INTELLIGENT PROTECTION MANAGEMENT CORP. 10-K

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Number Report of Independent Registered Public Accounting Firm F-1 Consolidated Balance Sheets as of December 31, 2020 and 2019 F-3 Consolidated Statements of Operations for the Years Ended December 31, 2020 and 2019 F-4 Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2020 and 2019 F-5 Consolidated Statements of Cash Flows for the Years Ended December 31, 2020 and 2019 F-6 Notes to Consolidated Financial Statements F-7 38 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Directors of Paltalk, Inc. and Subsidiaries Opinion on the Financial Statements We have audited the accompanying consolidated balance sheets of Paltalk, Inc. and Subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate. Evaluation of the Accounting for and Disclosure of Digital Tokens and Related Technology Service Revenue As disclosed in Notes 2 and 7 to the consolidated financial statements, the Company’s digital tokens, which mainly consist of utility tokens (“Props”), held as of December 31, 2020, are accounted for as indefinite-lived intangible assets, and have been included in non-current assets on the consolidated balance sheet. The Company’s digital tokens as of December 31, 2020 totaled $439,145. F- 1 Also, as disclosed in Note 2 and 7 to the consolidated financial statements, during the year ended December 31, 2020 the Company entered into a contract with a customer to provide technology services, which included the Company agreeing to serve as a launch partner, integrate the customer’s Props infrastructure into the Company’s multimedia social applications, perform side-chain validator services and operate a loyalty program for the customer. Additionally, the Company was to provide Props under the loyalty platform to its customers based on their usage and activities on its multimedia social applications. In exchange for these services, the revenue earned by the Company was to be paid in Props. The Props were recorded at their estimated fair value on the transaction dates. In connection with the agreement, the Company recognized revenue related to the technology services of $525,748, of which $210,000 was included as a receivable as of December 31, 2020. Digital tokens owed to the Company’s customers under the loyalty program as of December 31, 2020 totaled $123,397 and were recorded as a current liability. We identified the accounting for and disclosure of digital tokens and the related technology service revenue as a critical audit matter for the following reasons. Currently, no authoritative guidance exists for the accounting for and disclosure of digital assets in accordance with accounting principles generally accepted in the United States (“GAAP”). The Company’s management has exercised significant judgment in their determination of how existing GAAP should be applied to the accounting for digital assets, the related technology service revenue, the associated financial statement presentation and accompanying footnote disclosures. Further, specialists were required to perform audit procedures to test the valuation of the Props token used in the determination of the Company’s recognition of technology service revenue, and with the associated carrying amounts of the digital token assets and liability. The primary procedures we performed to address this critical audit matter included the following: ● We evaluated management’s rationale for the application of Accounting Standards Codification (“ASC”) 350 to account for its digital tokens held and application of ASC 606 for the related technology service revenue; ● We evaluated management’s basis for recording digital token intangible assets and receivables as a non-current asset, and digital tokens payable as a current liability on the balance sheet; ● We evaluated management’s disclosures of its digital token activity in the financial statement footnotes; ● We confirmed digital asset receivables and payables with the Company’s customer and examined supporting documentation and evidence of Props earned by the Company and its customers; ● We tested the digital token activity by comparing the Company’s digital tokens wallet records to publicly available blockchain records; ● We performed testing procedures to gain reasonable assurance that the digital wallets and associated addresses were owned by the Company; and ● We utilized our internal valuation specialist to test the valuation methods and assumptions used by management to estimate the value of the digital tokens earned and held. /s/ Marcum LLP Marcum LLP We have served as the Company’s auditor since 2016. Melville, NY March 23, 2021 F- 2 PALTALK, INC. CONSOLIDATED BALANCE SHEETS December 31, 2020 2019 Assets Current assets: Cash and cash equivalents $ 5,585,420 $ 3,427,058 Accounts receivable, net of allowances of $3,648 and $23,832, as of December 31, 2020 and 2019, respectively 71,410 130,686 Prepaid expense and other current assets 236,704 167,441 Total current assets 5,893,534 3,725,185 Digital tokens receivable 210,000 - Operating lease right-of-use asset 68,967 685,042 Property and equipment, net 255,777 620,059 Goodwill 6,326,250 6,326,250 Intangible assets, net 381,210 627,891 Digital tokens 439,145 148,229 Other assets 13,937 86,876 Total assets $ 13,588,820 $ 12,219,532 Liabilities and stockholders’ equity Current liabilities: Accounts payable $ 742,141 $ 1,007,851 Accrued expenses and other current liabilities 254,084 434,739 Operating lease liabilities, current portion 68,967 178,479 Digital tokens payable 123,397 - Term debt, current portion 338,792 - Deferred subscription revenue 2,058,721 1,829,493 Total current liabilities 3,586,102 3,450,562 Operating lease liabilities, non-current portion - 583,075 Term debt, non-current portion 167,708 - Total liabilities 3,753,810 4,033,637 Commitments and contingencies Stockholders’ equity: Common stock, $0.001 par value, 25,000,000 shares authorized, 6,916,404 and 6,878,904 shares issued and 6,906,454 and 6,877,004 shares outstanding as of December 31, 2020 and 2019, respectively 6,917 6,879 Treasury stock, 9,950 and 1,900 shares, at par as of December 31, 2020 and 2019, respectively (10,859 ) (2,015 ) Additional paid-in capital 21,568,041 21,281,382 Accumulated deficit (11,729,089 ) (13,100,351 ) Total stockholders’ equity 9,835,010 8,185,895 Total liabilities and stockholders’ equity $ 13,588,820 $ 12,219,532 The accompanying notes are an integral part of these consolidated financial statements. F- 3 PALTALK, INC. CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended December 31, 2020 2019 Revenues Subscription revenue $ 11,966,497 $ 11,405,787 Advertising revenue 325,475 438,503 Technology service revenue 540,700 3,439,327 Total revenue 12,832,672 15,283,617 Costs and expenses Costs of revenue 2,573,083 3,174,453 Sales and marketing expense 825,069 1,056,967 Product development expense 5,025,482 6,563,449 General and administrative expense 3,166,343 6,343,859 Impairment loss on goodwill - 6,760,222 Total costs and expenses 11,589,977 23,898,950 Income (loss) from continuing operations 1,242,695 (8,615,333 ) Interest income, net 7,119 156,423 Gain from sale of Secured Communications Assets 250,000 - Other expense (128,165 ) - Impairment loss on digital tokens - (625,368 ) Income (loss) from continuing operations before provision for income taxes 1,371,649 (9,084,278 ) Income tax (expense) benefit (387 ) 141,593 Net income (loss) from continuing operations 1,371,262 (8,942,685 ) Discontinued Operations: Gain on sale from discontinued operations - 826,770 Loss from discontinued operations - (104,880 ) Income tax expense from discontinued operations - (159,265 ) Net income from discontinued operations - 562,625 Net income (loss) 1,371,262 (8,380,060 ) Basic net income (loss) per share of common stock: Continuing operations $ 0.20 $ (1.30 ) Discontinued operations - 0.08 Net income (loss) per share of common stock $ 0.20 $ (1.22 ) Diluted net income (loss) per share of common stock: Continuing operations $ 0.20 $ (1.30 ) Discontinued operations - 0.08 Net loss per