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 September 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 SEPTEMBER 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 nine months ended September 30, 2019 are not necessarily indicative of results for the year ending December 31, 2019, or for any other period.

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

During the nine months ended September 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 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 nine months ended September 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 $1,389,978 was subsequently recognized as subscription revenue during the nine months ended September 30, 2019. The ending balance of deferred revenue at September 30, 2019 was $1,433,679. 

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 $1,245,041 and $4,144,114 for the three and nine months ended September 30, 2019, respectively. Virtual gift revenue was approximately $1,883,582 and $5,636,505 for the three and nine months ended September 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”) 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. 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 remaining $2.5 million due under the ProximaX Agreement. 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 September 30, 2019, the Company recognized approximately $22,400 in revenue in connection with payments received.

Digital Tokens

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.

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 on the Kryptono Exchange. In September 2019, the Kryptono Exchange announced that as part of its periodic review of its listed digital assets it was determined that ProximaX no longer met its standards for continued listing. Accordingly, it delisted and ceased trading for XPX tokens on October 4, 2019. Because the value of XPX as listed on other exchanges had declined significantly, the Company recorded an impairment charge in the amount of $503,464 which is reported as a component of other income and expenses in the accompanying condensed consolidated statements of operations for the three and nine months ended September 30, 2019.

For the nine months ended September 30, 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 September 30, 2019 and December 31, 2018:

Depreciation expense for the three and nine months ended September 30, 2019 was $84,587 and $262,022, respectively, as compared to $86,076 and $292,214 for the three and nine months ended September 30, 2018, respectively.

PEERSTREAM, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Amortization expense for the three and nine months ended September 30, 2019 was $64,084 and $192,249, respectively, as compared to $421,188 and $1,263,564 for the three and nine months ended September 30, 2018, respectively. The estimated aggregate amortization expense for each of the next five years will be $64,083 in 2019, $246,681 in 2020, $184,667 in 2021, $149,944 in 2022 and $46,599 thereafter.

Accrued expenses and other current liabilities consisted of the following at September 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 September 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 September 30, 2019, the Company recorded an income tax benefit from continuing operations of $157,180 on a pre-tax loss of $1,571,822. For the nine months ended September 30, 2019, the Company recorded an income tax benefit from continuing operations of $152,680 on a pre-tax loss of $1,199,213. The Company recorded an income tax provision for state and local taxes and, 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. The effective tax rate for the three and nine months ended September 30, 2019 was 10.0% and 12.73%, respectively.

For the three months ended September 30, 2018, the Company recorded an income tax benefit from continuing operations of $13,636. For the nine months ended September 30, 2018, the Company recorded an income tax provision from continuing operations of $1,864. The effective tax rate for the three and nine months ended September 30, 2018 was 10.5% and (0.10%), 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 September 30, 2019, there were 420,344 shares available for future issuance under the 2016 Plan.

On April 29, 2019, the Company implemented a stock repurchase plan to repurchase up to $500 thousand of its common stock for cash. The repurchase plan expires on April 29, 2020. The Company has not repurchased any shares of its common stock under the repurchase plan as of September 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 nine months ended September 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 September 30, 2019, there was $655,138 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted average period of 1.1 years.

On September 30, 2019, the aggregate intrinsic value of stock options that were outstanding and exercisable was $22,173 and $9,363, respectively. On September 30, 2018, the aggregate intrinsic value of stock options that were outstanding and exercisable was $1,752,348 and $825,048, 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 nine months ended September 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 nine months ended September 30, 2019 was $337,598. The aggregate fair value for the options granted during the nine months ended September 30, 2018 was $708,501.

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 nine months ended September 30, 2019:

At September 30, 2019, there was no unrecognized compensation expense related to unvested restricted stock awards.

Stock-based compensation expense relating to restricted stock awards included in general and administrative expense for the three and nine months ended September 30, 2019 was $185,374 and $556,122, respectively, as compared to $185,374 and $556,122 for the three and nine months ended September 30, 2018, respectively.

Basic net 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 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. For the three and nine months ended September 30, 2019, 1,055,691 shares upon the exercise of outstanding stock options and 79,286 shares of unvested restricted stock were not included in the computation of diluted net loss per share for continuing operations because their inclusion would be antidilutive. 

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

For the three and nine months ended September 30, 2018, 1,067,527 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 were 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 per month. The term of the sublease runs until April 26, 2023.

