PALTALK, INC. - Quarter Report: 2020 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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

For the quarterly period ended March 31, 2020

OR

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

For the transition period from ________ to ________

Commission File Number      000-52176

PEERSTREAM, INC.

(Exact name of registrant as specified in its charter)

122 East 42nd Street

New York, NY 10168

(Address of principal executive offices) (Zip Code)

(212) 967-5120

(Registrant’s telephone number, including area code)

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

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

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

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

* Excludes 8,500 shares of common stock that are held as treasury stock by PeerStream, Inc. 

PEERSTREAM, INC. QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2020

Table of Contents

PeerStream, Paltalk, our logo and other trademarks or service marks appearing in this report are the property of PeerStream, Inc. Trade names, trademarks and service marks of other companies appearing in this report are the property of their respective owners. Solely for convenience, the trademarks, service marks and trade names included in this report are without the ®, or other applicable symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensors to these trademarks, service marks and trade names.

Unless otherwise indicated, operational metrics such as those related to active subscribers or active users are based on internally-derived metrics for users across all platforms through which our applications are accessed. 

FORWARD-LOOKING STATEMENTS

Certain statements contained in this Quarterly Report on Form 10-Q constitute “forward-looking statements” as defined in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on current expectations, estimates, forecasts and assumptions and are subject to risks and uncertainties. Words such as “anticipate,” “assume,” “began,” “believe,” “budget,” “continue,” “could,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “seek,” “should,” “target,” “would” and variations of such words and similar expressions are intended to identify such forward-looking statements. All forward-looking statements speak only as of the date on which they are made. Such forward-looking statements are subject to certain risks, uncertainties and assumptions relating to factors that could cause actual results to differ materially from those anticipated in such statements, including, without limitation, the following:

For a more detailed discussion of these and other factors that may affect our business, see the discussion in “Item 1A. Risk Factors” and “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this report and the risk factors set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, which was filed with the Securities and Exchange Commission on March 24, 2020. We caution that the foregoing list of factors is not exclusive, and new factors may emerge, or changes to the foregoing factors may occur, that could impact our business. We do not undertake any obligation to update any forward-looking statement, whether written or oral, relating to the matters discussed in this report, except to the extent required by applicable securities laws.

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PEERSTREAM, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these condensed consolidated financial statements.

PEERSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

PEERSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

PEERSTREAM, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The accompanying condensed consolidated financial statements include PeerStream, Inc. and its wholly owned subsidiaries, A.V.M. Software, Inc., Paltalk Software Inc., Paltalk Holdings, Inc., Tiny Acquisition Inc., Camshare, Inc., Fire Talk LLC and Vumber LLC (collectively, the “Company,” “we,” “our” or “us”).

The Company is a communications software innovator that powers multimedia social applications. The Company has also developed a secure business communication solution for use worldwide. Our product portfolio includes Paltalk and Camfrog, which together host one of the world’s largest collections of video-based communities. Our other products include Tinychat and Vumber. The Company has an over 20-year history of technology innovation and holds 18 patents.

The condensed consolidated financial statements included in this report have been prepared on a going concern basis in accordance with generally accepted accounting principles in the United States (“GAAP”) and the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial information. The Company has not included certain information and notes required by GAAP for complete financial statements pursuant to those rules and regulations, although it believes that the disclosure included herein is adequate to make the information presented not misleading. The condensed consolidated financial statements contained herein should be read in conjunction with the Company’s audited consolidated financial statements and the related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 24, 2020 (the “Form 10-K”).

In the opinion of management, the accompanying unaudited condensed consolidated financial information contains all normal and recurring adjustments necessary to fairly present the condensed consolidated balance sheet, results of operations, cash flows and changes in the stockholders’ equity of the Company for the interim periods presented. The Company’s historical results are not necessarily indicative of future operating results, and the results for the three months ended March 31, 2020 are not necessarily indicative of results for the year ending December 31, 2020, or for any other period.

Reclassifications

Certain prior period amounts have been reclassified for comparative purposes to conform to the current presentation. These reclassifications have no impact on the previously reported net income (loss).

For a detailed discussion about the Company’s significant accounting policies, see the Form 10-K.

During the three months ended March 31, 2020, there were no significant changes made to the Company’s significant accounting policies.

Significant Estimates and Assumptions

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period.

Significant estimates relied upon in preparing these financial statements include the estimates used to determine the fair value of the stock options issued in share based payment arrangements, collectability of the Company’s accounts receivable, measurements of proportional performance under certain service contracts, subscription revenues net of refunds, credits, and known and estimated credit card chargebacks, the valuation allowance on deferred tax assets, fair value of digital tokens and impairment assessment of goodwill. Management evaluates these estimates on an ongoing basis. Changes in estimates are recorded in the period in which they become known. The Company bases estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results may differ from the Company’s estimates.  

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Recent Accounting Pronouncements

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. ASU 2019-12 is effective for fiscal years beginning after December 15, 2021. The Company has not early adopted ASU 2019-12 and is currently evaluating its impact on the Company’s financial position, results of operations, and cash flows.

Revenue

In accordance with Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers, revenue from contracts with customers is recognized when control of the promised services is transferred to the customers in an amount that reflects the consideration the Company expects to receive in exchange for those services. Sales tax is excluded from reported revenue. The Company has elected the practical expedient allowable by the guidance to not disclose information about remaining performance obligations pertaining to contracts that have an original expected duration of one year or less. 

Subscription Revenue

The Company generates subscription revenue primarily from monthly premium subscription services. Subscription revenues are presented net of refunds, credits, and known and estimated credit card chargebacks. During the three months ended March 31, 2020 and 2019, subscriptions were offered in durations of one-, three-, six- and twelve- month terms. All subscription fees, however, are paid by credit card at the origination of the subscription regardless of the term of the subscription. Revenues from multi-month subscriptions are recognized on a straight-line basis over the period where the service is offered to the customer, indicated by length of the subscription term purchased. The unearned portion of subscription revenue is presented as deferred revenue in the accompanying condensed consolidated balance sheets. The deferred revenue at December 31, 2019 was $1,829,493, of which $1,043,533 was subsequently recognized as subscription revenue during the three months ended March 31, 2020. The ending balance of deferred revenue at March 31, 2020 was $1,764,634. 

