PALTALK INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Description of Business

Overview

The accompanying condensed 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, Vumber LLC and ManyCam ULC (collectively, the “Company”).

The Company is a communications software innovator that powers multimedia social applications. The Company’s product portfolio includes Paltalk, Camfrog and Tinychat, which together host a large collection of video-based communities. The Company’s other products include ManyCam and Vumber. ManyCam is a live streaming software and virtual camera that allows users to deliver professional live videos on streaming platforms, video conferencing apps and distance learning tools. Vumber is a telecommunications services provider that enables users to communicate privately by having multiple phone numbers with any area code through which calls can be forwarded to a user’s existing telephone number. The Company has an over 20-year history of technology innovation and holds 8 patents.

Impact of Macro-Economic Factors

The Company’s results of operations have been and may continue to be negatively impacted by macro-economic factors, including the timing of economic recessions and/or recovery and the overall inflationary environment. Prolonged periods of inflation have affected, and may continue to affect, the Company’s ability to target new customers as well as keep existing customers engaged and may ultimately have a correlating effect on its users’ discretionary spending. Future adverse developments with respect to the economic environment and geopolitical tensions may create additional market and economic uncertainty, which could affect the Company’s industry.

Employee Retention Tax Credit

Under the provisions of the extension of the Coronavirus Aid, Relief, and Economic Security Act, the Company was eligible for a refundable employee retention tax credit (the “ERTC”), subject to certain criteria. During the year ended December 31, 2023, the Company applied for the ERTC and recorded a receivable in the amount of $343,045, net of related costs, which was recognized in the Company’s condensed consolidated statement of operations as other income. As of June 30, 2024, the Company received an aggregate of $294,833, or $228,833 net of related costs, which was recorded as a reduction of the receivable on the Company’s condensed consolidated balance sheet.

Basis of Presentation

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, 2023, filed with the SEC on March 15, 2024 (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 sheets and statements of operations, cash flows and changes in stockholders’ equity of the Company for the interim periods presented. The Company’s historical results are not necessarily indicative of future operating results, and the results for the three and six months ended June 30, 2024 are not necessarily indicative of results for the year ending December 31, 2024, or for any other period.

2. Summary of Significant Accounting Policies

During the six months ended June 30, 2024, there were no significant changes made to the Company’s significant accounting policies.

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

Inflation Reduction Act of 2022

On August 16, 2022, the Inflation Reduction Act of 2022 (the “IR Act”) was signed into federal law. The IR Act provides for, among other things, a new U.S. federal 1% excise tax on certain repurchases of stock by publicly traded U.S. domestic corporations and certain U.S. domestic subsidiaries of publicly traded foreign corporations occurring on or after January 1, 2023. The excise tax is imposed on the repurchasing corporation itself, not its shareholders from which shares are repurchased. The amount of the excise tax is generally 1% of the fair market value of the shares repurchased at the time of the repurchase. However, for purposes of calculating the excise tax, repurchasing corporations are permitted to net the fair market value of certain new stock issuances against the fair market value of stock repurchases during the same taxable year. In addition, certain exceptions apply to the excise tax. The U.S. Department of the Treasury has been given authority to provide regulations and other guidance to carry out and prevent the abuse or avoidance of the excise tax. The IR Act was not applicable to the Company during the year ended December 31, 2023 or the six months ended June 30, 2024, given that repurchases of stock during such periods, if any, were below the threshold required to be subject to taxation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. The most significant accounting estimates inherent in the preparation of the Company’s financial statements include the discount rates and weighted average costs of capital used in the fair value of the ManyCam assets and in assigning their respective useful lives. These fair values and estimates were based on a number of factors, including a valuation by an independent third party.

Revisions to the Company’s estimates may result in increases or decreases to revenues and income and are reflected in the condensed 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 condensed consolidated statements of operations. There were no contract losses for the periods presented in this report.

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.

The Company generates subscription revenue primarily from monthly premium subscription services. Subscription revenues are presented net of refunds, credits, and known and estimated credit card chargebacks. During the six months ended June 30, 2024 and 2023, subscriptions were offered in durations of one-, three-, six-, twelve-month and twenty four-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 subscription revenue in the accompanying condensed consolidated balance sheets. Deferred subscription revenue at December 31, 2023 was $2,043,362, of which $1,251,430 was subsequently recognized as subscription revenue during the six months ended June 30, 2024. The ending balance of deferred subscription revenue at June 30, 2024 and 2023 was $1,891,047 and $2,169,454, respectively.