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

The Company recognizes right-of-use (“ROU”) assets and lease liabilities when it enters into a lease agreement. The Company evaluates the nature of each lease at the inception of an arrangement to determine whether it is an operating or financing lease and recognizes the ROU asset and lease liabilities based on the present value of future minimum lease payments over the expected lease term. The Company’s leases do not generally contain an implicit interest rate and therefore the Company uses the incremental borrowing rate it would expect to pay to borrow on a similar collateralized basis over a similar term in order to determine the present value of its lease payments. 

Total operating lease expense for the nine months ended September 30, 2019 was $309,537 and is recorded in general and administrative expense on the unaudited condensed statements of operations.

The following table summarizes the Company’s operating and financing leases as of and for the nine months ended September 30, 2019:

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 September 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 nine months ended September 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.

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 the future, we plan to grow our software licensing and technology implementation business by securing new clients to license PSP and/or Backchannel, as well as implementing 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.

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.

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. On October 18, 2019, we agreed to collaborate with a third party with a community of over 35 million monthly active users, which has agreed to promote a co-branded version of our Paltalk video chat program to its user base on a trial basis.

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 potential platform partnerships and new and existing advertising campaigns that we run through internet and mobile advertising networks.

Operational Highlights and Objectives 

During the nine months ended September 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 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 will provide. More specifically, we expect that we will generate technology service 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 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.

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 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.

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 loss adjusted to exclude net loss from discontinued operations, interest income, gain on the sale of dating applications, income tax expense from discontinued operations, income tax expense (benefit) 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 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 September 30, 2019 Compared to Three Months Ended September 30, 2018

Revenue

Revenue decreased to $2,958,439 for the three months ended September 30, 2019 from $5,304,734 for the three months ended September 30, 2018. The decrease was driven by a decline of $1,425,886 of technology service revenue recognized under the ProximaX Agreement, along with a decline of $746,401 in subscription revenue partly as a result of lower virtual goods transaction volume and a 5.5% decline in active subscribers, as well as a decrease of $174,008 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 September 30, 2019 and the three months ended September 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 September 30, 2019 decreased by $746,401, or 20.8%, as compared to the three months ended September 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 6,100, or 5.5%, contributed to the decrease in subscription revenue. 

Advertising Revenue – Our advertising revenue for the three months ended September 30, 2019 decreased by $174,008, or 66.2%, as compared to the three months ended September 30, 2018. The decrease in advertising revenue was primarily due to a decline in the volume of advertising impressions, which resulted from a 22.3% 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 September 30, 2019, we recognized $22,444 of technology service revenue as consideration for providing certain development and related services to ProximaX to facilitate the integration of PSP into ProximaX’s proprietary blockchain protocol. Under the terms of our termination agreement with ProximaX, effective June 24, 2019 (the “Termination Agreement”), ProximaX is 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 September 30, 2019 reflect a decrease of $841,360, or 17.2%, as compared to the three months ended September 30, 2018. The following table presents our costs and expenses for the three months ended September 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 September 30, 2019 decreased by $188,632, or 21.7%, as compared to the three months ended September 30, 2018. The decrease for the three months ended September 30, 2019 was primarily driven by a decrease in headcount in our technical personnel and consulting services.

Sales and marketing expense – Our sales and marketing expense for the three months ended September 30, 2019 decreased by $221,360, or 47.1%, as compared to the three months ended September 30, 2018. The decrease in sales and marketing expense for the three months ended September 30, 2019 was primarily due to a decrease in Paltalk marketing expenditures of approximately $144,100 along with a decrease of approximately $45,800 related to headcount reductions to marketing personnel.

Product development expense – Our product development expense for the three months ended September 30, 2019 increased by $31,536, or 1.9%, as compared to the three months ended September 30, 2018. The increase was primarily due to an increase of approximately $209,900 resulting from increased headcount of our technical personnel related to technology services. This increase was offset by a decrease of approximately $152,700 due to decreased headcount in the Paltalk product and engineering teams.

General and administrative expense – Our general and administrative expense for the three months ended September 30, 2019 decreased by $462,904, or 24.5%, as compared to the three months ended September 30, 2018. The decrease in general and administrative expense for the three months ended September 30, 2019 was in part due to a decrease in professional fees of approximately $198,700 and a decrease in compensation related expenses of approximately $105,500 due to headcount reduction.

Non-Operating Loss

The following table presents the components of non-operating loss for the three months ended September 30, 2019 and the three months ended September 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:  

Non-operating loss for the three months ended September 30, 2019 was $643,853, a net increase of $357,038, as compared to non-operating loss of $1,000,891 for the three months ended September 30, 2018. The decrease in non-operating loss was driven by the gain on the sale of the dating services business.

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 September 30, 2019 and 2018, the Company recorded an income tax benefit from continuing operations of $157,180 and $13,636, respectively.

As of September 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.

Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018

Revenue

Revenue decreased to $12,704,488 for the nine months ended September 30, 2019 from $15,200,295 for the nine months ended September 30, 2018. The decrease was driven by a decline of $2,006,025 in subscription revenue primarily as a result of lower virtual goods transaction volume and a 5.5% decline in active subscribers, as well as a decrease of $432,299 in advertising revenue across all products and a decrease of $57,483 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 nine months ended September 30, 2019 and the nine months ended September 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 nine months ended September 30, 2019 decreased by $2,006,025, or 18.4%, as compared to the nine months ended September 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 6,100, or 5.5%, contributed to the decrease in subscription revenue.

Advertising Revenue – Our advertising revenue for the nine months ended September 30, 2019 decreased by $432,299, or 57.4%, as compared to the nine months ended September 30, 2018. The decrease in advertising revenue was primarily due to a decline in the volume of advertising impressions, which resulted from a 22.3% 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 nine months ended September 30, 2019, we generated $3,482,879 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. Technology service revenue is generated through software licensing and technology implementation services and has decreased by $57,483, or 1.6%, as compared to the nine months ended September 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. Under the terms of the Termination Agreement, ProximaX is 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 remaining payments due under the Termination Agreement, revenue is being recognized as the payments are received.

Costs and Expenses

Total costs and expenses for the nine months ended September 30, 2019 reflect a decrease in costs and expenses of $1,115,086, or 7.6%, as compared to the nine months ended September 30, 2018. The following table presents our costs and expenses for the nine months ended September 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 nine months ended September 30, 2019 decreased by $75,629, or 2.9%, as compared to the nine months ended September 30, 2018. The decrease for the nine months ended September 30, 2019 was primarily driven by a decrease in compensation expense due to decreased headcount in system administration support.

Sales and marketing expense - Our sales and marketing expense for the nine months ended September 30, 2019 decreased by $412,320, or 32.5%, as compared to the nine months ended September 30, 2018. The decrease in sales and marketing expense for the nine months ended September 30, 2019 was primarily due to a decrease in marketing expenditures of approximately $275,100 related to our video properties along with a decrease of approximately $129,400 in compensation to marketing personnel.

Product development expense - Our product development expense for the nine months ended September 30, 2019 increased by $286,673, or 5.9%, as compared to the nine months ended September 30, 2018. The increase was primarily due to an increase in stock compensation expense of approximately $75,000 due to stock options granted to employees in the product development department, along with an increase in compensation expense of approximately $145,700 due to increased headcount in the product development department.

General and administrative expense - Our general and administrative expense for the nine months ended September 30, 2019 decreased by $913,810, or 15.7%, as compared to the nine months ended September 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. Additionally, there was a decrease in professional fees of approximately $282,900 and a decrease in compensation related expenses of approximately $229,200 due to headcount reduction.

Non-Operating Income (Loss)

The following table presents the components of non-operating income (loss) for the nine months ended September 30, 2019 and the nine months ended September 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:  

Non-operating income for the nine months ended September 30, 2019 was $132,831, a net increase of $3,985,493, as compared to non-operating loss of $3,852,662 for the nine months ended September 30, 2018. The increase in non-operating income was driven by the gain on the sale of the dating services business, along with the reduced impairment loss on digital tokens compared to that incurred in the nine months ended September 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 nine months ended September 30, 2019, the Company recorded an income tax benefit from continuing operations of $152,680. For the nine months ended September 30, 2018, the Company recorded an income tax provision from continuing operations of $1,864.

As of September 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 September 30, 2019, we had $3,625,237 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 $4,286,731 for the nine months ended September 30, 2019, as compared to net cash provided by operating activities of $3,301,115 for the nine months ended September 30, 2018. The increase in net cash used in operating activities of $7,587,846 was mainly due to a one-time prepayment of the ProximaX Agreement during the nine months ended September 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 nine months ended September 30, 2019 and 2018 was $1,356,592 and $(249,021), respectively. The increase in net cash provided by investing activities for the nine months ended September 30, 2019 was primarily the result of proceeds from the sale of the dating services business.

Financing Activities

There was no net cash provided by financing activities for the nine months ended September 30, 2019 as compared to net cash provided by financing activities of $28,210 for the nine months ended September 30, 2018.

Off-Balance Sheet Arrangements

As of September 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 September 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. 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

There were no material changes to the Risk Factors disclosed in “Item 1A. Risk Factors” in the Form 10-K, except as supplemented by the Risk Factors disclosed in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2019, which was filed with the SEC on August 8, 2019. For more information concerning our risk factors, please see “Item 1A. Risk Factors” in the Form 10-K. 

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 September 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 September 30, 2019: