other income (loss), net, decreased $0.1 million to a loss of $0.3 million for the nine months ended September 30, 2015 compared with a loss of $0.5 million for the same period in 2014. The change in interest and other income (loss), net, was primarily due to a foreign currency loss of $0.4 million partly offset by interest income and gains on embedded derivatives of less than $0.1 million recorded during the nine months ended September 30, 2015, compared with a foreign currency loss of $0.5 million for the same period in 2014.

Income Taxes
 
Our provision for income taxes consists of federal, state and local, and foreign taxes. For the nine months ended September 30, 2015 and 2014, the Company recorded an income tax provision of $0.4 million and $0.5 million, respectively, consisting primarily of federal, state and local and foreign taxes. Our domestic deferred tax assets are not realizable on a more-likely-than-not basis and, therefore, we have recorded a full valuation allowance against our domestic deferred tax assets. During the nine months ended September 30, 2015, our conclusion did not change with respect to our domestic deferred tax assets and therefore, we have not recorded any benefit for our expected net domestic deferred tax assets for the full year 2015 estimated annual effective tax rate.

LIQUIDITY AND CAPITAL RESOURCES 
 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Cash used in:
 
 
 
 
Operating activities
 
$
(4,026,184
)
 
$