In addition, the Company offers virtual gifts to its users. Users may purchase credits in $5, $10 or $20 increments that can be redeemed for a host of virtual gifts such as a rose, a beer or a car, among other items. These gifts are given among users to enhance communication and are typically redeemed within 30 days of purchase. Upon purchase, the virtual gifts are credited to the users’ account and are under the users’ control. Virtual gift revenue is recognized upon the users’ utilization of such at the fixed transaction price and included in subscription revenue in the accompanying condensed consolidated statements of operations. Virtual gift revenue was approximately $1,215,061 and $1,420,834 for the three months ended March 31, 2020 and 2019, respectively. The ending balance of deferred revenue from virtual gifts at March 31, 2020 and 2019 was $204,121 and $0, respectively.

Advertising Revenue

The Company generates advertising revenue from the display of advertisements on its products through contractual agreements with third parties that are based on the number of advertising impressions delivered. Measurements of impressions include when a customer clicks an advertisement (CPC basis), views an advertisement impression (CPM basis), or registers for an external website via an advertisement by clicking on or through the application (CPA basis). Advertising revenue is dependent upon traffic as well as the advertising inventory placed on the Company’s products.

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Technology Service Revenue

Revenue under the Company’s technology services agreement (the “ProximaX Agreement”) with ProximaX Limited (“ProximaX”) was recognized based upon proportional performance using labor hours as the unit of measurement. Pursuant to the terms of the ProximaX Agreement, ProximaX agreed to pay the Company, among other things, up to an aggregate of $10.0 million of cash or certain highly liquid cryptocurrencies in exchange for the Company’s services, $5.0 million of which was paid in May 2018, $2.5 million of which was due upon completion the second development milestone set forth in the ProximaX Agreement and $2.5 million of which was due upon completion of the third development milestone set forth in the ProximaX Agreement. The contractual upfront fee was paid in the Ethereum cryptocurrency and subsequently converted into U.S. dollars. The upfront fee also included 216.0 million XPX tokens. The total upfront fee was recognized as revenue under the input method based on proportional performance using labor hours as the unit of measurement.

In the second quarter of 2019, the Company completed, and ProximaX accepted delivery of, the work constituting the second development milestone under the ProximaX Agreement. During the final stages of delivery of the second milestone, ProximaX informed the Company that capital constraints made it unable to pay the Company the $2.5 million as stipulated under the ProximaX Agreement. Accordingly, the Company and ProximaX entered into an agreement, effective June 24, 2019, to terminate the ProximaX Agreement (the “Termination Agreement”) and provide for payment terms for the remaining $2.5 million due under the ProximaX Agreement. The portion of the upfront fee that remained unrecognized as of the termination of the ProximaX Agreement was $1.6 million and was recognized as revenue upon such termination, in addition to the $1.7 million of revenue recognized in the first quarter of 2019. Since there is no assurance of collectability on the remaining payments, revenue is being recognized as the payments under the Termination Agreement are received. For the three months ended March 31, 2020, the Company recognized approximately $15.0 thousand in revenue in connection with payments received under the Termination Agreement.

On January 31, 2019, the Company entered into an Asset Purchase Agreement with The Dating Company, LLC, pursuant to which the Company sold substantially all of the assets related to its online dating services business under the domain names FirstMet, 50more, and The Grade (collectively, the “Dating Services Business”) for a cash purchase price of $1.6 million, with $100.0 thousand of the purchase price held in an escrow account to secure certain of the Company’s post-closing indemnification obligations. The closing of the asset sale was effective as of January 31, 2019.

In the first quarter of 2019, management determined that the disposal of the Dating Services Business met the criteria for presentation as discontinued operations. Accordingly, the results of the Dating Services Business are presented as discontinued operations in our consolidated statements of operations and are excluded from continuing operations for all periods presented. In addition, the assets and liabilities of the Dating Services Business are classified as held for sale in our consolidated balance sheets for all periods presented.

The operations of the Dating Services Business are included in our results as discontinued operations through January 31, 2019, the date of sale.

The following tables summarize the major line items included in loss from discontinued operations for the Dating Services Business:

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Property and equipment, net consisted of the following at March 31, 2020 and December 31, 2019:

Depreciation expense for the three months ended March 31, 2020 was $88,860 as compared to $88,614 for the three months ended March 31, 2019.

The Company tests goodwill and indefinite-lived intangible assets for impairment annually and whenever events or circumstances arise that indicate an impairment may exist.

The Company recorded $6,760,222 of goodwill impairment for the year ended December 31, 2019 due to a sustained decrease in market price per share of the Company’s common stock. At December 31, 2019, the market price per share of the Company’s common stock declined to $1.29 and as such, the Company tested for an impairment and concluded that the goodwill should be reduced as result of the decline in the market price per share and fair value of the reporting unit.

The Company determined there were no indicators that would lead to a test for impairment during the three months ended, March 31, 2020. Goodwill was $6,326,250 at March 31, 2020 and December 31, 2019.

Intangible assets, net consisted of the following at March 31, 2020 and December 31, 2019: 

Amortization expense for the three months ended March 31, 2020 was $64,084, as compared to $64,082 for the three months ended March 31, 2019. The estimated aggregate amortization expense for each of the next five years and thereafter will be $182,597 in 2020, $184,667 in 2021, $149,944 in 2022, $18,000 in 2023, $17,354 in 2024 and $11,245 thereafter.

Digital tokens consist of XPX tokens received in connection with the ProximaX Agreement. Given that there is limited precedent regarding the classification and measurement of cryptocurrencies and other digital tokens under current GAAP, the Company has determined to account for these tokens as indefinite-lived intangible assets in accordance with ASC 350, Intangibles-Goodwill and Other until further guidance is issued by the FASB.

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Indefinite-lived intangible assets are recorded at cost and are not subject to amortization but shall be tested for impairment annually and more frequently if events or changes in circumstances indicate that it is more likely than not that the asset is impaired. If, at the time of an impairment test, the carrying amount of an intangible asset exceeds its fair value, an impairment loss in an amount equal to the excess is recognized. Fair value of the digital tokens had been based on the quoted market prices for the XPX tokens.

Accrued expenses and other current liabilities consisted of the following at March 31, 2020 and December 31, 2019:

The Company’s provision for income taxes consists of federal and state 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. Each quarter the Company updates its estimate of the annual effective tax rate and records cumulative adjustments as necessary. As of March 31, 2020, our conclusion regarding the realizability of our U.S. deferred tax assets did not change and we have recorded a full valuation allowance against them.

