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EX-32.1 - SAJAN INCv201858_ex32-1.htm
EX-31.2 - SAJAN INCv201858_ex31-2.htm
EX-32.2 - SAJAN INCv201858_ex32-2.htm
EX-10.2 - SAJAN INCv201858_ex10-2.htm
EX-31.1 - SAJAN INCv201858_ex31-1.htm
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010 or

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________________ to ___________________

Commission File Number: 000-51560
 

 
Sajan, Inc.
(Exact name of registrant as specified in its charter)

Delaware
41-1881957
(State of incorporation)
(I.R.S. Employer Identification No.)
   
625 Whitetail Blvd., River Falls, Wisconsin
54022
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number, including area code: (715) 426-9505
 


Former name, former address and former fiscal year, if changed since last report: N/A

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. x Yes    ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     ¨ Yes    ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definition of “accelerated filer,” large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨      Accelerated filer  ¨      Non-accelerated filer  ¨         Smaller reporting company  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨ Yes    x No

As of  November 12, 2010, the registrant had 16,009,331 shares of common stock, $0.01 par value per share, outstanding.

 

 

Sajan, Inc.

Table of Contents
 
   
Page
PART I. FINANCIAL INFORMATION
   
Item 1. Financial Statements
 
3
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
23
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
38
     
Item 4T. Controls and Procedures
 
38
     
PART II. OTHER INFORMATION
   
Item 1. Legal Proceedings
 
39
     
Item 1A. Risk Factors
 
40
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
40
     
Item 3. Defaults Upon Senior Securities
 
40
     
Item 4. Removed and Reserved
 
40
     
Item 5. Other Matters
 
40
     
Item 6. Exhibits
 
41
     
SIGNATURES
 
42

 
2

 
 
PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.

Sajan, Inc., Subsidiaries and Affiliate (River Valley Business Center, LLC) (1)
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
  
September
30, 2010
(Unaudited)
  
  
December 31,
 2009
  
Assets
           
             
Current assets:
           
Cash and cash equivalents
 
$
2,170,171
   
$
120,493
 
Restricted cash
   
1,000,000
     
-
 
Accounts receivable, net of allowance of $15,000 and $10,000
   
2,910,495
     
2,871,005
 
Deferred tax asset, net of allowance
   
680,336
     
660,170
 
Unbilled services
   
497,430
     
256,697
 
Prepaid expenses and other current assets
   
168,343
     
38,534
 
Total current assets
   
7,426,775
     
3,946,899
 
                 
Property and equipment, net
   
750,534
     
3,349,556
 
                 
Other assets:
               
Intangible assets, net
   
218,807
     
336,983
 
Capitalized software development costs, net
   
574,443
     
877,117
 
Other assets, net
   
27,797
     
24,294
 
Total other assets
   
821,047
     
1,238,394
 
                 
Total assets
 
$
8,998,356
   
$
8,534,849
 
                 
Liabilities and Stockholders’ Equity
               
                 
Current liabilities:
               
Checks issued in excess of bank balance
 
$
-
   
$
113,048
 
Current portion of capital lease obligations
   
1,715
     
10,514
 
Current portion of long-term debt
   
-
     
105,159
 
Note payable – related party
   
1,000,000
     
292,973
 
Note payable – indemnification escrow
   
1,000,000
     
-
 
Line of credit
   
-
     
1,000,000
 
Accounts payable
   
1,459,276
     
901,213
 
Accrued interest – related party
   
48,000
     
23,415
 
Accrued compensation and benefits
   
728,190
     
505,084
 
Other accrued liabilities
   
832,919
     
747,671
 
Deferred revenue
   
258,307
     
336,458
 
Total current liabilities
   
5,328,407
     
4,035,535
 
                 
Long-term liabilities:
               
Long-term debt, net of current portion
   
-
     
2,412,194
 
Tax liability – uncertain tax position
   
19,687
     
19,687
 
Deferred tax liability – long-term
   
563,845
     
605,497
 
Total long-term liabilities
   
583,532
     
3,037,378
 
Total liabilities
   
5,911,939
     
7,072,913
 
                 
Commitments and contingencies
               
                 
Stockholders’ equity:
               
