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 June 30, 2019

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) 594-5050

(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.

PEERSTREAM, INC. QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2019

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 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, 2018, which was filed with the Securities and Exchange Commission (the “SEC”) on March 22, 2019. 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 developing enhanced security and privacy solutions for multimedia communication and data transmission. Our offerings target consumer, government and enterprise clients. Using multi-layered encryption, blockchain technology and other recent innovations, we are developing our proprietary PeerStream Protocol (“PSP”) to offer clients maximal data security and confidentiality over distributed or decentralized networks. We also offer our Backchannel product suite, which includes cross platform applications, middleware and software development kits (“SDKs”) designed to offer a highly secure end user communication experience when coupled with PSP. For 20 years, we have built and continue to operate innovative consumer applications, including Paltalk and Camfrog, two of the largest live video social communities. The Company has a long history of technology innovation and holds 26 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, 2018, filed with the SEC on March 22, 2019 (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 six months ended June 30, 2019 are not necessarily indicative of results for the year ending December 31, 2019, 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 six months ended June 30, 2019, 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. 

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 and the valuation allowance on deferred tax assets. 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.

Recent Accounting Pronouncements

In January 2017, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. This standard, which will be effective for the Company beginning in the first quarter of fiscal year 2020, is required to be applied prospectively. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact this standard will have on its condensed consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 replaces the incurred loss impairment methodology in current GAAP with a methodology that utilizes expected credit losses to provide for an allowance for credit losses for financial instruments and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendments in this ASU require a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The income statement includes the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. The amendments affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, and interim periods within those annual periods with early adoption permitted for fiscal years beginning after December 31, 2018 and interim periods within such year. The Company adopted this guidance, and its adoption did not have any significant impact on the Company’s condensed consolidated financial statements and related disclosures.

Revenue

In accordance with ASC No. 606, 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 six months ended June 30, 2019 and 2018, 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, 2018 was $1,468,571, of which approximately $1,150,454 was subsequently recognized as subscription revenue during the six months ended June 30, 2019. The ending balance of deferred revenue at June 30, 2019 was $1,477,367. 

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 $1,478,239 and $2,899,073 for the three and six months ended June 30, 2019, respectively. Virtual gift revenue was approximately $1,742,423 and $3,752,923 for the three and six months ended June 30, 2018, 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.

Technology Service Revenue

Revenue under the Company’s technology services agreement (the “ProximaX Agreement”) with ProximaX Limited (“ProximaX”) is 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. The portion of the upfront fee that remained unrecognized as of the termination of the ProximaX Agreement was $1,631,105 and was recognized as revenue upon such termination.

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 $2.5 million due under the ProximaX Agreement. Since there is no assurance of collectability on the remaining payments, revenue will be recognized as the payments under the Termination Agreement are received.

Digital Tokens

Digital tokens consist of XPX tokens received in connection with the technology services agreement with ProximaX. 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.

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 is based on the quoted market prices on the Kryptono Exchange.

During the second quarter of 2019, the Company sold 16,604,747 digital tokens for $56,100. The loss recorded of approximately $8,000 was immaterial in respect to the condensed consolidated financial statements. 

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 $100,000 of the purchase price to be 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 condensed 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 condensed 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:

Property and equipment, net consisted of the following at June 30, 2019 and December 31, 2018:

Depreciation expense for the three and six months ended June 30, 2019 was $88,820 and $177,435, respectively, as compared to $106,148 and $206,138 for the three and six months ended June 30, 2018, respectively.

The Company only holds property and equipment in the United States.  

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Intangible assets, net consisted of the following at June 30, 2019 and December 31, 2018: 

Amortization expense for the three and six months ended June 30, 2019 was $64,083 and $128,165, respectively, as compared to $421,189 and $842,372 for the three and six months ended June 30, 2018, respectively. The estimated aggregate amortization expense for each of the next five years will be $128,167 in 2019, $246,681 in 2020, $184,667 in 2021, $149,944 in 2022 and $46,599 in 2023.