On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”) was enacted in response to COVID-19 pandemic. Under ASC 740, the effects of changes in tax rates and laws are recognized in the period in which the new legislation is enacted. The CARES Act made various tax law changes. including. among other things. (i) increasing the limitation under Section 163(j) of the Internal Revenue Code of 1986, as amended (the “Code”), for 2018 through 2020 to permit additional expensing of interest, (ii) enacting a technical correction so that qualified improvement property can be immediately expensed under Section 168(k) of the IRC, (iii) making modifications to the federal net operating loss rules, including permitting federal net operating losses incurred in 2018, 2019, and 2020 to be carried back to the five preceding taxable years in order to generate a refund of previously paid income taxes, and (iv) enhancing the recoverability of alternative minimum tax credits. Given the Company’s full valuation allowance position, the CARES Act did not have a material impact on the Company’s condensed consolidated financial statements.

For the three months ended March 31, 2020, the Company recorded an income tax provision of $2,500. The effective tax rate for the three months ended March 31, 2020 was (0.57%). The effective tax rate differs from the statutory rate of 21% as the Company has concluded that its deferred tax assets are not realizable on a more-likely-than-not basis.

For the three months ended March 31, 2019, the Company recorded an income tax benefit from continuing operations of $158,990 on a pre-tax loss of $75,275. As a result of the gain recorded in discontinued operations in connection with the sale of the Dating Services Business, the Company was able to record an income tax benefit in continuing operations under the intra-period allocation guidance. As such, our effective tax rate of 211.21% differed from the statutory rate of 21%.

The PeerStream, Inc. Amended and Restated 2011 Long-Term Incentive Plan (the “2011 Plan”) was terminated as to future awards on May 16, 2016. A total of 121,930 shares of the Company’s common stock may be issued pursuant to outstanding options awarded under the 2011 Plan; however, no additional awards may be granted under such plan. The PeerStream, Inc. 2016 Long-Term Incentive Plan (the “2016 Plan”) was adopted by the Company’s stockholders on May 16, 2016 and permits the Company to award stock options (both incentive stock options and non-qualified stock options), stock appreciation rights, restricted stock, restricted stock units, performance awards, dividend equivalent rights, and other stock-based awards and cash-based incentive awards to its employees (including an employee who is also a director or officer under certain circumstances), non-employee directors and consultants. The maximum number of shares of common stock that may be issued pursuant to awards under the 2016 Plan is 1,300,000 shares, 100% of which may be issued pursuant to incentive stock options. In addition, the maximum number of shares of common stock that may be issued under the 2016 Plan may be increased by an indeterminate number of shares of common stock underlying outstanding awards issued under the 2011 Plan that are forfeited, expired, cancelled or settled in cash. As of March 31, 2020, there were 702,660 shares available for future issuance under the 2016 Plan.

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Treasury Shares

On April 29, 2019, the Company implemented a stock repurchase plan to repurchase up to $500,000 of its common stock for cash. The repurchase plan expired on April 29, 2020. The Company had purchased 8,500 shares of its common stock under the repurchase plan as of March 31, 2020 and has classified them as treasury shares.

Stock Options

The following table summarizes the assumptions used in the Black-Scholes pricing model to estimate the fair value of the options granted during the following period:

The expected life of the options is the period of time over which employees and non-employees are expected to hold their options prior to exercise. The expected life of options has been determined using the “simplified” method as prescribed by Staff Accounting Bulletin 110, which uses the midpoint between the vesting date and the end of the contractual term. The volatility of the Company’s common stock is calculated using the Company’s historical volatilities beginning at the grant date and going back for a period of time equal to the expected life of the award. The Company estimates potential forfeitures of stock awards and adjusts recorded stock-based compensation expense accordingly. The Company estimates pre-vesting forfeitures primarily based on the Company’s historical experience and is adjusted to reflect actual forfeitures as the stock-based awards vest.

The following table summarizes stock option activity during the three months ended March 31, 2020:

At March 31, 2020, there was $303,703 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted average period of 1.7 years.

On March 31, 2020, the aggregate intrinsic value of stock options that were outstanding and exercisable was $1,440 and $360, respectively. On March 31, 2019, the aggregate intrinsic value of stock options that were outstanding and exercisable was $238,293 and $124,821, respectively. The intrinsic value for stock options is calculated based on the exercise price of the underlying awards and the fair value of such awards as of the period-end date.

During the three months ended March 31, 2020, the Company granted options to members of the Board of Directors to purchase an aggregate 24,000 shares of common stock at an exercise price of $0.80 per share. The options vest in four equal quarterly installments on the last day of each calendar quarter in 2020 and have a term of ten years.

The aggregate fair value for the options granted during the three months ended March 31, 2020 and 2019 was $18,664 and $187,429, respectively.

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Stock-based compensation expense for the Company’s stock options included in the condensed consolidated statements of operations is as follows:

Basic net income (loss) per share of common stock is computed based upon the number of weighted average shares of common stock outstanding as defined by ASC Topic 260, Earnings Per Share. Diluted net income (loss) per share of common stock includes the dilutive effects of stock options and stock equivalents. To the extent stock options are antidilutive, they are excluded from the calculation of diluted net income (loss) per share of common stock.

For the three months ended March 31, 2020, 773,375 of shares issuable upon the exercise of outstanding stock options were not included in the computation of diluted net income (loss) per share for continuing operations because their inclusion would be antidilutive.

For the three months ended March 31, 2019, 1,062,745 shares issuable upon the exercise of outstanding stock options and 79,286 shares of unvested restricted stock were not included in the computation of diluted net income per share because their inclusion would be anti-dilutive. 

Operating Leases

On June 7, 2016, the Company entered into a lease agreement with Jericho Executive Center LLC for office space at 30 Jericho Executive Plaza in Jericho, New York which commenced on September 1, 2016 and runs through November 30, 2021. The Company’s monthly office rent payments under the lease are currently approximately $5,900 per month.

On May 1, 2019, the Company entered into a lease agreement for office space located at 122 East 42nd Street in New York, NY and paid a $133,968 security deposit in the form of a letter of credit. The term of the lease runs until April 26, 2023. The Company’s monthly office rent payments under the lease are currently approximately $33,492 per month.

On May 1, 2019, the Company entered into a sublease agreement with Telecom Infrastructure Corp. for office space located at 122 East 42nd Street in New York, NY, pursuant to which Telecom Infrastructure Corp. is required to pay the Company $11,164 per month. The term of the sublease runs until April 26, 2023. We have been notified that, due to the coronavirus outbreak, Telecom Infrastructure Corp. is currently unable to make its monthly payments under the sublease agreement, and such payments ceased being made in March 2020. We are currently in discussions with Telecom Infrastructure Corp. concerning its nonpayment and we are exploring all remedies available to us.

As of March 31, 2020, the Company had no long-term leases that were classified as a financing lease. As of March 31, 2020, the Company did not have additional operating and financing leases that have not yet commenced.

At March 31, 2020, the Company had operating lease liabilities of approximately $0.7 million and right of use assets of approximately $0.6 million, which are included in the condensed consolidated balance sheet.

Total rent expense for the three months ended March 31, 2020 was $61,895, of which $36,095 was sublease income, and $81,816 for the three months ended March 31, 2019. Rent expense is recorded in general and administrative expense on the condensed consolidated statements of operations.

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table summarizes the Company’s operating leases:

On March 31, 2020, future minimum payments under non-cancelable operating leases were as follows: 

Legal Proceedings

On December 16, 2016, a wholly owned subsidiary of the Company, Paltalk Holdings, Inc., filed a patent infringement lawsuit in Delaware against Riot Games, Inc. and Valve Corporation for infringement of U.S. Patent Nos. 5,822,523 and 6,226,686 with respect to their online games League of Legends and Defense of the Ancients 2. These two patents were previously asserted against, and then licensed to, Microsoft, Sony, and Activision. In 2018, Valve Corporation moved to transfer the litigation from Delaware to the Western District of Washington. Such motion was granted by the court.

Riot Games, Inc. has filed a total of four inter partes reviews at the Patent Trial and Appeal Board (“PTAB”) of the United States Patent and Trademark Office, two per patent held by Paltalk Holdings, Inc., seeking to have the Paltalk Holdings, Inc. patents declared invalid. On May 14, 2019, the PTAB rejected the validity of the patents. On September 27, 2019, the Company filed an appeal of the PTAB’s ruling.

The Company may be included in legal proceedings, claims and assessments arising in the ordinary course of business. The Company evaluates the need for a reserve for specific legal matters based on the probability of an unfavorable outcome and the reasonability of an estimable loss. No reserve was deemed necessary as of March 31, 2020. 

On February 21, 2020, we entered into an Asset Purchase Agreement (the “SecureCo Purchase Agreement”) with SecureCo, LLC (“SecureCo”), whereby we agreed to sell substantially all of the assets related to our secure communications business, which includes communication solutions and operations capabilities with respect to the development and commercialization of secure messaging and data applications, software and middleware for enterprise and government client targets (the “Secure Communications Assets”), to SecureCo for a cash purchase price of approximately $540,000, which is comprised of a base purchase price of $500,000 plus the reimbursement or waiver of certain severance expenses payable by the Company to certain former executive officers. In addition, we shall be entitled to receive a transition service fee of five percent (5%) of all revenue received by SecureCo or its Affiliates pursuant to certain unassignable contracts.

 PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The closing of the sale of the Assets is subject to the fulfilment of certain conditions by the Company and SecureCo, including, among other things, a condition that SecureCo shall have received financing that is sufficient to fund the purchase price. If the transaction is consummated, we do not expect to continue to pursue secured communications products or technology implementation services as part of our overall business strategy. The SecureCo Purchase Agreement may be terminated by either party if the conditions to closing have not been fulfilled by April 15, 2020, provided that such date may be extended to May 31, 2020 conditioned upon a $2,000 per business day increase in the purchase price payable by SecureCo for every day past April 15, 2020. As of April 15, 2020, the conditions to closing under the SecureCo Purchase Agreement had not been fulfilled, and accordingly, the purchase price payable by SecureCo began and will continue to increase by $2,000 per business day until the conditions to closing under the SecureCo Purchase Agreement have been fulfilled. If the transaction is not consummated, we expect to take a measured approach with respect to the potential commercialization of these products in a fiscally responsible manner.

In December 2019, a strain of coronavirus was reported to have surfaced in Wuhan, China, and has since reached multiple other countries, including the United States, resulting in government-imposed quarantines, travel restrictions and other public health safety measures in affected countries. The various precautionary measures taken by many governmental authorities around the world in order to limit the spread of the coronavirus has had and could continue to have an adverse effect on the global markets and its economy, including on the availability and pricing of employees and resources, and other aspects of the global economy. Although we cannot predict the impact that the recent outbreak of coronavirus will have on our business or results of operations in 2020, to date, our core multimedia social applications have been able to support the increased demand we have experienced.

On April 13, 2020, to help ensure adequate liquidity in light of the uncertainties posed by the coronavirus pandemic, we applied for a $506,500 loan (the “Loan”) under the Small Business Administration (“SBA”) Paycheck Protection Program under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). On May 3, 2020, we entered into a promissory note (the “Note”) in favor of Citibank, N.A., as lender (the “Lender”).

The Note has a two-year term, matures on May 3, 2022, and bears interest at a stated rate of 1.0% per annum. Monthly principal and interest payments will commence in December 2020. We did not provide any collateral or guarantees for the Loan, nor did we pay any facility charge to obtain the Loan. The Note provides for customary events of default, including, among others, those relating to failure to make payment, bankruptcy, breaches of representations and material adverse effects. We may prepay the principal of the Loan at any time without incurring any prepayment charges.

The Loan may be partially or fully forgiven if we comply with the provisions of the CARES Act, including the use of Loan proceeds for payroll costs, rent, utilities and certain other expenses, and at least 75% of the Loan proceeds must be used for payroll costs as defined in the CARES Act. Any forgiveness of the Loan will be subject to approval by the SBA and the Lender. 

PeerStream continues to serve as a form of safe and entertaining communication during this global pandemic and in order to help those affected in hardest hit countries will continue to offer some of our group video conferencing services free of charge.

Management has evaluated subsequent events or transactions occurring through the date the condensed consolidated financial statements were issued and determined that no other events or transactions are required to be disclosed herein.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. The following discussion and analysis should be read in conjunction with: (i) the accompanying unaudited condensed consolidated financial statements and notes thereto for the three months ended March 31, 2020 and 2019, (ii) the consolidated financial statements and notes thereto for the year ended December 31, 2019 included in our Annual Report on Form 10-K (the “Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on March 24, 2020 and (iii) the discussion under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Form 10-K. Aside from certain information as of December 31, 2019, all amounts herein are unaudited.

Forward-Looking Statements

In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. See “Forward-Looking Statements.” Our results and the timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Item 1A. Risk Factors” in Part II of this report and “Item 1A. Risk Factors” in the Form 10-K.

Overview

We are a leading communications software innovator that powers multimedia social applications and secure business communication solutions worldwide. We operate a leading network of consumer applications that we believe create a unique social media enterprise where users can meet, see, chat, broadcast and message in real time in a secure environment with others in our network. Our consumer applications generate revenue principally from subscription fees and advertising arrangements.

We believe that the scale of our subscriber base presents a competitive advantage in the video social networking industry and provides growth opportunities to advance existing products with up-sell opportunities and build future brands with cross-sell offers. 