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 condensed consolidated statements of operations. Virtual gift revenue is presented as deferred revenue in the condensed consolidated balance sheets until virtual gifts are redeemed. Virtual gift revenue was $686,763 and $1,312,113 for the three months ended June 30, 2024 and 2023, respectively. Virtual gift revenue was $1,703,711 and $2,322,313 for the six months ended June 30, 2024 and 2023, respectively. The ending balance of deferred revenue from virtual gifts, which is included in deferred subscription revenue at June 30, 2024 and 2023 was $359,733 and $465,199, respectively.

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.

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 as of December 31 of each fiscal year or more frequently if there are indicators that the fair value of the goodwill exceeds its carrying amount. The Company hasone reporting unit. The Company performed a qualitative assessment and concluded that no impairment existed as of December 31, 2023 and 2022.

Intangible Assets

The Company’s acquired amortizable intangible assets primarily consist of the assets acquired in June 2022 relating to ManyCam software, which assets consist of internally developed software, intellectual property (trade names, trademarks and URLs) and subscriber relationships/customer lists.

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:

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.

3. Intangible Assets, Net

Intangible assets, net consisted of the following at June 30, 2024 and December 31, 2023:

Amortization expense for the three and six months ended June 30, 2024 was $205,583 and $411,166, respectively, as compared to $205,584 and $411,167 for the three and six months ended June 30, 2023, respectively. The aggregate amortization expense for each of the next five years is estimated to be $410,521 for the remainder of 2024, $568,529 in 2025, $382,133 in 2026, $382,133 in 2027, $382,133 in 2028 and $167,862 in 2029.

4. Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following for the periods presented:

5. Income Taxes

The Company’s provision for income taxes consists of federal, foreign, 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.

For the three and six months ended June 30, 2024, the Company recorded an income tax provision of $50,591 and an income tax benefit of $67,309, respectively. The effective tax rate for the three and six months ended June 30, 2024 was (5.25)% and 4.79%, respectively. The effective tax rate differs from the statutory rate of 21%, primarily related to changes in the Company’s valuation allowance, differences in foreign tax rates from the U.S. statutory rate of 21%, and state and local taxes. The Company continues to conclude that its U.S. deferred tax assets are not realizable on a more-likely-than-not basis and maintains a full valuation allowance against such deferred tax assets.

For the three and six months ended June 30, 2023, the Company recorded an income tax provision of $101,059 and $51,505, respectively, primarily related to a discrete item related to the filing of the Company’s Canadian tax return. The effective tax rate for the three and six months ended June 30, 2023 was 42.70% and (9.34)%, respectively. The effective tax rate differs from the statutory rate of 21% as the Company has concluded that its deferred tax assets are not realizable on a more-likely-than-not basis.

6. Stockholders’ Equity

The Paltalk, 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 17,748 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 Paltalk, Inc. 2016 Long-Term Incentive Plan (the “2016 Plan”) was adopted by the Company’s stockholders on May 16, 2016 and permits the Company to award stock options (both incentive stock options and non-qualified stock options), stock appreciation rights, restricted stock, restricted stock units, performance awards, dividend equivalent rights, and other stock-based awards and cash-based incentive awards to its employees (including an employee who is also a director or officer under certain circumstances), non-employee directors and consultants. The maximum number of shares of common stock that may be issued pursuant to awards under the 2016 Plan is 1,300,000 shares,100% of which may be issued pursuant to incentive stock options. In addition, the maximum number of shares of common stock that may be issued under the 2016 Plan may be increased by an indeterminate number of shares of common stock underlying outstanding awards issued under the 2011 Plan that are forfeited, expired, cancelled or settled in cash. As of June 30, 2024, there were 632,257 shares available for future issuance under the 2016 Plan.

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 nine months ended June 30, 2024:

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

The following table summarizes stock option activity during the six months ended June 30, 2024:

At June 30, 2024, there was $299,671 of total unrecognized compensation expense related to stock options, which is expected to be recognized over a weighted average period of 2.5 years.

On June 30, 2024, the aggregate intrinsic value of stock options that were outstanding and exercisable was $928,892 and $605,520, respectively. On June 30, 2023, the aggregate intrinsic value of stock options that were outstanding and exercisable was $26,010 and $24,323, respectively. The intrinsic value of stock options is calculated based on the exercise price of the underlying awards and the fair value of such awards as of the period-end date.