Accrued expenses and other current liabilities consisted of the following at June 30, 2019 and December 31, 2018:

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 June 30, 2019, our conclusion regarding the realizability of our US deferred tax assets did not change and we have recorded a full valuation allowance against them.

For the three months ended June 30, 2019, the Company recorded an income tax provision of $163,490 from continuing operations. The Company recorded an income tax provision for state and local taxes and reversed the income tax benefit recorded during the three months ended March 31, 2019 as the intra-period allocation guidance no longer applies as the Company reported income from both continuing and discontinued operations. For the six-months ended June 30, 2019, the Company recorded an income tax provision of $4,500. The effective tax rate for the three and six months ended June 30, 2019 was 35.9% and 1.18%, respectively.

For the three and six months ended June 30, 2018, the Company recorded an income tax provision from continuing operations of $15,500 and $15,500, respectively. The effective tax rate for the three and six months ended June 30, 2018 was (0.80%) and (0.56%), respectively. The effective tax rate differs from the statutory rate of 21% as no benefit has been provided to current year pre-tax losses as the Company concluded its deferred tax assets are not realizable on a more-likely-than-not basis.

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 181,604 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 June 30, 2019, there were 418,346 shares available for future issuance under the 2016 Plan.

On April 29, 2019, we implemented a stock repurchase plan to repurchase up to $500 thousand of our common stock for cash. The repurchase plan expires on April 29, 2020. There were no repurchased shares of our common stock as of June 30, 2019.

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 the 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 adjusts pre-vesting forfeitures to reflect actual forfeitures as the stock-based awards vest. 

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table summarizes stock option activity during the six months ended June 30, 2019:

On May 7, 2019, in connection with Judy Krandel’s resignation as an officer and employee of the Company, the Company (i) entered into an option cancellation and release agreement, pursuant to which the Company canceled Ms. Krandel’s option award agreement, dated November 15, 2016, related to the award of a stock option representing the right to purchase 142,857 shares of common stock and (ii) entered into a revised option agreement granting Ms. Krandel a stock option representing the right to purchase up to 142,857 shares of common stock at an exercise price equal to $3.55 per share (the “Revised Option Agreement”). The stock option subject to the Revised Option Agreement vests: (i) 50% on the date of grant, (ii) 25% on May 15, 2019 and (iii) 25% in 12 equal installments on the 15th day of each month, with the first tranche vesting on June 15, 2019 and the last tranche vesting on May 15, 2020. The Company accounted for these agreements as an option modification and recognized approximately $115,000 of stock compensation expense in connection with the agreements.

At June 30, 2019, there was $810,526 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted average period of 1.3 years.

On June 30, 2019, the aggregate intrinsic value of stock options that were outstanding and exercisable was $154,514 and $99,340, respectively. On June 30, 2018, the aggregate intrinsic value of stock options that were outstanding and exercisable was $2,923,478 and $1,400,918, 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 six months ended June 30, 2019, the Company granted options to employees to purchase an aggregate 193,294 shares of common stock at exercise prices ranging from $3.55 to $4.55 per share. The options vest on the grant date or between one and four years and have a term of ten years.

The aggregate fair value for the options granted during the six months ended June 30, 2019 was $337,598. The aggregate fair value for the options granted during the six months ended June 30, 2018 was $522,774.

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

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Restricted Stock Awards

The following table summarizes restricted stock award activity for the six months ended June 30, 2019:

At June 30, 2019, there was $185,374 of total unrecognized compensation expense related to unvested restricted stock awards, which is expected to be recognized over a weighted average period of 0.3 years.

Stock-based compensation expense relating to restricted stock awards included in general and administrative expense for the three and six months ended June 30, 2019 was $185,374 and $370,748, respectively, as compared to $185,374 and $370,746 for the three and six months ended June 30, 2018, respectively.

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 loss per share of common stock.

