Notes to Unaudited Condensed Consolidated Financial Statem ents

1.	Basis of Presentation

 

The unaudited condensed consolidated financial statements include the accounts of GraphOn Corporation and its subsidiaries (collectively, “we”, “us” or “our”); significant intercompany accounts and transactions are eliminated upon consolidation. The unaudited condensed consolidated financial statements included herein have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) applicable to interim financial information and the rules and regulations promulgated by the Securities and Exchange Commission (the “SEC”).  Accordingly, such unaudited condensed consolidated financial statements do not include all information and footnote disclosures required in annual financial statements.

 

The unaudited condensed consolidated financial statements included herein reflect all adjustments, which include only normal, recurring adjustments, that are, in our opinion, necessary to state fairly the results for the periods presented. This Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the SEC on April 16, 2012 (“2011 10-K Report”). The interim results presented herein are not necessarily indicative of the results of operations that may be expected for the full fiscal year ending December 31, 2012 or any future period.

 

 

2.	Significant Accounting Policies

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. These estimates include: the amount of stock-based compensation expense; the allowance for doubtful accounts; the estimated lives, valuation, and amortization of intangible assets (including capitalized software); depreciation of long-lived assets; valuation of warrants; and accruals for liabilities. While we believe that such estimates are fair, actual results could differ materially from those estimates.

 

Revenue Recognition

 

We market and license our products indirectly through channel distributors, independent software vendors (“ISVs”), value-added resellers (“VARs”) (collectively, “resellers”) and directly to corporate enterprises, governmental and educational institutions and others.  Our product licenses are generally perpetual.  We also separately sell intellectual property licenses, maintenance contracts, which are comprised of license updates and customer service access, as well as other products and services.

Software license revenues are recognized when:

·

Persuasive evidence of an arrangement exists, (i.e., when we sign a non-cancelable license agreement wherein the customer acknowledges an unconditional obligation to pay, or upon receipt of the customer’s purchase order), and

·

Delivery has occurred or services have been rendered and there are no uncertainties surrounding product acceptance (i.e., when title and risk of loss have been transferred to the customer, which generally occurs when the media containing the licensed program(s) is provided to a common carrier or, in the case of electronic delivery, when the customer is given access to the licensed program(s)), and

·

The price to the customer is fixed or determinable, as typically evidenced in a signed non-cancelable contract, or a customer’s purchase order, and

·

Collectability is probable.  If collectability is not considered probable, revenue is recognized when the fee is collected.

 

 

Revenue recognized on software arrangements involving multiple deliverables is allocated to each deliverable based on vendor-specific objective evidence (“VSOE”) or third party evidence of the fair values of each deliverable; such deliverables include licenses for software products, maintenance, private labeling fees, and customer training.  We limit our assessment of VSOE for each deliverable to either the price charged when the same deliverable is sold separately or the price established by management having the relevant authority to do so, for a deliverable not yet sold separately.

 

If sufficient VSOE of the fair value does not exist so as to permit the allocation of revenue to the various elements of the arrangement, all revenue from the arrangement is deferred until such evidence exists or until all elements are delivered. If VSOE of the fair value does not exist, and the only undelivered element is maintenance, then we recognize revenue on a ratable basis. If VSOE of the fair value of all undelivered elements exists but does not exist for one or more delivered elements, then revenue is recognized using the residual method.  Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue.

 

Certain resellers (“stocking resellers”) purchase product licenses that they hold in inventory until they are resold to the ultimate end user (an “inventory stocking order”). At the time that a stocking reseller places an inventory stocking order, no product licenses are shipped by us to the stocking reseller; rather, the stocking reseller’s inventory is credited with the number of licenses purchased and the stocking reseller can resell (issue) any number of licenses from their inventory at any time. Upon receipt of an order to issue a license(s) from a stocking reseller’s inventory (a “draw down order”), we will ship the license(s) in accordance with the draw down order’s instructions. We defer recognition of revenue from inventory stocking orders until the underlying licenses are sold and shipped to the end user, as evidenced by the receipt and fulfillment of the stocking reseller’s draw down order, assuming all other revenue recognition criteria have been met.

 

There are no rights of return granted to resellers or other purchasers of our software products.

 

Revenue from maintenance contracts is recognized ratably over the related contract period, which generally ranges from one to five years.

 

Intellectual property license agreements provide for the payment of a fully paid licensing fee in consideration for the grant of a one-time, non-exclusive license to manufacture and/or sell products covered by patented technologies we own. Generally, the execution of these license agreements also provides for the release of the licensee from certain past and future claims, and the dismissal of any pending litigation between us and the licensee. Pursuant to the terms of these license agreements, we have no further obligation with respect to the grant of the license, including no express or implied obligation to maintain or upgrade the patented technologies, or provide future support or services to the licensee. As such, the earnings process is complete upon the execution of the license agreement, and revenue is recognized upon execution of the agreement, and the determination that collectability is probable.

 

All of our software and intellectual property licenses are denominated in U.S. dollars.

 

Deferred Rent

 

The lease for our office in Campbell, California, contains free rent and predetermined fixed escalations in our minimum rent payments. We recognize rent expense related to this lease on a straight-line basis over the term of the lease. We record any difference between the straight-line rent amounts and amounts payable under the lease as part of deferred rent in current or long-term liabilities, as appropriate.

 

Incentives that we received upon entering into the lease agreement are recognized on a straight-line basis as a reduction to rent over the term of the lease. We record the unamortized portion of these incentives as a part of deferred rent in current or long-term liabilities, as appropriate.

 

Postemployment Benefits (Severance Liability)

 

Nonretirement postemployment benefits, including salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits and continuation of benefits such as health care benefits, are recognized as a liability and a loss when it is probable that the employee(s) will be entitled to such benefits and the amount can be reasonably estimated. The cost of termination benefits recognized as a liability and an expense includes the amount of any lump-sum payments and the present value of any expected future payments. During the three and nine-month periods ended September 30, 2012, we recorded $0 and $721,800 of severance expense, respectively, including stock compensation expense, of which an aggregate of $336,800 is reflected as a severance liability, at September 30, 2012. Such liability was recorded as a result of a separation agreement and a release with Robert Dilworth in connection with Mr. Dilworth’s resignation as our Chief Executive Officer and as a member of our board of directors. No such liability was recorded during either of the three or nine-month periods ended September 30, 2011.

 

 

Software Development Costs

 

We capitalize software development costs incurred from the time technological feasibility of the software is established until the software is available for general release, in accordance with GAAP. Such capitalized costs are subsequently amortized as costs of revenue over the shorter of three years or the remaining estimated useful life of the product.

Research and development costs and other computer software maintenance costs related to the software development are expensed as incurred.

 

Long-Lived Assets

 

Long-lived assets are assessed for possible impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable, whenever we have committed to a plan to dispose of the assets or, at a minimum, annually. Typically, for long-lived assets to be held and used, measurement of an impairment loss is based on the fair value of such assets, with fair value being determined based on appraisals, current market value, comparable sales value, and discounted future cash flows, among other variables, as appropriate. Assets to be held and used (which assets are affected by an impairment loss) are depreciated or amortized at their new carrying amount over their remaining estimated life; assets to be sold or otherwise disposed of are not subject to further depreciation or amortization. No such impairment charge was recorded during either of the three or nine-month periods ended September 30, 2012 or 2011.

 

Allowance for Doubtful Accounts

 

We maintain an allowance for doubtful accounts that reflects our best estimate of potentially uncollectible trade receivables. The allowance is based on assessments of the collectability of specific customer accounts and the general aging and size of the accounts receivable.  We regularly review the adequacy of our allowance for doubtful accounts by considering such factors as historical experience, credit worthiness, and current economic conditions that may affect a customer’s ability to pay. We specifically reserve for those accounts deemed uncollectible. We also establish, and adjust, a general allowance for doubtful accounts based on our review of the aging and size of our accounts receivable.  The following table sets forth the details of the Allowance for Doubtful Accounts for the three and nine-month periods ended September 30, 2012 and 2011:

 

Concentration of Credit Risk

 

For the three-month period ended September 30, 2012, we had three customers who accounted for approximately 10.1%, 8.7%, and 7.9%, respectively, of sales during such period. As of September 30, 2012, the accounts receivable balances attributable to these customers represented approximately 19.9%, 1.2%, and 15.7%, respectively, of reported net accounts receivable.