Preferred stock, $.01 par value, 10,000,000 shares authorized and no shares issued outstanding
   
-
     
-
 
Common stock, $.01 par value, 35,000,000 shares authorized, 16,009,331 issued and outstanding at September 30, 2010 and 18,000,000 shares authorized and 5,686,250 issued and outstanding at December 31, 2009
   
160,093
     
56,863
 
Additional paid-in capital
   
6,271,315
     
1,919,161
 
Accumulated deficit
   
(3,315,665
)
   
(709,393
)
Accumulated other comprehensive loss:
               
Foreign currency adjustment
   
(29,326
)
   
(22,896
)
Stockholders’ equity
   
3,086,417
     
1,243,735
 
                 
Non-controlling interest in equity affiliate
               
(River Valley Business Center, LLC) and subsidiary
   
-
     
218,201
 
Total equity
   
3,086,417
     
1,461,936
 
Total liabilities and stockholders’ equity
 
$
8,998,356
   
$
8,534,849
 

See notes to condensed consolidated financial statements.

(1)
MathStar and Sajan consolidated as of February 24, 2010.
River Valley Business Center, LLC deconsolidated as of February 23, 2010.

 
3

 
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

   
Three months ended
   
Nine months ended
 
   
September 30,
2010
   
September 30,
2009
   
September 30,
2010
   
September 30,
2009
 
Revenues:
                       
Translation and consulting income
 
$
3,809,968
   
$
2,790,848
   
$
10,433,551
   
$
8,029,772
 
Technology income
   
314,696
     
276,559
     
943,697
     
715,218
 
Product income
   
50,506
     
19,289
     
120,473
     
35,105
 
Other income
   
34,075
     
16,786
     
54,046
     
50,358
 
Total revenues
   
4,209,245
     
3,103,482
     
11,551,767
     
8,830,453
 
                                 
Cost of revenues
                               
Cost of revenues (exclusive of depreciation and amortization included below)
   
2,563,706
     
1,613,422
     
6,614,335
     
4,799,579
 
                                 
Gross Profit
   
1,645,539
     
1,490,060
     
4,937,432
     
4,030,874
 
                                 
Operating expenses:
                               
Sales and marketing
   
838,906
     
748,835
     
2,571,394
     
2,449,906
 
Research and development
   
327,184
     
175,179
     
1,288,376
     
511,606
 
General and administrative
   
816,533
     
600,312
     
2,994,117
     
1,354,546
 
Depreciation and amortization
   
217,009
     
252,145
     
682,748
     
675,978
 
Total operating expenses
   
2,199,632
     
1,776,471
     
7,536,635
     
4,992,036
 
                                 
Loss from operations
   
(554,093
)
   
(286,411
)
   
(2,599,203
)
   
(961,162
)
                                 
Other income (expense):
                               
Interest expense
   
(21,843
)
   
(52,563
)    
(90,259
)
   
(155,638
)
Interest and other income
   
8,866
     
-
     
36,422
     
20,140
 
Other expense
   
(883
   
(23,132
   
(18,262
)
   
(33,150
)
Total other income (expense)
   
(13,860
   
(75,695
   
(72,099
)
   
(168,648
)
                                 
Net loss before income taxes and non-controlling interests in subsidiary and affiliate
   
(567,953
)
   
(362,106
)
   
(2,671,302
)
   
(1,129,810
)
                                 
Income tax benefit
   
-
     
(79,663
)
   
(62,311
)
   
(248,557
)
                                 
Net loss before non-controlling interest
   
(567,953
)
   
(282,443
)
   
(2,608,991
)
   
(881,253
)
Less Non-controlling interest in subsidiary
   
-
     
(7,869
   
7,284
     
(5,738
Less Non-controlling interest in affiliate (River Valley Business Center)
   
-
     
(8,722
)
   
(4,565
   
21,752
 
Net loss attributable to Sajan, Inc. and subsidiaries
 
$
(567,953
)
 
$
(299,034
)
 
$
    (2,606,272
)
 
$
(865,239
)
Loss per common share – Basic and diluted
 
$
(0.04
)
 
$
(0.05
)
 
$
(0.18
)
 
$
(0.15
)
Weighted average shares outstanding – Basic and diluted
   
16,009,331
     
5,686,250
     
14,658,770
     
5,686,250
 
 
See notes to condensed consolidated financial statements.

(1)
MathStar and Sajan consolidated as of February 24, 2010.
River Valley Business Center, LLC deconsolidated as of February 23, 2010.

 
4

 
 
Sajan, Inc., Subsidiaries and Affiliate (River Valley Business Center, LLC) (1)
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
 
   
Nine months ended
 
   
September 30, 2010
   
September 30, 2009
 
Cash flows from operating activities:
           
Net loss
  $ (2,608,991 )   $ (881,253 )
Adjustments to reconcile net loss to net cash from operating activities:
               
Amortization of capitalized software costs
    383,346       382,600  
Amortization of license costs and debt issuance costs
    120,227       91,009  
Depreciation
    179,037       202,606  
Stock-based compensation expense
    516,915       96,000  
Deferred taxes
    (61,818 )     (209,512 )
Change in allowance for doubtful accounts
    5,000       -  
Decrease (increase) in current assets:
               
Accounts receivable
    (150,862 )     1,013,154  
Change in unbilled services
    (240,733 )     (107,721 )
Prepaid expenses and other current assets
    (119,499 )     17,879  
Increase (decrease) in current liabilities:
               
Accounts payable
    587,297       (22,495 )
Accrued interest – related party
    48,031       985  
Accrued compensation and benefits
    223,106       3,778  
Other accrued liabilities
    (556,013 )     182,231  
Deferred revenue
    (78,151 )     72,875  
Net cash flows provided by (used in) operating activities
    (1,753,108 )     842,136  
                 
Cash flows from investing activities:
               
Purchases of property and equipment
    (136,680 )     (174,176 )
Purchases of intangible assets
    (2,051 )     (354,586 )
Capitalized software development costs
    (82,517 )     (316,956 )
Cash acquired in merger transaction
    5,472,000       -  
Payment for security deposit
    (15,406 )     -  
Payment to dissenter
    (366,943 )     -  
Deconsolidation of affiliate
    (98,730 )     -  
Net cash flows provided by (used in) investing activities
    4,769,673       (845,718 )
                 
Cash flows from financing activities:
               
Checks issued in excess of cash
    (113,048     -  
Net proceeds on line of credit
    -       150,000  
Payments on note payable – related party
    (285,645 )     (12,710 )
Payments on merger costs
    (540,254     -  
Payments on capital lease obligation
    (8,799     (38,229 )
Payments on mortgage long-term liability
    (14,571 )     (64,082 )
Net cash flows provided by (used in) financing activities
    (962,317 )     34,979  
                 
Net increase in cash and cash equivalents
    2,054,248       31,397  
                 
Effect of exchange rate changes in cash
    (4,570 )     -  
                 
Cash and cash equivalents – beginning of period
    120,493       381,501  
                 
Cash and cash equivalents – end of period
  $ 2,170,171     $ 412,898  
                 
Cash paid for interest, net of amortization of loan fees
  $ 69,409     $ 155,638  
Non-cash investing and financing transactions:
               
Note payable – related party acquired in merger
  $ 1,000,000     $ -  
Short-term note payable – indemnification escrow and restricted cash acquired in merger
  $ 1,000,000     $ -  
Reduction in line of credit via merger transaction
  $ 1,000,000     $ -  
Dissenter accrual acquired in merger transaction
  $ 364,000     $ -  

See notes to condensed consolidated financial statements.

(1)
MathStar and Sajan consolidated as of February 24, 2010.
River Valley Business Center, LLC deconsolidated as of February 23, 2010.

 
5

 
 
Sajan, Inc., Subsidiaries and Affiliate (River Valley Business Center, LLC)
 
Notes to Condensed Consolidated Financial Statements
 
1.
Nature of Business and Summary of Significant Accounting Policies –

Nature of Business / Basis of Presentation

Sajan, Inc. (the “Company” or “Sajan”) provides language translation and technology solutions to companies located throughout the world, particularly in the technology, consumer products, medical and life sciences, financial services, manufacturing, government, and retail industries that are selling products into global markets.  The Company is located in River Falls, Wisconsin. In 2009, we established Sajan Software Ltd (“Sajan Software”), which is based in Dublin, Ireland. The Ireland facility serves as both a Global Language Service Center and is home to Sajan Software, the producer of Sajan’s technology tools. Sajan India Software Private Limited (“Sajan India”), based in Delhi, India, houses our software development center.  In 2010 we also established a Global Language Service Center in Spain, Sajan Spain S.L A (“Sajan Spain”)., to serve the European market.  All of these operations are wholly-owned subsidiaries of Sajan.

Sajan, Inc. was originally organized as a Wisconsin corporation in March 1998, reorganized as a Minnesota corporation in October 2001, and reorganized as a Delaware corporation in February 2010 as part of the Merger (as such term is defined in Note 2 to the Notes to Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q).

Interim Financial Information
 
The condensed consolidated balance sheet as of December 31, 2009, which has been derived from audited consolidated financial statements, and the unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial information. Accordingly, certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with GAAP have been omitted pursuant to such rules and regulations. Operating results for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010 or any other period. The accompanying consolidated financial statements and related notes should be read in conjunction with the audited consolidated financial statements of the Company, and notes thereto, contained in our Current Report on Form 8-K filed with the SEC on February 24, 2010.  The financial information furnished in this report is unaudited and reflects all adjustments which are normal recurring adjustments and, which in the opinion of management, are necessary to fairly present the results of the interim periods presented in order to make the consolidated financial statements not misleading.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Sajan, Inc. and its wholly-owned subsidiaries, Sajan Software, Sajan India and Sajan Spain, from the effective date of their acquisition or formation. The non-controlling interest in subsidiary on the consolidated balance sheets and consolidated statements of operations represents the 6% of Sajan India that was held by third parties during 2009 and part of 2010. This non-controlling interest was reacquired during the third quarter of 2010.

 
6

 

River Valley Business Center, LLC (River Valley), is a limited liability company that owns real estate leased to Sajan. River Valley is owned by Shannon Zimmerman and Angela Zimmerman, each of whom is an executive officer and director of the Company, and beneficial owners of the Company’s outstanding voting common stock. Prior to the Merger, the consolidated financial statements included both Sajan, its subsidiaries and River Valley (affiliate) based on a requirement for variable interest entities to be consolidated by their primary beneficiary when certain circumstances exist. The primary beneficiary is the entity that holds the majority of the beneficial interests in the variable interest entity (VIE). A VIE is a legal entity used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. At December 31, 2009 and up until the date of the Merger, Sajan was the primary beneficiary of River Valley, requiring consolidation with the Company.

All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.

The Merger is a reconsideration event for the lease between Sajan and River Valley.  Based on the change in ownership, the Company is no longer considered the primary beneficiary of the lease with River Valley. The pro forma unaudited consolidated financial statements are presented with the deconsolidation of the affiliate.  (See Note 2)

Accounts Receivable

The Company extends unsecured credit to customers in the normal course of business. The Company provides an allowance for doubtful accounts when appropriate, the amount of which is based upon a review of outstanding receivables, historical collection information, and existing economic conditions, on an individual customer basis. Normal accounts receivable are due 30 days after issuance of the invoice. Receivables are written off only after all collection attempts have failed, and are based on individual credit evaluation and specific circumstances of the customer. Accounts receivable have been reduced by an allowance for uncollectible accounts of approximately $15,000 at September 30, 2010 and $10,000 at December 31, 2009. Management believes all accounts receivables in excess of the allowance are fully collectible. The Company does not accrue interest on accounts receivable.