During the six months ended June 30, 2024, the Company granted stock options to members of the Board of Directors to purchase an aggregate of 24,000 shares of common stock at an exercise price of $2.78 per share. The stock options vest in four equal quarterly installments on the last day of each calendar quarter in 2024 and have a term of ten years. During the six months ended June 30, 2024, the Company also granted options to employees to purchase an aggregate of 4,000 shares of common stock. These options vest in four equal annual installments over four years, have a term of ten years and have an exercise price of $2.78. The aggregate fair value for the options granted during the six months ended June 30, 2024 and 2023 was $72,240 and $90,380, respectively.

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

Treasury Shares

The Board of Directors approved a stock repurchase plan for up to $1,750,000 of the Company’s outstanding common stock (the “Stock Repurchase Plan”), effective as of March 29, 2022, which expired on March 29, 2023, the one-year anniversary of such date. Under the Stock Repurchase Plan, shares were repurchased from time-to-time in open market transactions at prevailing market prices, in privately negotiated transactions or by other means in accordance with federal securities laws, including Rule 10b5-1 programs. The actual timing, number and value of shares repurchased was determined by a committee of the Board of Directors at its discretion and depended on a number of factors, including the market price of the Company’s common stock, general market and economic conditions, alternative investment opportunities and other corporate considerations.

As of June 30, 2024 and December 31, 2023, the Company had* *641,963 shares of its common stock classified as treasury shares on the Company’s consolidated balance sheets.

7. Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing the net income (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 net income (loss) 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 six months ended June 30, 2024 and 2023,763,736 and 650,155 of shares issuable upon the exercise of outstanding stock options, respectively, were not included in the computation of diluted net income (loss) per share because their inclusion would be antidilutive.

The following table summarizes the net loss per share calculation for the periods presented:

8.Leases

On April 9, 2021, the Company entered into a lease extension agreement with Jericho Executive Center LLC (“JEC”) for the office space at 30 Jericho Executive Plaza in Jericho, New York, which commenced on December 1, 2021 and runs through November 30, 2024. The Company’s monthly office rent payments under the lease are currently approximately $7,081 per month. On May 28, 2024, the Company entered into a lease extension agreement with JEC, which extendsthe lease period by two years to November 30, 2026. Beginning on December 1, 2024, the monthly rent will be $6,850 per month. The new extension gives the Company an option to terminate the second year in July 2025.

As of June 30, 2024, the Company had no long-term leases that were classified as financing leases and did not have additional operating or financing leases that had not yet commenced.

As of June 30, 2024, the Company had operating lease liabilities of approximately $116,388 and operating lease right-of-use assets of approximately $116,388 which are included in the accompanying condensed consolidated balance sheets.

Total rent expense for the six months ended June 30, 2024 was $42,863, of which $3,000 was sublease income. Total rent expense for six months ended June 30, 2023 was $40,829, of which $1,500 was sublease income. Rent expense is recorded under general and administrative expense in the accompanying condensed consolidated statements of operations.

The following table summarizes the Company’s operating leases for the periods presented:

As of June 30, 2024, future minimum payments under non-cancelable operating leases were as follows:

9. Commitments and Contingencies

Patent Litigation

On July 23, 2021, a wholly owned subsidiary of the Company, Paltalk Holdings, Inc., filed a patent infringement lawsuit against WebEx Communications, Inc., Cisco WebEx LLC, and Cisco Systems, Inc. (collectively, “Cisco”), in the U.S. District Court for the Western District of Texas (the “Court”). The Company alleges that certain of Cisco’s products have infringed U.S. Patent No. 6,683,858, and that the Company is entitled to damages.

A Markman hearing took place on February 24, 2022. On September 7, 2022, the United States Patent Office issued a reexamination of U.S. Patent No. 6,683,858, and on January 19, 2023, the Examiner issued an Ex Parte Reexamination Certificate, ending the reexamination and confirming the patentability of claims 1-10 of U.S. Patent No. 6,683,858. On June 29, 2023, the Court held a pretrial conference and denied Cisco’s motion for summary judgment. On August 1, 2024, the Court held the final pretrial conference and the trial is set to proceed on August 26, 2024.