 

For the three-month period ended September 30, 2011, we had three customers who accounted for approximately 18.9%, 8.4%, and 7.7%, respectively, of sales during such period. As of September 30, 2011, the accounts receivable balances attributable to these customers represented approximately 0.0%, 6.7%, and 21.2%, respectively, of reported net accounts receivable.

 

For the nine-month period ended September 30, 2012, we had three customers who accounted for approximately 10.5%, 9.4%, and 8.1%, respectively, of sales during such period. As of September 30, 2012, the accounts receivable balances attributable to these customers represented approximately 0.0%, 0.1%, and 19.9%, respectively, of reported net accounts receivable.

 

For the nine-month period ended September 30, 2011, we had three customers who accounted for approximately 9.0%, 8.7%, and 6.6%, respectively, of sales during such period. As of September 30, 2011, the accounts receivable balances attributable to these customers represented approximately 0.0%, 21.2%, and 17.5%, respectively, of reported net accounts receivable.

 

 

Derivative Financial Instruments

 

We currently do not have a material exposure to either commodity prices or interest rates; accordingly, we do not currently use derivative instruments to manage such risks. We evaluate all of our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. All derivative financial instruments are recognized in the balance sheet at fair value. Changes in fair value are recognized in earnings if they are not eligible for hedge accounting or in other comprehensive income if they qualify for cash flow hedge accounting.

 

Fair Value of Financial Instruments

 

The fair value of our accounts receivable, accounts payable and accrued liabilities approximate their carrying amounts due to the relative short maturities of these items.

The fair value of our warrants are determined in accordance with the Financial Account Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 820, “Fair Value Measurement,” which establishes a fair value hierarchy that prioritizes the assumptions (inputs) to valuation techniques used to price assets or liabilities that are measured at fair value. The hierarchy, as defined below, gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The guidance for fair value measurements requires that assets and liabilities measured at fair value be classified and disclosed in one of the following categories:

 

·

Level 1: Defined as observable inputs, such as quoted (unadjusted) prices in active markets for identical assets or liabilities.

 

·

Level 2: Defined as observable inputs other than quoted prices included in Level 1. This includes quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

·

Level 3: Defined as unobservable inputs to the valuation methodology that are supported by little or no market activity and that are significant to the measurement of the fair value of the assets or liabilities. Level 3 assets and liabilities include those whose fair value measurements are determined using pricing models, discounted cash flow methodologies or similar valuation techniques, as well as significant management judgment or estimation.

 

As of September 30, 2012, all of our $6,167,100 Warrants Liability reported at fair value was categorized as Level 3 inputs (See Note 4).

 

Comprehensive Income

 

In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2011-05 “Presentation of Comprehensive Income” (ASU 2011-05). The adoption of ASU 2011-05 did not impact the Unaudited Condensed Consolidated Financial Statements for the three or nine-month periods ended September 30, 2012 or 2011 as comprehensive loss was the same as net loss.

 

Recent Accounting Pronouncements

 

In July 2012, FASB issued ASU No. 2012-02 “Intangibles – Goodwill and Other” (ASU 2012-02). The objective of ASU 2012-02 is to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance among long-lived asset categories. ASU 2012-02 is effective for fiscal years beginning after September 15, 2012. Early adoption is permitted. We currently have no goodwill or indefinite-lived intangible assets; accordingly, we do not anticipate that adoption of ASU 2012-02 will have a material impact on our results of operations, cash flows or financial position.

 

Restricted Cash

 

Restricted cash, received by us relates to payroll related taxes that was paid by certain employees, who filed a section 83(b) election in regard to a stock award granted to them by us, which will be remitted by us to the appropriate taxing authorities on their behalf.