The weighted-average number of shares used in the calculation of basic and diluted earnings per share attributable to the Company’s common stockholder’s consists of the following:

For the three and six months ended June 30, 2018, 1,063,509 shares upon the exercise of outstanding stock options and 158,571 shares of unvested restricted stock were not included in the computation of diluted net loss per share because their inclusion would be antidilutive.

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 September 18, 2017, the Company entered into a lease agreement for a second office space located at 122 East 42nd Street in New York, NY that expired on July 31, 2019 and paid a security deposit in the amount of $8,000. The Company’s monthly office rent payments under the lease are currently approximately $4,000 per month.

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

On May 1, 2019, the Company entered into a lease agreement for an additional 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 a month. The term of the sublease runs until April 26, 2023.

As of June 30, 2019, the Company had no long-term leases that were classified as financing leases. As of June 30, 2019, the Company did not have additional operating and financing leases that have not yet commenced. 

Total operating lease expense for the six months ended June 30, 2019 was $178,305 and is recorded in general and administrative expense on the unaudited condensed statements of operations.

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. The Company is currently pursuing 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 June 30, 2019. 

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 and six months ended June 30, 2019 and 2018, (ii) the consolidated financial statements and notes thereto for the year ended December 31, 2018 included in our Annual Report on Form 10-K (the “Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on March 22, 2019 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, 2018, 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 the Form 10-K.

Recent Developments

CFO Resignation

On April 30, 2019, Judy Krandel announced that she would be resigning from her position as our Chief Financial Officer, effective May 6, 2019. Following Ms. Krandel’s resignation, Alexander Harrington, the Company’s Chief Executive Officer, has assumed the role of our principal financial officer while we search for a permanent replacement Chief Financial Officer. Concurrent with the announcement of Ms. Krandel’s resignation, we entered into a Consulting Agreement with Ms. Krandel, effective May 6, 2019, pursuant to which Ms. Krandel has agreed to perform certain transitional services for the Company as a Senior Business Development consultant.

Termination of ProximaX Agreement

As previously disclosed, on March 21, 2018, we entered into a technology services agreement with ProximaX Limited (“ProximaX”) whereby we agreed to provide certain development and related services to ProximaX to facilitate the implementation of PeerStream Protocol into ProximaX’s proprietary blockchain protocol that is currently under development (the “ProximaX Agreement”). 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 our 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.

In the second quarter of 2019, we 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 us that capital constraints made it unable to pay us the $2.5 million as stipulated under the ProximaX Agreement. Accordingly, following negotiations between the parties, on June 29, 2019, we entered into an agreement with ProximaX, effective June 24, 2019 (the “Termination Date”), to terminate the ProximaX Agreement (the “Termination Agreement”) and provide for payment terms for the $2.5 million due under the ProximaX Agreement.

Pursuant to the Termination Agreement, the parties agreed, among other things, that (i) we have no further obligation to provide any deliverables or services under the ProximaX Agreement, including any services related to the completion of the third development milestone, (ii) all services performed by us under the ProximaX Agreement are accepted by ProximaX and (iii) all payments previously made by ProximaX to us prior to the Termination Date are final and non-refundable.

Under the Termination Agreement, ProximaX also acknowledged and agreed to pay us the $2.5 million owed for the completion of the second development milestone as follows:

If ProximaX raises capital prior to December 31, 2019, ProximaX is required to apply a percentage of the net cash proceeds from such capital raise towards the Remaining Balance as follows: 5% of the net cash proceeds from the first $5.0 million of capital raised; 10% of the net cash proceeds from the next $2.5 million of capital raised; and 15% of the net cash proceeds from any additional capital raised. Any amount of the Remaining Balance outstanding as of December 31, 2019 after the application of the net cash proceeds from a capital raise, if any, will be paid in security tokens issued by ProximaX.