share of common stock $ 0.20 $ (1.22 ) Weighted average number of shares of common stock used in calculating net loss per share of common stock: Basic 6,884,690 6,873,652 Diluted 6,887,808 6,873,652 The accompanying notes are an integral part of these consolidated financial statements. F- 4 PALTALK, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY Common Shares Stock Amount Treasury Shares Stock Amount Additional Paid-in Capital Retained Earnings (Accumulated Deficit) Total Stockholders’ Equity Balance at December 31, 2018 6,868,679 $ 6,869 - - $ 19,867,259 $ (4,720,291 ) $ 15,153,837 Stock-based compensation expense for restricted stock awards and stock options - - - - 1,385,118 - 1,385,118 Issuance of common stock for consulting services 10,225 10 - - 29,005 - 29,015 Repurchases of common stock - - (1,900 ) (2,015 ) - - (2,015 ) Net loss - - - - - (8,380,060 ) (8,380,060 ) Balance at December 31, 2019 6,878,904 $ 6,879 (1,900 ) (2,015 ) $ 21,281,382 $ (13,100,351 ) $ 8,185,895 Stock-based compensation expense - - - - 243,197 - 243,197 Issuance of common stock for consulting services 37,500 38 - - 43,462 - 43,500 Repurchases of common stock - - (8,050 ) (8,844 ) - - (8,844 ) Net income - - - - - 1,371,262 1,371,262 Balance at December 31, 2020 6,916,404 $ 6,917 (9,950 ) $ (10,859 ) $ 21,568,041 $ (11,729,089 ) $ 9,835,010 The accompanying notes are an integral part of these consolidated financial statements. F- 5 PALTALK, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2020 2019 Cash flows from operating activities: Net income (loss) $ 1,371,262 $ (8,380,060 ) Less: Income from discontinued operations - 562,625 Income (loss) from continuing operations 1,371,262 (8,942,685 ) Adjustments to reconcile net income (loss) from continuing operations to net cash provided by (used in) operating activities of continuing operations: Depreciation of property and equipment 325,044 349,082 Amortization of intangible assets 246,681 256,332 Amortization of operating lease right-of-use assets 104,083 178,158 Gain on lease termination (141,001 ) - Loss on disposal of property and equipment 39,238 - Write-off of note receivable 56,042 - Stock-based compensation 243,197 1,385,118 Common stock issued for consulting services 43,500 29,015 Bad debt expense 4,015 - Impairment loss on goodwill - 6,760,222 Impairment loss on digital tokens - 625,368 Realized (gain) loss from the sale of digital tokens 72,823 (70,995 ) Changes in operating assets and liabilities: Credit card holdback receivable - 83,175 Accounts receivable 55,261 196,100 Digital tokens (439,145 ) - Digital tokens receivable (210,000 ) - Operating lease liability (107,674 ) (101,647 ) Digital tokens payable 123,397 - Prepaid expense and other current assets (219,263 ) 113,550 Other assets 16,897 29,891 Accounts payable, accrued expenses and other current liabilities (378,285 ) (2,138,302 ) Deferred subscription revenue 229,228 360,922 Deferred technology service revenue - (3,379,435 ) Net cash provided by (used in) continuing operating activities 1,435,300 (4,266,131 ) Net cash used in discontinued operating activities - (199,232 ) Net cash provided by (used in) operating activities 1,435,300 (4,465,363 ) Cash flows from investing activities: Payment for property and equipment, including website development, net - (391,230 ) Proceeds from Secured Communications Assets 150,000 - Proceeds from the sale of digital tokens 75,406 130,290 Net cash provided by (used in) continuing investing activities 225,406 (260,940 ) Net cash provided by discontinued investing activities - 1,600,000 Net cash provided by investing activities 225,406 1,339,060 Cash flows from financing activities: Borrowings of term debt 506,500 - Purchase of treasury stock (8,844 ) (2,015 ) Net cash provided by (used in) financing activities 497,656 (2,015 ) Net increase (decrease) in cash and cash equivalents 2,158,362 (3,128,318 ) Balance of cash and cash equivalents at beginning of period 3,427,058 6,555,376 Balance of cash and cash equivalents at end of period $ 5,585,420 $ 3,427,058 The accompanying notes are an integral part of these consolidated financial statements. F- 6 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Description of Business The accompanying consolidated financial statements include Paltalk, 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”). Effective May 15, 2020, the Company changed its name from “PeerStream, Inc.” to “Paltalk, Inc.” In connection with the name change, the Company changed its trading symbol on the OTCQB Marketplace from “PEER” to “PALT.” The Company is a communications software innovator that powers multimedia social applications. The Company’s product portfolio includes Paltalk and Camfrog, which together host a large collection of video-based communities. The Company’s other products include Tinychat and Vumber. The Company has an over 20-year history of technology innovation and holds 18 patents. COVID-19 In December 2019, a novel strain of coronavirus (“COVID-19”) was reported to have surfaced in Wuhan, China, and has since reached multiple other countries, including the United States, resulting in government-imposed quarantines, travel restrictions and other public health safety measures in affected countries. The various precautionary measures taken by many governmental authorities around the world in order to limit the spread of COVID-19 has had, and could continue to have, an adverse effect on the global markets and its economy, including on the availability and pricing of employees and resources, and other aspects of the global economy. Although the Company cannot predict the impact that the COVID-19 pandemic will have on its business or results of operations in future periods, to date, the Company’s core multimedia social applications have been able to support the increased demand the Company has experienced. On May 3, 2020, to help ensure adequate liquidity in light of the uncertainties posed by the COVID-19 pandemic, the Company entered into a promissory note with an aggregate principal amount of $506,500 (the “Note”) in favor of Citibank, N.A., as lender (the “Lender”) under the Small Business Administration (“SBA”) Paycheck Protection Program under the recently enacted Coronavirus Aid, Relief and Economic Security Act (“CARES Act”). On January 13, 2021, the Note was fully forgiven by the SBA and the Lender in compliance with the provisions of the CARES Act. 2. Summary of Significant Accounting Policies Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and were prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and with the requirements of the Security and Exchange Commission (“SEC”). All intercompany balances and transactions have been eliminated upon consolidation. 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 consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates relied upon in preparing these financial statements include the estimates used to determine the fair value of the stock options issued in share-based payment arrangements, collectability of the Company’s accounts receivable, measurements of proportional performance under certain service contracts, subscription revenues net of refunds, credits, and known and estimated credit card chargebacks, the valuation allowance on deferred tax assets, fair value of digital tokens and impairment assessment of goodwill. Management evaluates these estimates on an ongoing basis. Changes in estimates are recorded in the period in which they become known. The Company bases estimates on historical experience and various other assumptions that it believes to be reasonable under the circumstances. Actual results may differ from the Company’s estimates. F- 7 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair Value Measurements The fair value framework under the guidance issued by the Financial Accounting Standards Board (“FASB’”) requires the categorization of assets and liabilities into three levels based upon the assumptions used to measure the assets or liabilities. Level 1 provides the most reliable measure of fair value, whereas Level 3, if applicable, would generally