 

 

3.	Property and Equipment

 

Aggregate property and equipment depreciation and amortization expense was $25,900 during the three-month period ended September 30, 2012 and $67,100 during the nine-month period ended September 30, 2012. During the nine-month period ended September 30, 2012, we capitalized the following costs: equipment; $86,200, furniture; $167,000 and leasehold improvements; $147,500.  Also during the period we disposed of assets that had a cost value of $45,800.

 

4.	Warrants Liability

 

The exercise price of the warrants we issued in September 2011 in conjunction with the private placement of our common stock (the “2011 Private Placement”) and the warrants we issued in October 2011 in connection with our engagement of an intellectual property firm (ipCapital Group) could, in certain circumstances, be reset to below-market value. Accordingly, we have concluded that such warrants are not indexed to our common stock; therefore, the fair value of the warrants was recorded as a liability upon their issuance. Changes in fair value of the 2011 Private Placement warrants liability are recognized in other expense and changes in the fair value of the warrants issued to ipCapital are recognized as a component of general and administrative expense in the condensed consolidated statement of operations.

 

We used a binomial pricing model to determine the fair value of our warrants as of September 30, 2012, the balance sheet date, using the following assumptions:

 

 

The following table is a reconciliation of the warrants liability measured at fair value using significant unobservable inputs (Level 3) for the nine months ended September 30, 2012:

 

 

The Company used a binomial pricing model to determine the fair value of its warrants as of September 1, 2011, their issuance date, and September 30, 2011, the balance sheet date, using the following assumptions:

 

 

The following table is a reconciliation of the warrants liability measured at fair value using significant unobservable inputs (Level 3) for the nine months ended September 30, 2011:

 

 

 

5.	Severance Liability

 

On April 12, 2012, we entered into a separation agreement and a release with Robert Dilworth in connection with Mr. Dilworth’s resignation as our Chief Executive Officer and as a member of our board of directors. Subject to the terms of the separation agreement, effective April 20, 2012 (the “Release Effective Date”) we paid or provided Mr. Dilworth the following:

 

·

On the Release Effective Date, Mr. Dilworth’s outstanding unvested options became fully vested and exercisable, and his outstanding vested options were modified to extend the exercise period. All options will remain exercisable until the earlier of (i) the expiration dates of each of such options or (ii) the date that is 30 months after the Release Effective Date. The number of shares of common stock issuable upon exercise of such outstanding options is 2,000,000. We recognized $172,800 of non-cash stock-based compensation expense during the nine-month period ended September 30, 2012, as a result of the modification of Mr. Dilworth’s outstanding stock options.  No expense was recognized during the three- month period ended September 30, 2012 as a result of the modifications.

 

·

On the Release Effective Date, Mr. Dilworth was granted an option to purchase 500,000 shares of common stock at an exercise price of $0.20 per share. Such option has a term of 30 months from the date of grant and will vest and become exercisable at a rate of 62,500 shares per quarter commencing on July 1, 2012. We recognized $64,700 of non-cash stock-based compensation expense during the nine-month period ended September 30, 2012 as a result of the issuance of this stock option to Mr. Dilworth.  No expense was recognized during the three-month period ended September 30, 2012 as a result of the issuance.

 

·

We paid Mr. Dilworth $15,000 as reimbursement for a portion of his legal fees in connection with negotiation of the separation agreement and the release.

 

Mr. Dilworth’s participation in the Key Employee Severance Plan and the Director Severance Plan was automatically terminated on the Release Effective Date. In addition, the separation agreement contains confidentiality and non-disparagement provisions subject to the terms set forth therein. Pursuant to the terms of the release, Mr. Dilworth provided as of the Release Effective Date a release of claims in connection with his employment and resignation. As a result of the separation agreement, we recognized an aggregate $721,800 of additional operating expenses in the three months ended June 30, 2012 and the nine-month periods ended September 30, 2012, as summarized above.