Loss Per Common Share

Basic earnings (loss) per share is computed based on the weighted average number of common shares outstanding. Diluted earnings (loss) per share is computed based on the weighted average number of common shares outstanding adjusted by the number of additional shares that would have been outstanding had the potentially dilutive common shares been issued. Potentially dilutive shares of common stock include unexercised stock options and warrants. Basic per share amounts are computed, generally, by dividing net income (loss) by the weighted average number of common shares outstanding. Diluted per share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless their effect is anti-dilutive, thereby reducing the loss or increasing the income per common share. In calculating diluted weighted average shares and per share amounts, we included stock options and warrants (see Note 9) with exercise prices below average market prices, for the respective fiscal years in which they were dilutive, using the treasury stock method. The Company calculated the number of additional shares by assuming the outstanding stock options and warrants were exercised and that the proceeds from such exercises were used to acquire common stock at the average market price during the year.  For both the three months and nine months ended September 30, 2010 and 2009, we excluded options to purchase 1,168,748 and 729,375 shares and warrants to purchase 628,008 and 102,875 shares from the diluted weighted average share outstanding calculation as the effect of these options is anti-dilutive. The effect of all options and warrants outstanding during the three and nine months ended September 30, 2010 and 2009 was anti-dilutive.

 
7

 
 
A reconciliation of the denominator in the basic and diluted income or loss per share is as follows:

 
Three Months
 
Three Months
 
 
Ended
 
Ended
 
 
September 30, 2010
 
September 30, 2009
 
Numerator:
       
Net loss attributable to Sajan, Inc. and Subsidiaries
  $ (567,953 )   $ (299,034 )
Denominator:
               
Weighted average common shares outstanding - basic
    16,009,331       5,686,250  
Weighted average common shares outstanding – diluted
    16,009,331       5,686,250  
Loss per common share – basic & diluted
  $ (0.04 )   $ (0.05 )
 
 
Nine Months
 
Nine Months
 
 
Ended
 
Ended
 
 
September 30, 2010
 
September 30, 2009
 
Numerator:
       
Net loss attributable to Sajan, Inc. and Subsidiaries
  $ (2,606,272 )   $ (865,239 )
Denominator:
               
Weighted average common shares outstanding - basic
    14,658,770       5,686,250  
Weighted average common shares outstanding – diluted
    14,658,770       5,686,250  
Loss per common share – basic & diluted
  $ (0.18 )   $ (0.15 )

Capitalized Software Development Costs

Sajan capitalizes software development costs incurred during the application development stage related to new software or major enhancements to the functionality of existing software that is developed solely to meet the entity’s internal operational needs and when no substantive plans exist or are being developed to market the software externally. Costs capitalized include external direct costs of materials and services and internal payroll and payroll-related costs. Any costs during the preliminary project stage or related to training or maintenance are expensed as incurred. Capitalization ceases when the software project is substantially complete and ready for its intended use. The capitalization and ongoing assessment of recoverability of development costs requires considerable judgment by management with respect to certain external factors, including, but not limited to, technological and economic feasibility, and estimated economic life.
 
When the projects are ready for their intended use, the Company amortizes such costs over their estimated useful lives of three years. Capitalized software amortization expense for the three and nine months ended September 30, 2010 was $120,863 and $383,346, respectively, and for the three and nine months ended September 30, 2009 was $144,512 and $382,600, respectively.  Estimated amortization expense for capitalized software costs are expected to be approximately $112,000 for the remainder of 2010 and, $332,000, and $130,000 for the years ending December 31, 2011, and 2012, respectively.
  
Capitalized software development costs consist of the following as of September 30, 2010 and December 31, 2009, respectively:

   
September 30, 2010
   
December 31, 2009
 
Capitalized software development costs
  $ 2,567,000     $ 2,483,356  
Less accumulated amortization
    (1,992,557 )     (1,606,239 )
Total capitalized software development costs, net
  $ 574,443     $ 877,117  

 
8

 

Stock-Based Compensation

The Company measures and recognizes compensation expense for all stock-based compensation at fair value. The Company recognizes stock-based compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term.  For the three and nine months ended September 30, 2010, total stock-based compensation expense was approximately $60,000 ($0.00 per share) and $517,000 ($0.04, per share), respectively.  For the three and nine months ended September 30, 2009, total stock-based compensation expense was approximately $16,000 ($0.00 per share) and $96,000 ($0.02 per share), respectively.   As of September 30, 2010, there was approximately $565,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Company’s 2004 Long-Term Incentive Plan. That cost is expected to be recognized over a weighted-average period of three years. This is an estimate based on options currently outstanding, and therefore this projected expense could be more in the future.