require significant management judgment. The three levels for categorizing assets and liabilities under the fair value measurement requirements are as follows: ● Level 1: Fair value measurement of the asset or liability using observable inputs such as quoted prices in active markets for identical assets or liabilities; ● Level 2: Fair value measurement of the asset or liability using inputs other than quoted prices that are observable for the applicable asset or liability, either directly or indirectly, such as quoted prices for similar (as opposed to identical) assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active; and ● Level 3: Fair value measurement of the asset or liability using unobservable inputs that reflect the Company’s own assumptions regarding the applicable asset or liability. The Company reviews the appropriateness of fair value measurements including validation processes, and the reconciliation of period-over-period fluctuations based on changes in key market inputs. All fair value measurements are subject to the Company’s analysis. Review and approval by management is required as part of the validation process. The carrying amounts of the Company’s cash and cash equivalents, accounts receivable and accounts payable, approximate fair value due to the short-term nature of these instruments. Revenue Recognition 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 years ended December 31, 2020 and 2019, subscriptions were offered in durations of one-, three-, six- and twelve- month terms. All subscription fees, however, are paid by credit card at the origination of the subscription regardless of the term of the subscription. Revenues from multi-month subscriptions are recognized on a straight-line basis over the period where the service is offered to the customer, indicated by length of the subscription term purchased. The unearned portion of subscription revenue is presented as deferred revenue in the accompanying consolidated balance sheets. Deferred revenue at December 31, 2019 was $1,829,493, of which $1,829,493 was subsequently recognized as subscription revenue during the year ended December 31, 2020. The ending balance of deferred revenue at December 31, 2020 was $2,058,721. 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’ redemption of virtual gifts at the fixed transaction price and included in subscription revenue in the accompanying consolidated statements of operations. Virtual gift revenue is presented as deferred revenue in the consolidated balance sheets until virtual gifts are redeemed. Virtual gift revenue was $5,188,858 and $5,079,837 for the years ended December 31, 2020 and 2019, respectively. The ending balance of deferred revenue from virtual gifts at December 31, 2020 and 2019 was $348,677 and $411,326, respectively. F- 8 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 Secure Communications . During 2019 and the first quarter of 2020, technology service revenue consisted of revenue that was recognized under the Company’s technology services agreement (the “ProximaX Agreement”) with ProximaX Limited (“ProximaX”) and 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. Effective June 24, 2019, the Company and ProximaX entered into an agreement to terminate the ProximaX Agreement (the “Termination Agreement”) and provide for payment terms for the remaining $2.5 million due under the ProximaX Agreement. The portion of the upfront fee that remained unrecognized as of the termination of the ProximaX Agreement was $1.6 million and was recognized as revenue upon such termination, in addition to the $1.7 million of revenue recognized in the first quarter of 2019. Since there is no assurance of collectability on the remaining payments, revenue is being recognized as the payments under the Termination Agreement are received. For the year ended December 31, 2020, the Company recognized approximately $15.0 thousand in revenue in connection with payments received under the Termination Agreement. On July 23, 2020, the Company completed an asset sale in relation to the secure communications assets. See Note 15, Sale of Secure Communication Assets, to the consolidated financial statements for further information. The Company does not expect to continue to pursue secure communications products or technology implementation services as part of its overall business strategy. Technology Partnerships . During the second and third quarters of 2020, the Company recorded technology service revenue in connection with its agreement to serve as a launch partner with YouNow, Inc. (“YouNow”) and to integrate YouNow’s props infrastructure (the “Props platform”) into its Camfrog and Paltalk applications (as amended, the “YouNow Agreement”). Pursuant to the terms of the YouNow Agreement, YouNow agreed to pay the Company, in exchange for the Company’s services, an aggregate of 10.5 million cryptographic props tokens (“Props tokens”) upon the achievement of certain milestones as follows: (i) 3.0 million Props tokens upon execution of the YouNow Agreement, (ii) 4.0 million Props tokens upon the integration of the Props platform in the Company’s Camfrog application and (iii) 3.5 million Props tokens due upon the integration of the Props platform in the Company’s Paltalk application. In determining the value of the contract, the Company converted the Props tokens into U.S. dollars using an independent third-party valuation. The Props tokens were estimated to have a price equal to $0.02 per token (see Note 7 for additional information on the fair value of the Props tokens) at the contract inception date. The total contract value to be recognized was estimated to be $210,000, which is recognized on the completion dates of the integration services performed. The upfront fee is recognized as revenue under the output method based on the direct measurements of the value of services transferred to date to the customer, relative to the remaining services under the contract. During the year ended December 31, 2020, the Company recognized $60,000 of the upfront fee and $150,000 from the completion of the first and second integration milestones under technology service revenue in the consolidated statements of operations and digital tokens receivable in the consolidated balance sheets. F- 9 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In addition, during the year ended December 31, 2020, the Company received 1.1 million Props tokens for a validator service and 13.5 million Props tokens under YouNow’s loyalty Props platform that was implemented on the Company’s Paltalk and Camfrog applications. The loyalty platform is used to drive engagement and empower users financially by providing users with the ability to earn Props tokens while using the Paltalk and Camfrog applications. The number of Props tokens earned by users for the year ended December 31, 2020 was 3.6 million, which is recorded under digital tokens payable in the consolidated balance sheets, and the net revenue earned is recorded under technology service revenue in the consolidated statements of operations. In the determining the value of the revenue for the validator service and digital tokens earned through the loyalty platform, the Company converted the Props tokens into U.S. dollars using an independent third-party valuation (see Note 7 for additional information on the fair value of the Props tokens). The total net revenue value to be recognized was estimated to be $315,748 which is recognized as earned. Revisions to the Company’s estimates may result in increases or decreases to revenues and income and are reflected in the consolidated financial statements in the periods in which they are first identified. If the Company’s estimates indicate that a contract loss will be incurred, a loss provision is recorded in the period in which the loss first becomes probable and can be reasonably estimated. Contract losses are the amount by which the estimated costs of the contract exceed the estimated total revenue that will be generated by the contract and are included in cost of revenues in the Company’s consolidated statements of