 

We estimated the fair value of each stock-based award granted during the three-month and nine month periods ended September 30, 2012 and 2011 as of the respective dates of grant, using a binomial model with the assumptions set forth in the following table:

 

 

Expected volatility is based on the historical volatility of our common stock over the expected option term period ended on the last business day of each respective quarterly reporting period. The estimated annualized forfeiture rate was based on an analysis of historical data and considered the impact of events such as work force reductions we carried out in previous years. The expected term of our stock-based awards was based on historical award holder exercise patterns and considered the market performance of our common stock and other items. The estimated exercise factor was based on an analysis of historical data; historical exercise patterns; and a comparison of historical and current share prices. The approximate risk free interest rate was based on the implied yield available on U.S. Treasury issues with remaining terms equivalent to our expected term on our stock-based awards. We do not anticipate paying dividends on our common stock for the foreseeable future.

 

We discounted the initial aggregate remaining cash salary continuation payments due Mr. Dilworth and medical premiums to be paid on his behalf of $458,600 under the terms of the separation agreement using a 14.3% discount factor, with such factor representing our average cost of capital, which we derived by analyzing the costs we incurred in the various private placement transactions we have closed since 2004.

 

The following table summarizes the salary continuation and medical coverage payments during the three and nine-month periods ended September 30, 2012.

 

 

6.	Deferred Rent

As of September 30, 2012 deferred rent was:

Deferred rent expense represents the remaining balance of the aggregate free rent we received from the landlord and escalations that are being recognized over the life of the lease as a component of rent expense. Deferred rent benefit relates to the unamortized portion of the leasehold improvements provided to us by our landlord (i.e., incentives) that we are recognizing on a straight-line basis as a reduction to rent expense over the term of the lease.

We had no deferred rent as of December 31, 2011.

 

		Three Months Ended September 30,								Nine Months Ended September 30 ,
Statement of Operations Classification		2012				2011				2012				2011
Costs of revenue		$	6,700			$	300			$	17,100			$	2,300
Selling and marketing expense			33,200				(6,200	)			84,800				2,700
General and administrative expense			71,000				28,700				404,700				46,300
Research and development expense			82,600				14,000				252,400				20,100
		$	193,500			$	36,800			$	759,000			$	71,400

 

The following table presents summaries of the status and activity of our stock option awards for the three-month period ended September 30, 2012.

 

 

The following table presents summaries of the status and activity of our stock option awards for the nine-month period ended September 30, 2012.

 

 

The weighted average fair value of options granted during the three and nine-month periods ended September 30, 2012 was $0.13 and $0.16, respectively.  Of the options outstanding as of September 30, 2012, 5,975,242 were vested, 7,309,111 were estimated to vest in future periods and 238,008 were estimated to be forfeited prior to their vesting.

 

All options are exercisable immediately upon grant. Options vest, generally, ratably over a 33-month period commencing in the fourth month after the grant date. We have the right to repurchase common stock issued upon the exercise of an option upon an optionee’s termination of service to us prior to full vesting at the option’s exercise price.

 

The following table presents summaries of the status and activity of our restricted stock awards for the three and nine-month periods ended September 30, 2012.

 

		Number of Shares				Weighted Average  Grant Date Fair Value				Weighted Average Remaining Recognition  Period (Years)				Unrecognized Compensation Cost  Remaining
Outstanding – December 31, 2011 and June 30, 2012			—			$	—
Awarded			3,964,500				0.18
Released			—				—
Forfeited			—				—
Outstanding – September 30, 2012			3,964,500			$	0.18				2.87			$	693,800

 

As of September 30, 2012, there was approximately $1,202,200 of total unrecognized compensation cost, net of estimated forfeitures, related to stock-based compensation attributable to all the outstanding stock options and restricted stock awards. That cost is expected to be recognized over a weighted-average period of approximately twenty six months.

 

8.