Overview

We are a communications software innovator developing enhanced security and privacy solutions for multimedia applications and data transmission. Our offerings target consumer, government and enterprise clients. Using multi-layered encryption, blockchain technology and other recent innovations, we are developing our proprietary PeerStream Protocol (“PSP”) to offer clients maximal data security and confidentiality over distributed or decentralized networks. We also offer our Backchannel product suite which includes cross platform applications, middleware and software development kits (“SDKs”) designed to offer a highly secure end user communication experience when coupled with PSP. For 20 years, we have built and continue to operate innovative consumer applications, including Paltalk and Camfrog, two of the largest live video social communities. The Company has a long history of technology innovation and holds 26 patents.

In March 2018, we launched our proprietary software business centered around the development of PSP and Backchannel. In addition, we began providing professional services to customize and integrate our software solutions to meet client needs. In late March 2018, we secured our first software licensing and implementation client, ProximaX, by entering into the ProximaX Agreement. We are seeking to grow our software licensing and technology implementation business by securing new clients to license PSP and/or Backchannel, as well as implement these products into their existing systems.

We also 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. As of August 1, 2019, our consumer applications were supported by a large user database with approximately 106,200 active subscribers worldwide, which excludes active subscribers to our dating services business, which was sold in January 2019.

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

Our continued growth depends on the expansion of our software licensing and implementation services business, attracting new consumer application users through the introduction of new applications and features and further penetration of our existing markets. Our principal growth strategy is to continue investing 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 advertising campaigns that we run through internet and mobile advertising networks. 

Operational Highlights and Objectives 

During the six months ended June 30, 2019, we executed key components of our objectives: 

For the near term, our business objectives include:

Sources of Revenue

Through the end of the first quarter of 2018, our sources of revenue were limited to subscription, advertising and other fees generated from users of our video chat and dating products. Beginning in April 2018, we started generating revenue through proprietary software licensing and technology implementation services as a result the ProximaX Agreement. 

Consumer Applications

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 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.

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 Services Revenue

Technology services 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 will provide. More specifically, we expect that we will generate technology services revenue from our software solutions, such as PSP, through licenses to our clients that may be bundled with service and support packages. In addition, technology services 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.

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. We expect to experience corresponding growth in our cost of revenue as our software licensing and technology implementation services business grows.

Sales and marketing expense. Sales and marketing expense consists 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.

We expect sales and marketing expense to potentially increase in future periods if we gain positive market feedback and expand our efforts in executing our software licensing and technology implementation services strategy. 

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.

As a result of the launch of our software licensing and technology implementation services business, we anticipate product development expense to increase in future periods as we expect to hire additional developers dedicated to the internal development of new software and technologies we plan to offer for license.

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, 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.

Active subscribers worldwide in all periods presented excludes active subscribers to the dating services business, which was sold in January 2019. 

Subscription Bookings

Subscription bookings is a financial measure representing the aggregate dollar value of subscription fees 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. 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. 

Subscription bookings in all periods presented excludes subscription bookings from the dating services business, which was sold in January 2019. 

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, net, gain on the sale of dating applications, income tax benefit from discontinued operations, income tax expense from continuing operations, depreciation and amortization expense, impairment loss on digital tokens 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.

Limitations of Adjusted EBITDA

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:

Because of these limitations, you should consider Adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net 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 consolidated statements of operations and present the related assets and liabilities as held for sale in our 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 our Notes to 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 June 30, 2019 Compared to Three Months Ended June 30, 2018

Revenue

Revenue decreased to $4,872,874 for the three months ended June 30, 2019 from $5,825,157 for the three months ended June 30, 2018. The decrease was driven by a decline of $379,927 of technology service revenue recognized under the ProximaX Agreement, along with a decline of $426,573 in subscription revenue partly as a result of lower virtual goods transaction volume and a 5.4% decline in active subscribers, as well as a decrease of $145,783 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 June 30, 2019 and the three months ended June 30, 2018, 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 June 30, 2019 decreased by $426,573, or 12.3%, as compared to the three months ended June 30, 2018. The decrease in subscription revenue was mainly driven by lower virtual gift transaction volume for both Paltalk and Camfrog products, corresponding to lower monthly active usage. In addition, a decrease in active subscribers of approximately 6,000, or 5.4%, contributed to the decrease in subscription revenue. 