We also believe that our proprietary consumer app technology platform can scalably support large communities of users in activities such as video, voice and text chat and provide robust user monetization tools. In October 2019, we commenced a strategy to make our video chat platform available to potential third-party partners with large user communities to provide retention-enhancing social and communication features while potentially providing additional commercial opportunities for those partners. We expect to participate in the commercial upside with such partners via revenue sharing arrangements that we plan to negotiate on a partner-specific basis.

Our continued growth depends on attracting new consumer application users through the introduction of new applications, features and partnerships and further penetration of our existing markets. Our principal growth strategy is to invest in the development of proprietary software, expand our sales and marketing efforts with respect to such software, and increase our consumer application user base through potential platform partnerships and new and existing advertising campaigns that we run through internet and mobile advertising networks, all while balancing the capital needs of the business.   

Our strategy is to approach these opportunities in a measured way, being mindful of the Company’s resources and evaluating factors such as potential revenue, time to market and amount of capital needed to invest in the opportunity. 

Recent Developments

COVID-19

In December 2019, a strain of coronavirus, was reported to have surfaced in Wuhan, China, and has reached multiple other countries, resulting in government-imposed quarantines, travel restrictions and other public health safety measures in affected countries. The various precautionary measures taken by many governmental authorities around the world in order to limit the spread of the coronavirus has had and could continue to have an adverse effect on the global markets and its economy, including on the availability and pricing of employees and resources, and other aspects of the global economy. Although we cannot predict the impact that the recent outbreak of coronavirus will have on our business or results of operations in 2020, to date, our core multimedia social applications have been able to support the increased demand we have experienced. On April 13, 2020, to help ensure adequate liquidity in light of the uncertainties posed by the coronavirus pandemic, we applied for a $506,500 loan (the “Loan”) under the Small Business Administration (“SBA”) Paycheck Protection Program under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”)., and on May 3, 2020, we entered into a promissory note (the “Note”) in favor of Citibank, N.A., as lender (the “Lender”).

PeerStream continues to serve as a form of safe and entertaining communication during this global pandemic and in order to help those affected in hardest hit countries will continue to offer some of our group video conferencing services free of charge.

Pending Sale of Secured Communications Assets

On February 21, 2020, we entered into an Asset Purchase Agreement (the “SecureCo Purchase Agreement”) with SecureCo, LLC (“SecureCo”), whereby, subject to the terms of the SecureCo Purchase Agreement, we agreed to sell substantially all of the assets related to our secure communications business, which includes communication solutions and operations capabilities with respect to the development and commercialization of secure messaging and data applications, software and middleware for enterprise and government client targets (the “Secure Communications Assets”) to SecureCo for a cash purchase price of approximately $540,000, which is comprised of a base purchase price of $500,000 plus the reimbursement or waiver of certain severance expenses payable by the Company to certain former executive officers. In addition, we are entitled to receive a transition service fee of five percent (5%) of all revenue received by SecureCo or its affiliates pursuant to certain unassignable contracts in certain circumstances.

The closing of the sale of the Secure Communications Assets is subject to the fulfilment of certain conditions by the Company and SecureCo, including, among other things, a condition that SecureCo shall have received financing that is sufficient to fund the purchase price. If the transaction is consummated, we do not expect to continue to pursue secured communications products or technology implementation services as part of our overall business strategy. The SecureCo Purchase Agreement may be terminated by either party if the conditions to closing have not been fulfilled by April 15, 2020, provided that such date may be extended to May 31, 2020 conditioned upon a $2,000 per business day increase in the purchase price payable by SecureCo for every day past April 15, 2020. As of April 15, 2020, the conditions to closing under the SecureCo Purchase Agreement had not been fulfilled, and accordingly, the purchase price payable by SecureCo began and will continue to increase by $2,000 per business day until the conditions to closing under the SecureCo Purchase Agreement have been fulfilled. If the transaction is not consummated, we expect to take a measured approach with respect to the potential commercialization of these products in a fiscally responsible manner.

Operational Highlights and Objectives 

During the three months ended March 31, 2020, we executed key components of our objectives: 

For the near term, our business objectives include:

Sources of Revenue

Our sources of revenue are subscription, advertising and other fees generated from users of our video chat products. In April 2018, we started generating revenue through proprietary software licensing and technology implementation services as a result our technology services agreement (the “ProximaX Agreement”) with ProximaX Limited (“ProximaX”). In January 2019, we sold substantially all of the assets related to our dating products. As described above, we recently entered into an agreement to sell our Secured Communications Assets. If the sale is completed, we expect that our sole source of revenue will return to being revenue generated from our video chat products. 

Subscription Revenue

Our video chat platforms generate revenue primarily through subscription fees. Our tiers of subscriptions provide users with unlimited video windows and levels of status within the community. Multiple subscription tiers are offered in different durations depending on the product from one-, six- and twelve- month terms, which continue to vary as we continue to test and optimize length and pricing. Longer-term plans (those with durations longer than one month) are generally available at discounted monthly rates. Levels of membership benefits are offered in tiers, with the least membership benefits in the lowest paid tier and the most membership benefits in the highest paid tier. Our membership tiers are “Plus,” “Extreme,” “VIP” and “Prime” for Paltalk and “Pro,” “Extreme” and “Gold” for Camfrog. We also hold occasional promotions that offer discounted subscriptions and virtual gifts.

We recognize revenue from monthly premium subscription services beginning in the month in which the subscriptions are originated. Revenues from multi-month subscriptions are recognized on a gross and straight-line basis over the length of the subscription period. The unearned portion of subscription revenue is presented as deferred revenue in the accompanying condensed consolidated balance sheets.

We also offer virtual gifts to our users. Users may purchase credits that can be redeemed for a host of virtual gifts such as a rose, a beer, or a car, among other items. Virtual gift revenue is recognized upon the users’ utilization of the virtual gift and included in subscription revenue. The unearned portion of virtual gifts revenue is presented as deferred revenue in the accompanying condensed consolidated balance sheets.

Advertising Revenue

We generate a portion of our revenue through advertisements on our video platforms. Advertising revenue is dependent upon the volume of advertising impressions viewed by active users as well as the advertising inventory we place on our products. We recognize advertising revenue as earned on a click-through, impression, registration or subscription basis. Measurements of impressions include when a user clicks on an advertisement (CPC basis), views an advertisement impression (CPM basis), or registers for an external website via an advertisement by clicking on or through our application (CPA basis). 

Technology Service Revenue

Technology service revenue is generated under licensing and service agreements that we negotiate with our clients that describe the scope of the development, integration, engineering, licensing or other services that we provide. More specifically, technology service revenue relates to revenue that we would generate from our software solutions, such as PSP, through licenses to our clients that may be bundled with service and support packages. In addition, technology service revenue includes technology-based business development partnerships. We expect that any technology services agreements and business development partnerships are likely to contain pricing and other custom terms based on the needs of the client, which may include compensation in the form of cash or cryptocurrency tokens or a mix of cash and cryptocurrency tokens.

As described above, we recently entered into an agreement to sell our Secured Communications Assets. If the sale is completed, we do not anticipate generating any material technology service revenue or pursuing technology services as part of our business strategy.

Costs and Expenses

Cost of revenue

Cost of revenue consists primarily of compensation (including stock-based compensation) and other employee-related costs for personnel engaged in data center and customer care functions, credit card processing fees, hosting fees, and data center rent and bandwidth costs. Beginning in April 2018, cost of revenue also includes compensation and other employee-related costs for technical personnel and subcontracting costs relating to technology service revenue.

Sales and marketing expense

Sales and marketing expense consist primarily of advertising expenditures and compensation (including stock-based compensation) and other employee-related costs for personnel engaged in sales and sales support functions. Advertising and promotional spend includes online marketing, including fees paid to search engines, and offline marketing, which primarily consists of partner-related payments to those who direct traffic to our brands. 

Product development expense

Product development expense, which relates to the development of technology of our applications, consists primarily of compensation (including stock-based compensation) and other employee-related costs that are not capitalized for personnel engaged in the design, testing and enhancement of service offerings as well as amortization of capitalized website development costs. 

General and administrative expense

General and administrative expense consists primarily of compensation (including stock-based compensation) and other employee-related costs for personnel engaged in executive management, finance, legal, tax and human resources and facilities costs and fees for other professional services. General and administrative expense also includes depreciation of property and equipment and amortization of intangible assets.  

Key Metrics

Our management relies on certain non-GAAP and/or unaudited performance indicators to manage and evaluate our business. The key performance indicators set forth below help us evaluate growth trends, establish budgets, measure the effectiveness of our advertising and marketing efforts and assess operational efficiencies. We also discuss net cash provided by (used in) operating activities under the ‟Results of Operations” and ‟Liquidity and Capital Resources” sections below. Active subscribers, subscription bookings and Adjusted EBITDA are discussed below.

Active Subscribers

Active subscribers means users of our consumer applications that have prepaid a fee, redeemed credits or received an upgrade from another user as a gift for current unlocked application features such as enhanced voice and video access, elevated status in the community or unrestricted communication on our applications and whose subscription period has not yet expired. The metrics for active subscribers are based on internally-derived metrics across all platforms through which our applications are accessed. We assess the performance of our consumer applications by measuring active subscribers because we believe that this metric is the most reliable way to understand user engagement on our platform and estimate the future operational performance of our applications. We also believe that measuring active subscribers helps management estimate future subscription revenue. Because active subscribers generate the majority of our subscription revenue, as the number of active subscribers to our consumer applications increases, the amount of subscription revenue generated from our consumer applications also increases. Active subscribers is distinguished from active users, which represents the total number of free and paid users across all platforms during a certain period who access our various applications. We believe that active users are important to our operations because advertising revenue is largely dependent upon the volume of advertising impressions viewed by active users.

Subscription Bookings

Subscription bookings is a financial measure representing the aggregate dollar value of subscription fees and virtual gifts purchases received during the period. We calculate subscription bookings as subscription revenue recognized during the period plus the change in deferred subscription revenue recognized during the period. We record subscription revenue from subscription fees as deferred subscription revenue and then recognize that revenue ratably over the length of the subscription term or ratably over usage for virtual gifts. Our management uses subscription bookings internally in analyzing our financial results to assess operational performance and to assess the effectiveness of, and plan future, user acquisition campaigns. We believe that this financial measure is useful in evaluating the performance of our consumer applications because we believe, as compared to subscription revenue, it is a better indicator of the subscription activity in a given period. We believe that both management and investors benefit from referring to subscription bookings in assessing our performance and when planning, forecasting and analyzing future periods.

While the factors that affect subscription bookings and subscription revenue are generally the same, certain factors may affect subscription bookings more or less than such factors affect subscription revenue in any period. While we believe that subscription bookings is useful in evaluating our business, it should be considered as supplemental in nature and it is not meant to be a substitute for subscription revenue recognized in accordance with GAAP. 

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure. Adjusted EBITDA is defined as net income (loss) adjusted to exclude net loss from discontinued operations, interest income, other expense, gain on the sale of dating applications, income tax expense (benefit) from continuing operations, income tax expense from discontinued operations, depreciation and amortization expense and stock-based compensation expense. 

We present Adjusted EBITDA because it is a key measure used by our management and Board of Directors to understand and evaluate our core operating performance and trends, to develop short- and long-term operational plans and to allocate resources to expand our business. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA can provide a useful measure for period-to-period comparisons of the cash operating income generated by our business. We believe that Adjusted EBITDA is useful to investors and others to understand and evaluate our operating results, and it allows for a more meaningful comparison between our performance and that of competitors.

Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider this performance measure in isolation from or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

Limitations of Adjusted EBITDA

Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income (loss) and our other GAAP results. The following table presents a reconciliation of net income (loss), the most directly comparable financial measure calculated and presented in accordance with GAAP, to Adjusted EBITDA for each of the periods indicated: 

Results of Operations

In January 2019, we sold substantially all of the assets related to our dating service business under the domain names FirstMet, 50more and The Grade, which we collectively refer to as the dating services business. As a result, during the first quarter of 2019, we began to separately report the results of the dating services business as a discontinued operation in our condensed consolidated statements of operations and present the related assets and liabilities as held for sale in our condensed consolidated balance sheets. These changes have been applied for all periods presented. Unless otherwise noted, amounts and percentages for all periods discussed below reflect the results of operations and financial condition from our continuing operations. Refer to Note 3 of the notes to our condensed consolidated financial statements for additional information on discontinued operations. 

The following table sets forth condensed consolidated statements of operations data for each of the periods indicated as a percentage of total revenues: 

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019

Revenue

Total revenues decreased to $2,720,742 for the three months ended March 31, 2020 from $4,873,175 for the three months ended March 31, 2019. The decrease was driven by a decline of $1,733,378 of technology service revenue recognized under the ProximaX Agreement, along with a decline of $354,232 in subscription revenue partly as a result of lower virtual gifts transaction volume and a 1.6% decline in active subscribers, as well as a decrease of $64,823 in advertising revenue across all products.

The following table sets forth our subscription revenue, advertising revenue, technology service revenue and total revenues for the three months ended March 31, 2020 and 2019, the decrease between those periods, the percentage decrease between those periods and the percentage of total revenues that each represented for those periods: 

Subscription Revenue – Our subscription revenue for the three months ended March 31, 2020 decreased by $354,232, or 11.8%, as compared to the three months ended March 31, 2019. The decrease in subscription revenue was mainly driven by lower virtual gift transaction volume for both Paltalk and Camfrog products, corresponding to a decline in active subscribers of approximately 1.6% as well as shortfalls in the Middle East countries. 

Advertising Revenue – Our advertising revenue for the three months ended March 31, 2020 decreased by $64,823, or 53.8%, as compared to the three months ended March 31, 2019. The decrease in advertising revenue was primarily due to a decline in the volume of advertising impressions related to the changes in third party partners.

Technology Service Revenue – For the three months ended March 31, 2020, we recognized $14,952 of technology service revenue as consideration for providing certain development and related services to ProximaX to facilitate the integration of the PeerStream Protocol into ProximaX’s proprietary blockchain protocol. Under the terms of our termination agreement with ProximaX, effective June 24, 2019 (the “Termination Agreement”), ProximaX was required to make certain payments to us on a monthly basis through the remainder of 2019. Since there is no assurance of collectability on the payments due under the Termination Agreement, revenue is being recognized as the payments are received.

Costs and Expenses

Total costs and expenses for the three months ended March 31, 2020 reflect a decrease of $1,894,063, or 38.0%, as compared to the three months ended March 31, 2019. The following table presents our costs and expenses for the three months ended March 31, 2020 and 2019, the decrease between those periods, the percentage decrease between those periods and the percentage of total revenues that each represented for those periods:

Cost of revenue – Our cost of revenue for the three months ended March 31, 2020 decreased by $ 329,495, or 34.6%, as compared to the three months ended March 31, 2019. The decrease for the three months ended March 31, 2020 was primarily driven by a decrease of $191,300 in expenses related to headcount reduction due to the terminated ProximaX Agreement. Additionally, there was a decrease in expenses resulting from the reduction of fraud, hosting and content delivery services in the three months ended March 31, 2020.

Sales and marketing expense – Our sales and marketing expense for the three months ended March 31, 2020 decreased by $185,481, or 49.2%, as compared to the three months ended March 31, 2019. The decrease in sales and marketing expense for the three months ended March 31, 2020 was primarily due to a decrease in overall marketing expenditures of approximately $180,200 across all products.

Product development expense – Our product development expense for the three months ended March 31, 2020 decreased by $520,869, or 29.4%, as compared to the three months ended March 31, 2019. The decrease was primarily due to a decrease of approximately $570,900 resulting from reduced headcount in the product and engineering teams.

General and administrative expense – Our general and administrative expense for the three months ended March 31, 2020 decreased by $858,218, or 45.7%, as compared to the three months ended March 31, 2019. The decrease in general and administrative expense for the three months ended March 31, 2020 was primarily due to headcount reductions resulting in $478,600 reduced salary and related expenses. In addition, the decrease was in part due to the absence of $185,374 in stock compensation expense related to the vested restricted stock awards and reduced legal fees of approximately $116,000.

Non-Operating Income (Loss)

The following table presents the components of non-operating income (loss) for the three months ended March 31, 2020 and the three months ended March 31, 2019, the increase or decrease between those periods, the percentage increase or decrease between those periods and the percentage of total revenues that each represented for those periods:  

Non-operating loss for the three months ended March 31, 2020 increased by $824,129, or 109.6%, as compared to the three months ended March 31, 2019, primarily due to the sale of the assets related to our dating services business. In addition, other expense increased by $84,469 primarily due to a $28,427 realized loss from the sale of digital tokens and a $56,041 current asset write-off.

Income Taxes

Our provision for income taxes consists of federal and state taxes, as applicable, in amounts necessary to align the Company’s year-to-date tax provision with the effective rate that it expects to achieve for the full year. For the three months ended March 31, 2020, the Company recorded an income tax provision from continuing operations of $2,500 consisting primarily of state and local taxes. For the three months ended March 31, 2019, the Company recorded an income tax benefit from continuing operations of $158,990 under the intra-period allocation guidance as the Company recorded a gain in discontinued operations.

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

Liquidity and Capital Resources 

Currently, our primary source of liquidity is cash on hand and cash flows from continuing operations, and we believe that our cash balance and our expected cash flow from operations will be sufficient to meet all of our financial obligations for the twelve months from the date of this report. As of March 31, 2020, we had $3,436,710 of cash and cash equivalents. 

Our primary use of working capital is related to product development resources in order to maintain and create new services and features in applications for our clients and users. In particular, a significant portion of our working capital has been allocated to the improvement of our products. We have also used small amounts of capital to opportunistically repurchase our common stock from time to time. In the future, we may also seek to grow our business by expending our capital resources to fund strategic investments and partnership opportunities. 

On April 13, 2020, to help ensure adequate liquidity in light of the uncertainties posed by the coronavirus pandemic, we applied for the Loan, and on May 3, 2020, we entered into the Note in favor of the Lender.

The Note has a two-year term, matures on May 3, 2022, and bears interest at a stated rate of 1.0% per annum. Monthly principal and interest payments will commence in December 2020. We did not provide any collateral or guarantees for the Loan, nor did we pay any facility charge to obtain the Loan. The Note provides for customary events of default, including, among others, those relating to failure to make payment, bankruptcy, breaches of representations and material adverse effects. We may prepay the principal of the Loan at any time without incurring any prepayment charges.

The Loan may be partially or fully forgiven if we comply with the provisions of the CARES Act, including the use of Loan proceeds for payroll costs, rent, utilities and certain other expenses, and at least 75% of the Loan proceeds must be used for payroll costs as defined in the CARES Act. Any forgiveness of the Loan will be subject to approval by the SBA and the Lender.

In the future, it is possible that we will need additional capital to fund our operations, particularly growth initiatives, which we expect we would raise through a combination of equity offerings, debt financings, other third-party funding and other collaborations and strategic alliances. We may also attempt to raise capital through dispositions of our assets, such as our sale of the dating services business in January 2019 and our pending sale of the Secured Communications Assets. In addition, we may in the future seek to sell all or a portion of our XPX tokens or Vumber, a small telecommunications services provider that we operate, or certain of our patents, which we refer to collectively as our non-core properties. Our need to generate additional capital will largely depend on future capital requirements, which in turn will depend on many factors including our growth rate, headcount, sales and marketing activities, research and development efforts and the introduction of new features, products, acquisitions and continued user engagement. 