Revenue

 

Revenue for the three-month and nine-month periods ended September 30, 2012 and 2011 was:

 

 

9.	Cost of Revenue

Cost of revenue for the three-month periods ended September 30, 2012 and 2011 was:

 

 

Cost of revenue for the nine-month periods ended September 30, 2012 and 2011 was:

 

 

 

10.	Capitalized Software Development Costs

Capitalized software development costs consisted of the following:

 

 

Amortization of capitalized software development costs is a component of costs of revenue. Capitalized software development costs amortization aggregated $41,500 and $124,600 during the three and nine-month periods ended September 30, 2012, respectively, and $40,300 and $102,300 for the corresponding periods of the prior year, respectively.  We recorded $0 and $8,800 of capitalized software development costs during the three-month periods ended September 30, 2012 and 2011, respectively, and $0 and $209,900 of capitalized software development costs during the nine-month periods ended September 30, 2012 and 2011, respectively.  Such costs capitalized during 2011 were incurred in the development of GO-Global Cloud for Windows and GO-Global iPad Client.

 

11.	Stockholders’ Equity

 

Stock Repurchase Program

 

During each of the three-month and nine-month periods ended September 30, 2012 and 2011, we did not repurchase any of our common stock under the terms of our Board-approved $1,000,000 stock repurchase program (“stock repurchase program”). As of September 30, 2012, approximately $782,600 remained available for future purchases under this program. We are not obligated to repurchase any specific number of shares and the stock repurchase program may be suspended or terminated at our discretion.

 

12.	Commitments and Contingencies

 

Effective May 30, 2012, we relocated our corporate headquarters from Santa Cruz, California to Campbell, California. We currently occupy 4,413 square feet of office space in Campbell under a five-year lease that expires June 30, 2017. The following table sets forth the minimum lease payments we will be required to make throughout the remainder of this lease:

 

 

During September 2012, we reached settlement and licensing agreements that effectively ended all of our then on-going intellectual property litigation.  Having been approached by the respective counter-parties to each of our lawsuits, and in consultation with our board of directors, we determined that it was in our best long-term strategic interests to settle each lawsuit in order to move forward and shift our focus to our software products, including our new product initiatives.  As a result of such determination, we paid $311,000 in aggregate settlement fees during the three-month period ended September 30, 2012.  We do not intend to pursue intellectual property litigation as an integral part of our strategy to fund our future operations.  See Note 17 to our Notes to Unaudited Condensed Consolidated Financial Statements.

 

13.	Supplemental Disclosure of Cash Flow Information

 

We did not disburse any cash for the payment of interest expense during either of the three or nine-month periods ended September 30, 2012 or 2011.

 

We disbursed $1,400 and $500 for the payment of income taxes during the three-month periods ended September 30, 2012 and 2011, respectively, and $3,100 and $2,000 for the payment of income taxes during the nine-month periods ended September 30, 2012 and 2011, respectively. All such disbursements were for the payment of foreign income taxes related to the operation of our Israeli subsidiary, GraphOn Research Labs Ltd.

 

During the nine-month period ended September 30, 2012, we capitalized $130,900 of property and equipment for which no cash was disbursed. We recorded $104,100 of such amount to long term liabilities – deferred rent, $24,000 of such amount to current liabilities – deferred rent, and the balance to accounts payable.  During the nine-month period ended September 30, 2011, we capitalized $1,700 of stock-based compensation expense for which no cash was disbursed, as a component of capitalized software development costs. We did not capitalize any software development costs during the nine-month period ended September 30, 2012.

 

 

During the nine-month period ended September 30, 2011 we incurred costs associated with discontinued intellectual property operations activities of $106,800 of which $103,000 was disbursed, and the balance reported as component of accounts payable.  During the nine-month period ended September 30, 2012 we incurred costs associated with the discontinued intellectual property activities of $468,400 for which $432,800 was disbursed, and the balance reported as a component accounts payable.

 

14.	Earnings (Loss) Per Share

 

Earnings or loss per share is calculated by dividing the net income or loss for the period by the weighted average number of shares of common stock outstanding during the period. Diluted earnings or loss per share (“Diluted EPS”) is calculated by dividing the net income or loss for the period by the total of the weighted average number of shares of common stock outstanding during the period plus the effects of any dilutive securities. Diluted EPS considers the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of such potential shares of common stock would have an anti-dilutive effect. During all periods presented in our Condensed Consolidated Statements of Operations, potentially dilutive securities included shares of common stock potentially issuable upon exercise of stock options. During the three and nine-month periods ended September 30, 2012 and 2011, potentially dilutive securities also included common stock potentially issuable upon exercise of warrants. Diluted EPS excludes the impact of potential issuance of shares of common stock related to our stock options in periods in which the exercise price of the stock option is greater than the average market price of our common stock during such periods.