Advertising Revenue – Our advertising revenue for the three months ended June 30, 2019 decreased by $145,783, or 56.8%, as compared to the three months ended June 30, 2018. The decrease in advertising revenue resulted in part from a 21.2% decline in active users. We also believe a significant portion of the decrease was related to challenges in the digital advertising industry due to a greater emphasis on fraud control, resulting in lower demand and pricing.

Technology Service Revenue – For the three months ended June 30, 2019, we generated $1,712,105 of technology service revenue in exchange for providing certain development and related services to ProximaX to facilitate the integration of PSP into ProximaX’s proprietary blockchain protocol that is currently under development. The portion of the upfront fee associated with the ProximaX Agreement that remained unrecognized as of the termination of the ProximaX Agreement was $1,631,105 and was recognized as revenue upon such termination. Since there is no assurance of collectability on the payments due under the Termination Agreement, revenue will be recognized as the payments are received.

Costs and Expenses

Total costs and expenses for the three months ended June 30, 2019 reflect a decrease of $711,407, or 13.8%, as compared to the three months ended June 30, 2018. The following table presents our costs and expenses for the three months ended June 30, 2019 and 2018, 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:

Cost of revenue – Our cost of revenue for the three months ended June 30, 2019 decreased by $110,184, or 11.0%, as compared to the three months ended June 30, 2018. The decrease for the three months ended June 30, 2019 was primarily driven by a decrease of approximately $134,000 from headcount reduction in our technical personnel and consulting services related to technology service revenue.

Sales and marketing expense – Our sales and marketing expense for the three months ended June 30, 2019 decreased by $202,132, or 46.7%, as compared to the three months ended June 30, 2018. The decrease in sales and marketing expense for the three months ended June 30, 2019 was primarily due to a decrease in Paltalk marketing expenditures of approximately $156,200 along with a decrease of approximately $42,100 related to headcount reductions to marketing personnel.

Product development expense – Our product development expense for the three months ended June 30, 2019 increased by $203,896, or 13.5%, as compared to the three months ended June 30, 2018. The increase was primarily due to an increase in compensation expense of approximately $107,300 due to newly hired personnel in the product development department. 

General and administrative expense – Our general and administrative expense for the three months ended June 30, 2019 decreased by $602,987, or 27.2%, as compared to the three months ended June 30, 2018. The decrease in general and administrative expense for the three months ended June 30, 2019 was in part due to a decrease in legal expenses of approximately $185,000 and the absence of non-recurring charges from 2018 such as approximately $113,000 of transaction fees relating to cryptocurrency translation into U.S. dollars and $100,000 of consulting fees paid to a former board member.

Non-Operating Income (Loss)

The following table presents the components of non-operating income (loss) for the three months ended June 30, 2019 and the three months ended June 30, 2018, the increase between those periods, the percentage increase between those periods and the percentage of total revenues that each represented for those periods:  

Non-operating income for the three months ended June 30, 2019 was $183,827, a net increase of $2,697,265, as compared to non-operating loss of $2,513,438 for the three months ended June 30, 2018. The increase in non-operating income was driven by the gain on the sale of the dating services business, along with the absence of impairment losses on digital tokens.

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 June 30, 2019 and 2018, the Company recorded an income tax provision from continuing operations of $163,490 and $15,500, respectively. The Company recorded an income tax provision for state and local taxes and reversed the income tax benefit recorded during the three months ended March 31, 2019 as the intra-period allocation guidance no longer applies as the Company reported income from both continuing and discontinued operations.

As of June 30, 2019, our conclusion regarding the realizability of our US deferred tax assets did not change and we have recorded a full valuation allowance against them.

Six Months Ended June 30, 2019 Compared to Six Months Ended June 30, 2018

Revenue

Revenue decreased to $9,746,049 for the six months ended June 30, 2019 from $9,895,561 for the six months ended June 30, 2018. The decrease was driven by a decline of $1,259,623 in subscription revenue primarily as a result of lower virtual goods transaction volume and a 5.4% decline in active subscribers, as well as a decrease of $258,292 in advertising revenue across all products, offset by an increase of $1,368,403 in technology service revenue generated under the ProximaX Agreement.

The following table sets forth our subscription revenue, advertising revenue, technology service revenue and total revenues for the six months ended June 30, 2019 and the six months ended June 30, 2018, 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:

Subscription Revenue – Our subscription revenue for the six months ended June 30, 2019 decreased by $1,259,623, or 17.2%, as compared to the six months ended June 30, 2018. The decrease in subscription revenue was mainly driven by lower virtual gift transaction volume for both Paltalk and Camfrog products, corresponding to lower monthly active usage. In addition, a decrease in active subscribers of approximately 6,000, or 5.4%, contributed to the decrease in subscription revenue.  

Advertising Revenue – Our advertising revenue for the six months ended June 30, 2019 decreased by $258,292, or 52.8%, as compared to the six months ended June 30, 2018. The decrease in advertising revenue primarily resulted from a 21.2% decline in active users. We also believe a significant portion of the decrease was related to challenges in the digital advertising industry due to a greater emphasis on fraud control, resulting in lower demand and pricing.

Technology Service Revenue – For the six months ended June 30, 2019, we generated $3,460,435 of technology service revenue in exchange for providing certain development and related services to ProximaX to facilitate the integration of PSP into ProximaX’s proprietary blockchain protocol that is currently under development. Technology service revenue is generated through software licensing and technology implementation services and has increased by $1,368,403, or 65.4%, as compared to the six months ended June 30, 2018. The portion of the upfront fee associated with the ProximaX Agreement that remained unrecognized as of the termination of the ProximaX Agreement was $1,631,105 and was recognized as revenue upon such termination.  Since there is no assurance of collectability on the remaining payments due under the Termination Agreement, revenue will be recognized as the payments are received.

Costs and Expenses

Total costs and expenses for the six months ended June 30, 2019 reflect a decrease in costs and expenses of $255,174, or 2.6%, as compared to the six months ended June 30, 2018. The following table presents our costs and expenses for the six months ended June 30, 2019 and 2018, 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:

Cost of revenue - Our cost of revenue for the six months ended June 30, 2019 increased by $113,004, or 6.5%, as compared to the six months ended June 30, 2018. The increase for the six months ended June 30, 2019 was primarily driven by an increase in compensation expense of approximately $94,400 due to increased headcount in system administration support.

Sales and marketing expense - Our sales and marketing expense for the six months ended June 30, 2019 decreased by $190,960, or 23.9%, as compared to the six months ended June 30, 2018. The decrease in sales and marketing expense for the six months ended June 30, 2019 was primarily due to a decrease in marketing expenditures of approximately $118,800 related to our video properties along with a decrease of approximately $83,600 in compensation to marketing personnel.

Product development expense - Our product development expense for the six months ended June 30, 2019 increased by $273,590, or 8.5%, as compared to the six months ended June 30, 2018. The increase was primarily due to an increase in Paltalk and technology services compensation expense of approximately $128,300 due to newly hired personnel in the product development department.

General and administrative expense - Our general and administrative expense for the six months ended June 30, 2019 decreased by $450,808, or 11.4%, as compared to the six months ended June 30, 2018. The decrease in general and administrative expense was primarily driven by the absence of non-recurring charges from 2018, such as approximately $113,000 of transaction fees relating to cryptocurrency conversion into U.S. dollars and $100,000 of consulting fees paid to a former board member.

Non-Operating Income (Loss)

The following table presents the components of non-operating income (loss) for the six months ended June 30, 2019 and the six months ended June 30, 2018, the increase between those periods, the percentage increase between those periods and the percentage of total revenues that each represented for those periods:  

Non-operating income for the six months ended June 30, 2019 was $776,684, a net increase of $3,647,007, as compared to non-operating loss of $2,870,323 for the six months ended June 30, 2018. The increase in non-operating income was driven by the gain on the sale of the dating services business, along with the impairment losses on digital tokens incurred in the six months ended June 30, 2018.

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 six months ended June 30, 2019 and 2018, the Company recorded an income tax provision from continuing operations of $4,500 and $15,500, respectively. The Company recorded an income tax provision for state and local taxes and reversed the income tax benefit recorded during the three months ended March 31, 2019 as the intra-period allocation guidance no longer applies as the Company reported income from both continuing and discontinued operations.

As of June 30, 2019, our conclusion regarding the realizability of our US deferred tax assets did not change and we have recorded a full valuation allowance against them.

Liquidity and Capital Resources 

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 June 30, 2019, we had $4,641,988 of cash and cash equivalents. 

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. To raise additional funds through dispositions, 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. 

Our primary use of working capital is related to product development resources in order to maintain and create new products, services and applications for our clients and users. In particular, a significant portion of our working capital has been allocated to the development of PSP and Backchannel. In the future, we may also seek to grow our business by expending our capital resources to fund strategic investments and partnership opportunities. 

Operating Activities

Net cash used in operating activities was $3,373,991 for the six months ended June 30, 2019, as compared to net cash provided by operating activities of $3,761,687 for the six months ended June 30, 2018. The decrease in net cash used in operating activities of $7,135,678 was mainly due to a one-time prepayment of the ProximaX Agreement during in the six months ended June 30, 2018. In addition, the decrease was in part a result of the non-recurring payment of residual liabilities in connection to the sale of the dating services business as well as the payments of related legal and transaction fees.

Investing Activities

Net cash provided by (used in) investing activities for the six months ended June 30, 2019 and 2018 was $1,460,603 and $(159,900), respectively. The increase in net cash provided by investing activities for the six months ended June 30, 2019 was primarily the result of proceeds from the sale of the dating services business.

Financing Activities

We did not have any net cash provided by (used in) financing activities for the six months ended June 30, 2019 and 2018.

Off-Balance Sheet Arrangements

As of June 30, 2019, 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 Chief Executive Officer, who serves as our principal executive and principal 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 June 30, 2019, we determined that we maintain effective disclosure controls and procedures.

Changes in Internal Control over Financial Reporting

There have been no 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 which 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. The Company is currently pursuing 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. 

ProximaX may not have sufficient cash resources to pay us amounts owed under our termination agreement and may be required to make payments to us in security tokens.

On June 29, 2019, we entered into the Termination Agreement with ProximaX to, among other things, terminate the remaining obligations under our technology services agreement with ProximaX. Under the Termination Agreement, ProximaX acknowledged and agreed to pay us $2.5 million that ProximaX owed us for services completed under our technology services agreement as follows:

The Termination Agreement also provides that if ProximaX raises capital prior to December 31, 2019, it will apply a portion of the net cash proceeds raised towards the remaining balance of the $2.5 million we are owed.

As a recently formed entity with limited capital, ProximaX may not have sufficient cash or liquid assets, and may not be able to raise sufficient capital, to make payments to us in cash under the Termination Agreement. As a result, ProximaX may be required to pay us in an equivalent amount of newly issued security tokens. The value of any security tokens that would be issued in the future by ProximaX is speculative, and the price of such security tokens may experience periods of extreme volatility due to (i) such tokens having a very limited trading history, (ii) the limited public supply of such tokens, (iii) a potential lack of adoption of such tokens by token holders, and (iv) such tokens trading on a limited number of token exchanges or any at all. As a result, any future acquisition of newly issued security tokens from ProximaX could subject our business to additional risks and could have a material adverse impact on our operations.

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 June 30, 2019 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 June 30, 2019:

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

None.

ITEM 5. OTHER INFORMATION

None. 

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.