Operating Activities

Net cash provided by operating activities was $16,892 for the three months ended March 31, 2020, as compared to net cash used in operating activities of $2,787,027 for the three months ended March 31, 2019. The increase in net cash provided by operating activities of $2,803,919 was mainly as a result of the non-recurring payments of related legal and transaction fees in connection to the sale of the dating services business.

Investing Activities

There was no net cash provided by investing activities for the three months ended March 31, 2020, as compared to net cash provided by investing activities of $1,500,295 for the three months ended March 31, 2019. The decrease in net cash provided by investing activities for the three months ended March 31, 2020 was primarily due to the absence of proceeds from the sale of the dating services business.

Financing Activities

There was net cash of $7,240 used in financing activities for the three months ended March 31, 2020 as compared to no net cash used in financing activities for the three months ended March 31, 2019. The increase in net cash used in financing activities for the three months ended March 31, 2020 was primarily due to the repurchase of common stock pursuant to our repurchase plan.

Contractual Obligations and Commitments

There have been no material changes to our contractual obligations and commitments disclosed in the contractual obligations and commitments section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Form 10-K.

Off-Balance Sheet Arrangements

As of March 31, 2020, we did not have any off-balance sheet arrangements. 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, including our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, our Chief Executive Officer recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

Based on the evaluation as of March 31, 2020, for the reasons set forth below, our management concluded that our disclosure controls and procedures were not effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis. In its assessment of the effectiveness of internal control our financial reporting as of March 31, 2020, the Company determined that the following item constituted a material weakness:

Changes in Internal Control over Financial Reporting

We have implemented changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act) during the first quarter of 2020, related to general information technology controls in the area of change management in order to remediate the material weakness identified above. We will continue to test these controls to ensure that they appropriately address and remediate the material weakness identified above.

There have been no other changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act) during the quarterly period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On December 16, 2016, a wholly owned subsidiary of the Company, Paltalk Holdings, Inc., filed a patent infringement lawsuit in Delaware against Riot Games, Inc. and Valve Corporation for infringement of U.S. Patent Nos. 5,822,523 and 6,226,686 with respect to their online games League of Legends and Defense of the Ancients 2. These two patents were previously asserted against, and then licensed to, Microsoft, Sony, and Activision. In 2018, Valve Corporation moved to transfer the litigation from Delaware to the Western District of Washington. Such motion was granted by the court.

On November 2, 2017, Riot Games, Inc. filed a total of four petitions for inter partes review with the United States Patent and Trademark Office, two per patent held by Paltalk Holdings, Inc., seeking to have the Paltalk Holdings, Inc. patents declared invalid. On May 15, 2018, inter partes review was instituted, and on February 13, 2019, the Patent Trial and Appeal Board (the “PTAB”) held a hearing on the matter. On May 14, 2019 the PTAB rejected the validity of the patents. On September 27, 2019, the Company filed an appeal of the PTAB’s ruling.

To our knowledge, other than as described above, there are no material pending legal proceedings to which we are a party or of which any of our property is the subject.

ITEM 1A. RISK FACTORS

Except as follows, there were no material changes to the Risk Factors disclosed in “Item 1A. Risk Factors” in the Form 10-K. For more information concerning our risk factors, please see “Item 1A. Risk Factors” in the Form 10-K. 

The recent coronavirus outbreak may adversely affect our revenues, results of operations and financial condition.

In December 2019, a strain of coronavirus was reported to have surfaced in Wuhan, China, and has reached multiple other countries, including the United States, resulting in government-imposed quarantines, travel restrictions and other public health safety measures in the United States and other affected countries. The various precautionary measures taken by many governmental authorities around the world in order to limit the spread of the coronavirus have had and could continue to have an adverse effect on the global markets and its economy, including on the availability and pricing of employees and resources, and other aspects of the global economy. Therefore, the coronavirus could disrupt and cause delays in our software, disrupt the marketplace in which we operate, slow down the overall economy, curtail consumer spending, make it hard to adequately staff our operations or enter into agreements with independent contractors and have a material adverse effect on our operations. In addition, disruptions in the operations of the third parties with whom we do business have caused and could in the future cause such third parties to fail to perform under their respective contracts or commitments with us. For instance, we are party to a sublease agreement with Telecom Infrastructure Corp. (“Telecom”) for office space located at 122 East 42nd Street in New York, NY, pursuant to which Telecom is required to pay us $11,164 per month. We have been notified that, due to the coronavirus outbreak, Telecom is currently unable to make its monthly payments under the sublease agreement. While we are currently in discussions with Telecom concerning its nonpayment and are exploring all remedies available to us, Telecom’s continued failure to make its monthly payments under the sublease agreement could negatively impact our financial condition and results of operations.

The extent to which the coronavirus impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus and the actions to contain the coronavirus or treat its impact, among others.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Unregistered Sale of Equity Securities 

There were no sales of unregistered securities during the quarter ended March 31, 2020 that were not previously reported on a Current Report on Form 8-K.

Issuer Repurchases of Common Stock

The following table details our repurchases of common stock during the three months ended March 31, 2020:

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

On April 13, 2020, to help ensure adequate liquidity in light of the uncertainties posed by the coronavirus pandemic, the Company applied for the Loan, and on May 3, 2020, the Company entered into the Note in favor of the Lender.

The Note has a two-year term, matures on May 3, 2022, and bears interest at a stated rate of 1.0% per annum. Monthly principal and interest payments will commence in December 2020. The Company did not provide any collateral or guarantees for the Loan, nor did the Company pay any facility charge to obtain the Loan. The Note provides for customary events of default, including, among others, those relating to failure to make payment, bankruptcy, breaches of representations and material adverse effects. The Company may prepay the principal of the Loan at any time without incurring any prepayment charges.

The Loan may be partially or fully forgiven if the Company complies with the provisions of the CARES Act, including the use of Loan proceeds for payroll costs, rent, utilities and certain other expenses, and at least 75% of the Loan proceeds must be used for payroll costs as defined in the CARES Act. Any forgiveness of the Loan will be subject to approval by the SBA and the Lender. 

The foregoing description of the Note does not purport to be complete and is qualified in its entirety by reference to the full text of the Note, a copy of which is filed as Exhibit 10.1 to this report and is incorporated by reference herein.

ITEM 6. EXHIBITS

(a) Exhibits required by Item 601 of Regulation S-K.

SIGNATURES

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

27