 

For the nine-month periods ended September 30, 2012 and 2011, 36,997,357 and 33,013,311 shares of common stock equivalents, respectively, were excluded from the computation of dilutive loss per share since their effect would be antidilutive. For the three-month periods ended September 30, 2012 and 2011, 36,997,357 and 33,013,311 shares of common stock equivalents, respectively, were excluded from the computation of dilutive loss per share since their effect would be antidilutive.

 

15.	Segment Information

 

 

We will continue to pursue the intellectual property initiatives we have undertaken in conjunction with our relationship with ipCapital, however we believe that these initiatives do not comprise a reporting segment as the intent of these initiatives is to support and leverage our current software products and those in development.

 

 

Software revenue by country for the three and nine-month periods ended September 30, 2012 and 2011 was as follows.

 

 

 

 

16.	Related Party Transactions

 

Tamalpais Partners LLC

 

Steven Ledger, the Chairman of our Board of Directors, is the founder and managing partner of Tamalpais Partners LLC, a business consulting firm. On February 1, 2012, we entered into a consulting agreement with Tamalpais under which Tamalpais will provide us with advisory services focused on capital and business issues, including assistance on raising capital, mergers, acquisitions, business development and investor relations/positioning. We pay Tamalpais $6,000 per month during the term of this agreement, which runs for one year, beginning February 1, 2012. During the three-month period ended September 30, 2012, we paid Tamalpais $18,000 for services rendered, and $48,000 for the nine-month period ended September 30, 2012.  We had no amounts due them as of September 30, 2012.

 

ipCapital Group, Inc.

 

On October 11, 2011, we engaged ipCapital Group, Inc., an affiliate of John Cronin, who is one of our directors, to provide assistance in the execution of our strategic decision to significantly strengthen, grow, and commercially exploit our intellectual property assets. On January 30, 2012, we entered into a third addendum to our engagement agreement with ipCapital to provide additional services related to identifying and extracting additional new inventions, and to draft new invention disclosures, among other opportunities. We anticipate that costs for these additional services, if performed, will in the aggregate, be between $5,000 and $60,000. Should we choose to utilize all of the services contained within the engagement agreement, as amended, the total amount of all services provided under the engagement agreement, as amended, would, in the aggregate, be $540,000.

 

During the three and nine-month periods ended September 30, 2012, we received an aggregate of $37,300 and $167,300, respectively, of new invention extraction and disclosure drafting services from ipCapital of which we paid $130,000. The unpaid balance of $37,300 was reported in accounts payable as of September 30, 2012. We received no such services from ipCapital due either the three or nine-month period ended September 30, 2011.

In addition to the fees we agreed to pay ipCapital for its services, we issued ipCapital a five-year warrant to purchase up to 400,000 shares of our common stock at an initial price of $0.26 per share. The warrant vests for 200,000 of these shares in three equal annual installments, with the first installment having become fully vested on October 11, 2012. The remaining 200,000 shares will fully vest upon the completion to our satisfaction of all services that we have requested ipCapital perform on our behalf under the engagement agreement, prior to the signing of the amendments. We believe that these fees, together with the issuance of the warrant, constitute no greater compensation than we would be required to pay an unaffiliated person for substantially similar services.

 

17.	Discontinued Operations

 

 

We will continue to make significant investments in our intellectual property during the remainder of 2012 and throughout 2013.  We believe such investments will be an asset that will leverage our product strategy and protect our long-term growth strategies.  We do not intend to pursue intellectual property litigation as an integral part of our strategy to fund our future operations.

 

As of September 30, 2012 and 2011, all of our patents were fully amortized.  Additionally, we have characterized the NES patents as “held for sales” and will be pursuing reasonable sales opportunities for such patents as they become known to us.