operations. There were no contract losses for the periods presented. Digital Tokens At December 31, 2019, digital tokens consisted of XPX tokens received in connection with the ProximaX Agreement. At December 31, 2020, digital tokens and digital tokens receivable consist of Props tokens received in connection with the YouNow Agreement. Given that there is limited precedent regarding the classification and measurement of cryptocurrencies and other digital tokens under current GAAP, management has exercised significant judgment in determining the appropriate accounting treatment and in the event that authoritative guidance is enacted by the FASB, the Company may be required to change its policies, which could have an effect on the Company’s consolidated financial position and results from operations. The Company determined to account for digital tokens as indefinite-lived intangible assets in accordance with ASC 350, Intangibles-Goodwill and Other . Indefinite-lived intangible assets are not amortized but assessed for impairment annually, or more frequently when events or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount exceeds its fair value, which is measured using the quoted price of the digital token at the time its fair value is being measured. In testing for impairment, the Company has the option to first perform a qualitative assessment to determine whether it is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, a quantitative impairment test is not necessary. Otherwise, it is required to perform a quantitative impairment test. 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. Subsequent reversal of impairment losses is not permitted. Gains (if any) are not recorded until realized upon sale, at which point they would be presented net of any impairment losses in the Company’s consolidated statements of operations. In determining the gain to be recognized upon sale, the Company calculates the difference between the sales price and carrying value of the specific digital token sold immediately prior to sale. The Company determines the fair value of its digital tokens on a nonrecurring basis in accordance with ASC 820, Fair Value Measurement. See Note 7, Digital Tokens, to the consolidated financial statements for further information regarding the Company’s digital tokens. 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. Cost of revenue also includes compensation and other employee-related costs for technical personnel and subcontracting costs relating to technology service revenue. Sales and marketing 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 the Company’s brands. Total advertising expense for the year ended December 31, 2020 was approximately $0.8 million and $1.1 million for the year ended December 31, 2019. F- 10 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Product development Product development expense, which relates to the development of technology of the Company’s applications, consists primarily of compensation (including stock-based compensation) and other employee-related costs that are not capitalized for personnel engaged in the design, testing and enhancement of service offerings as well as amortization of capitalized website development costs. General and administrative 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. Reportable Segment The Company operates in one reportable segment, and management assesses the Company’s financial performance and makes operating decisions based on a single operating segment. Income Taxes The Company accounts for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, the Company determines deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. The Company recognizes deferred tax assets to the extent that the Company believes that these assets are more likely than not to be realized. In making such a determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If the Company determines that it would be able to realize deferred taxes in the future in excess of their net recorded amount, the Company would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes. The Company records uncertain tax positions in accordance with ASC No. 740, Accounting for Income Taxes (“ASC 740”) on the basis of a two-step process in which (1) the Company determines whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The Company recognizes interest and penalties related to unrecognized tax benefits on the income tax expense line in the accompanying consolidated statement of operations. Accrued interest and penalties would be included on the related tax liability line in the accompanying consolidated balance sheets. Stock-Based Compensation In accordance with ASC No. 718, Compensation – Stock Compensation , the Company measures the compensation costs of stock-based compensation arrangements based on the grant date fair value of granted instruments and recognizes the costs in the financial statements over the period during which employees are required to provide services. Stock-based compensation arrangements include stock options and restricted stock awards. F- 11 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Equity instruments issued to non-employees are recorded on the basis of the fair value of the instruments, as required by Accounting Standards Update (“ASU”) No. 2018-07, Compensation — Stock Compensation (Topic 718) (“ASU 2018-07”). ASU 2018-07 expands the scope of Topic 718, which currently only includes share-based payments to employees, to include share-based payments to non-employees for goods or services. Consequently, the accounting for share-based payments to non-employees and employees will be substantially aligned. The fair value of each option granted under the Company’s Amended and Restated 2011 Long-Term Incentive Plan (the “2011 Plan”) and 2016 Long-Term Incentive Plan (the “2016 Plan”) was estimated using the Black-Scholes option-pricing model (see Note 10 for further details). Using this model, fair value is calculated based on assumptions with respect to the (i) expected volatility of the Company’s common stock price, (ii) expected life of the award, which for options is the period of time over which employees and non- employees are expected to hold their options prior to exercise, (iii) expected dividend yield on the Company’s common stock, and (iv) a risk-free interest rate, which is based on quoted U.S. Treasury rates for securities with maturities approximating the expected term. Expected volatility is estimated based on the Company’s historical volatilities. The expected life of options has been determined using the “simplified” method, which uses the midpoint between the vesting date and the end of the contractual term. The expected dividend yield is zero as the Company has never paid dividends and does not currently anticipate paying dividends in the foreseeable future. Net Income (Loss) Per Share Basic earnings and loss per share are computed by dividing the net income or loss available to common stockholders by the weighted average number of common shares outstanding during the period as defined by ASC Topic 260, Earnings Per Share . Diluted earnings per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options (using the treasury stock method). To the extent stock options are antidilutive, they are excluded from the calculation of diluted income (loss) per share. Cash and Cash Equivalents The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents consist of cash on deposit with banks and money market funds. The Company maintains cash in bank accounts which, at times, may exceed federally insured limits. As part of its cash management process, the Company periodically reviews the relative credit standing of these banks. The Company has not experienced any losses in such accounts and periodically evaluates the credit worthiness of the financial institutions and has determined the credit exposure to be negligible. Receivables Accounts receivable are composed of amounts due from our advertising partners and from credit card processing companies following the initiation of subscription arrangements originated by the Company’s subscribers, which pay by credit card. These receivables are unsecured and are typically settled by the payment processing company within several days of transaction processing accordingly, an allowance for doubtful accounts is considered. Accounts receivable from advertising partners and payment processing companies amounted to $71,410 and $130,686 on December 31, 2020 and December 31, 2019, respectively. As of December 31, 2020, three advertising partners accounted for 61% of accounts receivable. As of December 31, 2019, three advertising partners accounted for 47% of accounts receivable. F- 12 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Property and equipment Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization is calculated using the straight-line method over the estimated useful lives of those assets, as follows: Computers and equipment 5 years Website development 3 years Furniture and fixtures 7 years Leasehold improvements Shorter of estimated useful life or remaining lease term Repairs and maintenance costs are expensed as incurred. Property and equipment is evaluated for recoverability whenever events or changes in circumstances indicate that the carrying amounts of the assets might not be recoverable. In evaluating an asset for recoverability, the Company estimates the future cash flow expected to result from the use and eventual disposition of the asset. If the expected future undiscounted cash flow is less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying amount over the fair value of the asset, is recognized. No impairment losses were recorded on property and equipment for the periods presented in these consolidated financial statements. Website Development Costs In accordance with ASC 350-50, Website Development Costs , the Company accounts for website development costs by capitalizing qualifying costs which are incurred during the development and infrastructure stage. Expenses incurred in the planning stage are expensed as incurred. Capitalized website development cost is included in property and equipment and are amortized straight-line over the expected period of benefit, which is three years, when the software is ready for its intended use. Amortization expense related to capitalize website development costs is included in product development expense. Goodwill Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. The Company evaluates its goodwill for impairment in accordance with ASC 350, Intangibles – Goodwill and Other (as amended by ASU 2017-04) , by assessing qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill. The Company performs the quantitative goodwill impairment test, if, after assessing the totality of events or circumstances such as those described in paragraph ASC 350-20-35-3C(a) through (g), the Company determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value, limited to the total amount of goodwill related to the reporting unit. The Company tests the recorded amount of goodwill for impairment on an annual basis on December 31 of each fiscal year or more frequently if there are indicators that the carrying amount of the goodwill exceeds its carried value. The Company has one reporting unit. The Company performed a qualitative assessment and concluded that no impairment existed as of December 31, 2020, compared to an impairment of $6.8 million for the year ended December 31, 2019 (See Note 5 for further details on the impairment recorded for the year ended December 31, 2019). Intangible Assets The Company’s intangible assets represent definite lived intangible assets, which are being amortized on a straight-line basis over their estimated useful lives as follows: Patents 20 years Trade names, trademarks, product names, URLs 5-10 years Internally developed software 5-6 years Non-compete agreements 3 years Subscriber/customer relationships 3-12 years Lead pool 2 years The Company reviews intangible assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets might not be recoverable. Factors that the Company considers in deciding when to perform an impairment review include significant underperformance of the business in relation to expectations, significant negative industry or economic trends, and significant changes or planned changes in the use of the assets. If an impairment review is performed to evaluate a long-lived asset for recoverability, the Company compares forecasts of undiscounted cash flows expected to result from the use and eventual disposition of the long-lived asset to its carrying value. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of an asset are less than its carrying amount. The impairment loss would be based on the excess of the carrying value of the impaired asset over its fair value, determined based on discounted cash flows. No impairments were recorded on intangible assets as no impairment indicators were noted for the periods presented in these consolidated financial statements. F- 13 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Leases Effective December 31, 2018, the Company accounts for its leases under ASC 842, Leases (“ASC 842”). Under this guidance, arrangements meeting the definition of a lease are classified as operating or financing leases and are recorded on the consolidated balance sheets as both a right of use asset and lease liability, calculated by discounting fixed lease payments over the lease term at the rate implicit in the lease or the Company’s incremental borrowing rate. Lease liabilities are increased by interest and reduced by payments each period, and the right of use asset is amortized over the lease term. For operating leases, interest on the lease liability and the amortization of the right of use asset result in straight-line rent expense over the lease term. Recent Accounting Pronouncements In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes , which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. ASU 2019-12 is effective for fiscal years beginning after December 15, 2021. The Company has not early adopted ASU 2019-12 and is currently evaluating its impact financial position, results of operations, and cash flows. 3. Discontinued Operations 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. 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 the Company’s consolidated statements of operations through January 31, 2019, the date of sale, 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 the Company’s consolidated balance sheets for all periods presented. The following tables summarize the major line items included in loss from discontinued operations for the Dating Services Business for the periods presented: Year Ended December 31, 2020 2019 Revenues $ - $ 440,225 Costs of revenue - (115,338 ) Sales and marketing expense - (270,200 ) Product development expense - (76,845 ) General and administrative expense - (82,722 ) Loss from discontinued operations $ - $ (104,880 ) There were no major line items included in loss from discontinued operations for the Dating Services Business for the year ended December 31, 2020. 4. Property and Equipment, Net Property and equipment, net consisted of the following for the periods presented: December 31, 2020 2019 Computer equipment $ 866,459 $ 3,706,017 Website development 3,076,323 3,076,323 Furniture and fixtures 47,463 89,027 Leasehold improvements - 32,726 Total property and equipment 3,990,245 6,904,093 Less: Accumulated depreciation (3,734,468 ) (6,284,034 ) Total property and equipment, net $ 255,777 $ 620,059 F- 14 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Depreciation expense, which includes amortization of website development costs, for the years ended December 31, 2020 and 2019 was $325,044 and $349,082, respectively. Loss on disposal of property and equipment for the years ended December 31, 2020 and 2019 was $39,238 and $0, respectively, as a result from the termination of one of our office leases. 5. Goodwill The Company tests goodwill and indefinite-lived intangible assets for impairment annually and whenever events or circumstances arise that indicate an impairment may exist. The Company recorded $6,760,222 of goodwill impairment for the year ended December 31, 2019 due to a sustained decrease in market price per share of the Company’s common stock. At December 31, 2019, the market price per share of the Company’s common stock declined to $1.29, and as such, the Company tested for an impairment and concluded that its goodwill should be reduced as result of the decline in the market price per share and fair value of the reporting unit. The Company determined there were no indicators that would lead to a test for impairment during the year ended December 31, 2020. Goodwill was $6,326,250 at December 31, 2020 and December 31, 2019. 6. Intangible Assets, Net Intangible assets, net consisted of the following for the periods presented: December 31, 2020 2019 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Gross Carrying Amount Accumulated Amortization Net Carrying Amount Patents $ 50,000 $ (28,750 ) $ 21,250 $ 50,000 $ (26,250 ) $ 23,750 Trade names, trademarks, product names, URLs 555,000 (493,648 ) 61,352 555,000 (446,479 ) 108,521 Internally developed software 1,990,000 (1,990,000 ) - 1,990,000 (1,959,655 ) 30,345 Subscriber/customer relationships 2,279,000 (1,980,392 ) 298,608 2,279,000 (1,813,725 ) 465,275 Total intangible assets $ 4,874,000 $ (4,492,790 ) $ 381,210 $ 4,874,000 $ (4,246,109 ) $ 627,891 Amortization expense for the years ended December 31, 2020 and 2019 was $246,681 and $256,332, respectively. The aggregate amortization expense for each of the next five years and thereafter is estimated to be $184,667 in 2021, $149,944 in 2022, $18,000 in 2023, $17,354 in 2024, $2,500 in 2025 and $8,745 thereafter. 7. Digital Tokens At December 31, 2019, digital tokens consisted of XPX tokens received in connection with the ProximaX Agreement. At December 31, 2020, digital tokens and digital tokens receivable consist of Props tokens received in connection with the YouNow 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. XPX Tokens Prior to September 2019, the fair value of the Company’s XPX tokens had been based on the quoted market prices for the XPX tokens (Level 1 inputs). 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 $625,368 which is reported as a component of other income and expenses in the accompanying consolidated statements of operations for the year ended December 31, 2019. F- 15 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS During the year ended December 31, 2020, the Company sold 124,752,914 digital tokens for proceeds of $75,406. The recorded loss of approximately $72,800 is included under other expense, net in the consolidated statements of operations. Props Tokens The Props tokens received and receivable from YouNow are intangible assets that are accounted for at cost, less impairment charges. According to the guidance, a holder of utility tokens cannot only compare the carrying value to fair value at the reporting period, but instead must assess impairment daily. As a result, the Company uses the amount equal the lowest price during the period in which the Props tokens are held as the carrying amount for purposes of testing for impairment. To calculate the fair value of the Props tokens received and receivable pursuant to the YouNow Agreement, the Company, through a third-party valuation, used the backsolve method, which utilizes the option pricing method to calculate the implied value of the Props tokens based on the most recent transaction price publicly available (Level 3 inputs). For purposes of the Backsolve method, the Company used a precedent transaction in which Props tokens were purchased at a price of $0.07 per Props token. The precedent transaction also included the issuance of warrants to purchase additional Props tokens at a strike price of $0.07 per Props token. Using the Backsolve method, the Company took into account the strike price of the warrants issued in the precedent transaction and then determined the allocated value of the Props tokens as though it were a basket purchase. The implied fair value of the Props tokens represents a marketable basis of value. As the Props tokens do not currently have access to a liquid marketplace, a discount for lack of marketability was applied to the implied fair value using a protective put calculation. A summary of the key inputs used in the Backsolve model at December 31, 2020 are summarized as follows: Maturity (time until an exit or liquidity) 1 year Volatility 197.0% Risk free rate of return 0.16% The basic logic of the protective put approach is supported by the notion that the holder of a non-marketable security can effectively purchase liquidity by purchasing a put option on the security. Therefore, the non-marketable value of a security is its value on a marketable basis, less the value of the hypothetical put option. The put option calculation relies on the Black-Scholes option pricing model, which utilizes volatility from comparable utility tokens, an estimated time to maturity (or liquidity), and the risk-free rate commensurate with that maturity. Digital tokens earned, receivable or payable before June 30, 2020, were recorded based on a $0.02 fair value estimated at the end of the reporting period. Digital tokens earned, receivable or payable from July 1, 2020 through December 31, 2020 were recorded based on an estimated fair value of $0.039. At December 31, 2020, the Company recorded $439,145 under digital tokens, $123,397 under digital tokens payable and $210,000 under digital tokens receivable pursuant to the YouNow Agreement. 8. Income Taxes On March 27, 2020, the CARES Act was enacted in response to COVID-19 pandemic. Under ASC 740, the effects of changes in tax rates and laws are recognized in the period which the new legislation is enacted. The CARES Act made various tax law changes including among other things (i) increasing the limitation under IRC Section 163(j) for 2019 and 2020 to permit additional expensing of interest, (ii) enacting a technical correction so that qualified improvement property can be immediately expensed under IRC Section 168(k), (iii) making modifications to the federal net operating loss rules including permitting federal net operating losses incurred in 2018, 2019, and 2020 to be carried back to the five preceding taxable years in order to generate a refund of previously paid income taxes and (iv) enhancing recoverability of AMT tax credits. Given the Company’s full valuation allowance position, the CARES Act did not have a material impact on the financial statements. F- 16 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company’s provision for income taxes is comprised of the following: December 31, 2020 2019 Current Federal $ - $ (151,597 ) State and local 387 10,004 Total Current 387 (141,593 ) Deferred Federal - - State and local - - Total Deferred - - Total Provision (Benefit) $ 387 $ (141,593 ) In 2020, the Company recorded an income tax provision of $387 for state and local taxes. In 2019, as a result of the gain recorded in discontinued operations related to the sale of the Dating Services Business, the Company recorded an income tax benefit of $159,265 from continuing operations pursuant to the intra-period allocation guidance in ASC 740-20-45-7 which was partially offset by an income tax provision of $17,672 for state and local taxes. The Company also recorded an income tax expense of $159,265 allocated to discontinued operations. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets and liabilities are as follows: December 31, 2020 2019 Deferred Tax Assets: Net operating losses $ 4,098,329 $ 4,265,150 Share-based compensation 859,100 989,763 Amortization of Intangible Assets 769,742 1,056,162 Rent 15,272 168,036 Tax Credits 62,969 62,969 Other 160,762 72,032 Subtotal 5,966,174 6,614,116 Less Valuation Allowance: (5,903,825 ) (6,349,900 ) Total Deferred Tax Assets 62,349 264,216 Deferred Tax Liabilities: Property and equipment (62,349 ) (264,216 ) Total Deferred Tax Liabilities (62,349 ) (264,216 ) Net Deferred Tax Assets $ - $ - In assessing the Company’s ability to recover its deferred tax assets, the Company evaluated whether it is more likely than not that some portion or the entire deferred tax asset will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income in those periods in which temporary differences become deductible and/or net operating losses can be utilized. The Company considered all positive and negative evidence when determining the amount of the net deferred tax assets that are more likely than not to be realized. This evidence includes, but is not limited to, historical earnings, scheduled reversal of taxable temporary differences, tax planning strategies and projected future taxable income. Based on these factors including cumulative losses in recent years, the Company determined that its deferred tax assets are not realizable on a more-likely-than-not basis and has recorded a valuation allowance against its net deferred tax assets. The Company’s valuation allowance decreased by $446,075 during 2020. The Company will continue to evaluate its deferred tax assets to determine whether any changes in circumstances could affect the realization of their future benefit. If it is determined in future periods that portions of the Company’s deferred income tax assets satisfy the realization standards, the valuation allowance will be reduced accordingly. F- 17 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As of December 31, 2020, the Company has U.S. federal net operating loss carryforwards of approximately $18.3 million, of which $14.4 million may be subject to a significant annual limitation under Section 382 of the Internal Revenue Code. Of the $18.3 million, approximately, $17.1 million will expire in 2030 to 2037, if not utilized. The remaining $1.2 million may be carried forward indefinitely. The Company’s effective tax rate differs from the U.S. federal statutory income tax rate of 21% for 2020 and 2019 as follows: 2020 2019 Federal statutory rate 21.0 % 21.0 % Permanent differences 0.2 % (6.7 )% State and local taxes 1.9 % (0.2 )% Valuation allowance (37.0 )% (0.1 )% Deferred tax adjustment 0.0 % (9.9 )% Share based compensation 14.6 % (2.7 )% Other (0.6 )% 0.1 % Effective tax rate 0.1 % 1.6 % The Company applies the applicable authoritative guidance which prescribes a comprehensive model for the manner in which a company should recognize, measure, present and disclose in its financial statements all material uncertain tax positions that the Company has taken or expects to take on a tax return. As of December 31, 2020, the Company has no uncertain tax positions. As such, there are no uncertain tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within twelve months from December 31, 2020. The Company files a federal income tax return and income tax returns in various state tax jurisdictions. The open tax years for the federal income tax return is 2017 through 2020. The state income tax returns have varying statutes of limitations. The open tax years relating to any of the Company’s federal and state net operating losses begin in 2009. 9. Accrued Expenses and Other Current Liabilities Accrued expenses and other current liabilities consisted of the following for the periods presented: December 31, 2020 2019 Compensation, benefits and payroll taxes $ 226,500 $ 138,001 Income tax payable - 17,672 Other accrued expenses 27,584 279,066 Total accrued expenses and other current liabilities $ 254,084 $ 434,739 F- 18 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. Stockholders’ Equity The 2011 Plan was terminated as to future awards on May 16, 2016. A total of 121,930 shares of the Company’s common stock may be issued pursuant to outstanding options awarded under the 2011 Plan; however, no additional awards may be granted under such plan. The 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 December 31, 2020, there were 853,999 shares available for future issuance under the 2016 Plan. Treasury Shares On April 29, 2019, the Company implemented a stock repurchase plan to repurchase up to $500,000 of its common stock for cash. The repurchase plan expired on April 29, 2020. The Company had purchased 9,950 shares of its common stock under the repurchase plan as of April 29, 2020 and has classified them as treasury shares on the Company’s consolidated balance sheets. Shares issued for consulting services On August 11, 2020, the Company issued 37,500 shares of its common stock to a consultant as consideration for investor relations services. The total expense for these grants was $43,500 and is included in general and administrative expense in the consolidated statements of operations. 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 years ended: December 31, 2020 2019 Expected volatility 188.0 % 171.0-177.0 % Expected life of option 5.3 5.0-6.3 Risk free interest rate 0.6 % 1.7-2.5 % Expected dividend yield 0.0 % 0.0 % The expected life of the options is the period of time over which employees and non-employees are expected to hold their options prior to exercise. The expected life of options has been determined using the “simplified” method as prescribed by Staff Accounting Bulletin 110, which uses the midpoint between the vesting date and the end of the contractual term. The volatility of the Company’s common stock is calculated using the Company’s historical volatilities beginning at the grant date and going back for a period of time equal to the expected life of the award. The Company estimates potential forfeitures of stock awards and adjusts recorded stock-based compensation expense accordingly. The Company estimates pre-vesting forfeitures primarily based on the Company’s historical experience and is adjusted to reflect actual forfeitures as the stock-based awards vest. The following tables summarize stock option activity during the year ended December 31, 2020: Number of Options Weighted Average Exercise Price Outstanding at January 1, 2020 1,021,243 $ 4.82 Granted 24,000 0.80 Exercised during period - - Forfeited or canceled, during the period (421,777 ) 3.52 Expired, during the period (1,430 ) 10.50 Outstanding at December 31, 2020 622,036 $ 5.53 Exercisable at December 31, 2020 479,702 $ 6.28 F- 19 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2020, there was $128,879 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted average period of 2.01 years. On December 31, 2020, the aggregate intrinsic value of stock options that were outstanding and exercisable was $15,840. On December 31, 2019, there was no aggregate intrinsic value of stock options that were outstanding and exercisable. 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 year ended December 31, 2020, the Company granted options to the Company’s board of directors to purchase an aggregate of 24,000 shares of common stock. These options vest over one year and have a term of ten years and have a weighted average exercise price of $0.80. The aggregate fair value for the options granted during the years ended December 31, 2020 and 2019 was $18,664 and $469,179, respectively. Stock-based compensation expense for the Company’s stock options included in the consolidated statements of operations was as follows: Year Ended December 31, 2020 2019 Cost of revenue $ 1,527 $ 1,478 Sales and marketing expense 90 130 Product development expense 19,491 117,375 General and administrative expense 222,089 710,013 Total stock-based compensation expense $ 243,197 $ 828,996 11. Net Income (Loss) Per Share Basic earnings and loss per share are computed by dividing the net income or loss available to common stockholders by the weighted average number of common shares outstanding during the period as defined by ASC Topic 260, Earnings Per Share . Diluted earnings per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options (using the treasury stock method). To the extent stock options are antidilutive, they are excluded from the calculation of diluted income (loss) per share. For the year ended December 31, 2020, 618,918 of shares issuable upon the exercise of outstanding stock options were not included in the computation of diluted net income per share for continuing operations because their inclusion would be antidilutive. For the year ended December 31, 2020, 3,118 of shares issuable upon the exercise of outstanding stock options were included in the computation of diluted net income per share for continuing operations because their inclusion would be dilutive. For the year ended December 31, 2019, 1,021,243 of shares issuable upon the exercise of outstanding stock options were not included in the computation of diluted net income (loss) per share for continuing operations because their inclusion would be antidilutive. F- 20 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes the net income (loss) per share calculation for the periods presented: Years Ended December 31, 2020 2019 Net income (loss) from continuing operations – basic and diluted $ 1,371,262 $ (8,380,060 ) Total weighted average shares outstanding – basic 6,884,690 6,873,652 Dilutive potential options 3,118 - Total weighted average shares outstanding – diluted 6,887,808 6,873,652 Per share data: Basic from continuing operations $ 0. 