Legal Proceedings

The Company may be included in legal proceedings, claims and assessments arising in the ordinary course of business. The Company evaluates the need for a reserve for specific legal matters based on the probability of an unfavorable outcome and the reasonability of an estimable loss. No reserve was deemed necessary as of June 30, 2024.

10. Subsequent Events

NTS Acquisition Agreement

On August 11, 2024, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”), by and among the Company, PALT Merger Sub 1, Inc., a direct and wholly owned subsidiary of the Company (“First Merger Sub”), PALT Merger Sub 2, LLC, a direct and wholly owned subsidiary of the Company (“Second Merger Sub”), Newtek Technology Solutions, Inc. (“NTS”), and NewtekOne, Inc., the sole stockholder of NTS (“Newtek”), to acquire NTS through a two-step merger process. Pursuant to the Merger Agreement, following the receipt of approval by the Company’s stockholders: (i) NTS will merge with and into First Merger Sub, with NTS continuing as the surviving entity (the “Interim Surviving Entity” and such merger, the “First Step Merger”), and (ii) immediately following the consummation of the First Step Merger, the Interim Surviving Entity will merge with and into Second Merger Sub, with Second Merger Sub continuing as the surviving entity (the “Second Step Merger” and, together with the First Step Merger, the “Mergers”).

Pursuant to the Merger Agreement, as consideration for the Mergers, the Company agreed to (i) pay Newtek an amount in cash equal to $4,000,000, which is subject to customary purchase price adjustments as set forth in the Merger Agreement, including a working capital adjustment (the “Closing Cash Consideration”) and (ii) issue Newtek 4,000,000 shares (the “Closing Stock Consideration” and together with the Closing Cash Consideration, the “Closing Consideration”) of a newly created series of preferred stock, the Series A Non-Voting Common Equivalent Stock of the Company, par value $0.001 per share (the “Preferred Stock”). In addition to the Closing Consideration, the Merger Agreement provides that Newtek is entitled to receive an amount up to $5,000,000 (the “Earn-Out Amount”) based on the Company’s achievement certain cumulative average Adjusted EBITDA thresholds for the 2025 and 2026 fiscal years. The Earn-Out Amount may be paid, at the Company’s sole discretion, in cash (the “Earn-Out Cash Consideration”), in shares of Preferred Stock (the “Earn-Out Stock Consideration”) or in a combination thereof. The issuance of the Closing Stock Consideration, the Earn-Out Stock Consideration (if any) and the shares of common stock issuable upon conversion of the Preferred Stock is referred to herein as the “Parent Stock Issuance”.

Pursuant to the Merger Agreement, if the issuance of the Closing Stock Consideration or the Earn-Out Stock Consideration would cause Newtek’s “total equity” (as calculated under the Bank Holding Company Act of 1956, as amended, and as implemented and interpreted by the Board of Governors of the Federal Reserve System) in the Company to exceed 33.33% (the “Total Equity Cap”), then the number of shares of Preferred Stock issuable as Closing Stock Consideration and/or Earn-Out Stock Consideration, as applicable, will be adjusted so that the Company will issue Newtek the maximum number of shares of Preferred Stock that would not cause Newtek’s total equity to exceed the Total Equity Cap, with a corresponding increase to the Closing Cash Consideration and the Earn-Out Cash Consideration, as applicable.

As a condition to the closing of the Mergers and the transactions contemplated by the Merger Agreement, the Merger Agreement provides that the Company must effectuate the sale of its Paltalk, Camfrog, and Tinychat applications and all assets and liabilities related to such applications (the “Divestiture Transaction”). Following the Divestiture Transaction, the Company will retain (i) all patents, patent applications, and any rights or causes of action related to such applications, and (ii) any assets (including intellectual property) that are not exclusively related to such applications.

In addition, the closing of the Mergers is subject to the satisfaction of various customary closing conditions, including, among others, approval of the Parent Stock Issuance and the Divestiture Transaction by the Company’s stockholders. The Merger Agreement contains certain termination rights for both the Company and Newtek, on behalf of itself and NTS, including, among other things, if the closing has not occurred prior to February 9, 2025. In the event the Merger Agreement is terminated, neither party thereto will owe a termination fee or otherwise incur a liability to any other party under or relating to the Merger Agreement.

For the three and six months ended June 30, 2024, the Company incurred general and administrative expenses of $315,889 and $383,842, respectively, associated with the Mergers.

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