20 (1.22 ) Diluted from continuing operations $ 0. 20 $ (1.22 ) 12. Leases Operating Leases On June 7, 2016, the Company entered into a lease agreement with Jericho Executive Center LLC for office space at 30 Jericho Executive Plaza in Jericho, New York, which commenced on September 1, 2016 and runs through November 30, 2021. The Company’s monthly office rent payments under the lease are currently approximately $5,900 per month. On May 1, 2019, the Company entered into a sublease agreement with Telecom Infrastructure Corp. (“Telecom”) for office space located at 122 East 42nd Street in New York, NY, pursuant to which Telecom was required to pay the Company $11,164 per month. The term of the sublease ran until April 26, 2023. On June 18, 2020, the Company entered into an agreement to terminate the sublease for this office space. Pursuant to the terms of the agreement, Telecom vacated the offices on June 30, 2020. F- 21 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Lease Cancellation On May 1, 2019, the Company entered into a lease agreement for office space located at 122 East 42nd Street in New York, NY and paid a $133,968 security deposit in the form of a letter of credit. The term of the lease ran until April 26, 2023. The Company’s monthly office rent payments under the lease were approximately $33,492 per month. On June 22, 2020, the Company entered into an agreement to terminate the lease for this office space. Pursuant to the terms of the agreement, the Company vacated the offices on June 30, 2020 and the Company agreed to forfeit its security deposit of $133,968. In accordance with ASC 842, the Company accounted for the cancellation of the lease by removing the right-of-use asset and the lease liability from the consolidated balance sheets, with a profit recognized for the difference. The Company recorded a net gain on the office lease cancellation of $141,001, which is reflected in the consolidated statements of operations for the year ended December 31, 2020. As of December 31, 2020, the Company had no long-term leases that were classified as financing leases. As of December 31, 2020, the Company did not have additional operating and financing leases that had not yet commenced. At December 31, 2020, the Company had operating lease liabilities of approximately $0.1 million and right-of-use assets of approximately $0.1 million, which are included in the consolidated balance sheets. Total rent expense for the year ended December 31, 2020 was $206,347, of which $36,095 was sublease income. Total rent expense for the year ended December 31, 2019 was $394,636. Rent expense is recorded under general and administrative expense in the consolidated statements of operations. The following table summarizes the Company’s operating leases for the periods presented: Years Ended December 31, 2020 2019 Cash paid for amounts included in the measurement of operating lease liabilities: $ 107,674 $ 178,158 Weighted average assumptions: Remaining lease term 0.9 3.1 Discount rate 3.5 % 2.5 % On December 31, 2020, future minimum payments under non-cancelable operating leases were as follows: For the years ending December 31, Amount 2020 $ 84,370 Total $ 84,370 Less: present value adjustment (15,403 ) Present value of minimum lease payments $ 68,967 13. Term debt On April 13, 2020, to help ensure adequate liquidity in light of the uncertainties posed by the coronavirus pandemic, the Company applied for a loan under the SBA Paycheck Protection Program under the recently enacted CARES Act. On May 3, 2020, the Company entered into the Note in favor of the Lender. F- 22 PALTALK, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Note has a two-year term, matures on May 3, 2022, and bears interest at a stated rate of 1.0% per annum. Monthly principal and interest payments commenced in December 2020. The Company did not provide any collateral or guarantees for the Note, nor did the Company pay any facility charge to obtain the Note. The Note provides for customary events of default, including, among others, those relating to failure to make payment, bankruptcy, breaches of representations and material adverse effects. The Company may prepay the principal of the Note at any time without incurring any prepayment charges. The Note may be partially or fully forgiven if the Company complies with the provisions of the CARES Act, including the use of Note proceeds for payroll costs, rent, utilities and certain other expenses as defined in the CARES Act. Any forgiveness of the Note will be subject to approval by the SBA and the Lender. Total term debt $ 506,500 Less: current portion of term debt (338,792 ) Non-current portion of term debt $ 167,708 On January 13, 2021, the Note was fully forgiven by the SBA and the Lender in compliance with the provisions of the CARES Act. 14. Commitments and contingencies 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. 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 December 31, 2020. 15. Sale of Secured Communications Assets On February 24, 2020, the Company entered into an Asset Purchase Agreement, which was subsequently amended and restated on May 29, 2020 (the “Amended and Restated Agreement”) with SecureCo, LLC (the “Buyer”), pursuant to which the Company agreed to sell substantially all of the assets related to its secure communications business (the “Secured Communications Assets”) to the Buyer (the “Asset Sale”). The Secured Communications Assets included communication solutions and operations capabilities for secure messaging and data applications, and software and middleware for enterprise and government client targets. On July 23, 2020, the Company completed the Asset Sale for a cash purchase price of $250,000, $150,000 of which was paid at closing and $100,000 of which is payable in four equal installments over the fifteen-month period following the closing of the Asset Sale and was recorded under other current assets in the consolidated balance sheets as of December 31, 2020. The Amended and Restated Agreement also provides for a revenue sharing arrangement, pursuant to which the Company is entitled to receive quarterly royalty payments ranging from 5% to 10% of certain revenues received by the Buyer, with the aggregate amount of such royalty payments not to exceed $500,000. The gain on the Asset Sale was recorded in the statements of operations for the year ended December 31, 2020. The sale of the Secured Communications Assets did not meet the requisite criteria to constitute discontinued operations or held for sale, as the historical results of Company’s secured communications business were not material to its results of operations. 16. Subsequent Events On January 13, 2021, the Note, with an aggregate principal amount of $506,500 was fully forgiven by the SBA and the Lender in compliance with the provisions of the CARES Act. Management has evaluated subsequent events or transactions occurring through the date the consolidated financial statements were issued and determined that no other events or transactions are required to be disclosed herein. F- 23 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.