The Company’s determination of fair value of share-based compensation awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of variables. These variables include, but are not limited to; the Company’s expected stock price volatility, and actual and projected stock option exercise behaviors and forfeitures. An option’s expected term is the estimated period between the grant date and the exercise date of the option. As the expected term increases, the fair value of the option and the compensation cost will also increase. The expected-term assumption is generally calculated using historical stock option exercise data; however the Company does not have historical exercise data to develop such an assumption. As a result, the Company determined the expected term assumption using the simplified expected-term calculation as provided in SEC Staff Accounting Bulletin 107.

In 2009, the Company calculated expected volatility for stock options and awards using an industry index and comparable companies, as the Company was a privately owned company and did not have sufficient information to utilize a historical volatility. The Company considered specific companies with comparable operations along with the Dow Jones software and computer services small cap technology index to be representative of the Company’s size and industry and has used the historical closing total return values of that index for the three years prior to the date of grant to estimate volatility.  Subsequent to the Merger and going forward, the Company calculates expected volatility for stock options and awards using its own stock price. Management expects and estimates substantially all director and employee stock options will vest, and therefore the forfeiture rate used is zero.  The risk-free rates for the expected terms of the stock options are based on the U.S. Treasury yield curve in effect at the time of grant.

In determining the compensation cost of the options granted, the fair value of each option grant in the quarter ended September 30, 2010 has been estimated on the date of grant using the Black-Scholes option pricing model, and the weighted average assumptions used in these calculations are summarized as follows:

   
Three Months Ended September 30,
 
   
2010
         
Risk-free interest rate
    1.3 %        
Expected life of options granted
 
7 Yrs
         
Expected volatility range
    62.8 %        
Expected dividend yield
    - %        

Using the Black-Scholes option pricing model, management has determined that the options issued have a weighted-average grant date fair value for the three months ended September 30, 2010 of $0.87 per share.  There were no stock option grants in the three month period ended September 30, 2009.

 
9

 

In determining the compensation cost of the options granted, the fair value of each option grant in the nine months ended September 30, 2010 and 2009, respectively, has been estimated on the date of grant using the Black-Scholes option pricing model, and the weighted average assumptions used in these calculations are summarized as follows:

   
Nine Months Ended September 30,
 
   
2010
   
2009
 
Risk-free interest rate
    1.3 %     2.52 %
Expected life of options granted
 
6.8 Yrs
   
7 Yrs
 
Expected volatility range
    62.9 %     24.07 %
Expected dividend yield
    - %     - %

Using the Black-Scholes option pricing model, management has determined that the options issued have a weighted-average grant date fair value for the nine months ended September 30, 2010 and 2009 of $0.87 and $1.06 per share, respectively.

Revenue Recognition

The Company derives revenues from language translation services, software licenses, subscription hosting services, professional services, maintenance fees or a combination thereof. The Company has three primary services models, each of which is described below.

Technology Enabled Service Model

In our Technology Enabled Service Model, the Company provides all of the customer’s language translation requirements. Services within the Technology Enabled Service Model include: language translation, account management, graphic design services, technical, consulting and professional services.  Language translation services are generally billed on a “per word” basis and other services are billed on a per hour rate basis.

In accordance with Financial Accounting Standard Board (“FASB”) and SEC accounting guidance on revenue recognition, the Company considers revenue earned and realizable at the time services are performed and amounts are earned. Sajan considers amounts to be earned when (1) persuasive evidence of an arrangement has been obtained; (2) services are delivered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the fee charged for services rendered and products delivered and the collectability of those fees. The Company recognizes revenue for translations managed on a standard “per word” basis at the time the translation is completed. The Company recognizes revenue for professional services when the services have been completed in accordance with the statement of work.

Managed Service Model

The Managed Service Model has five elements: language translation services, software license fees, post-contract customer support, transaction fees, and professional services. We recognize revenue as earned through transaction fees delivered through the Application Service Provider (ASP) and associated fees for professional services including, implementation, training, and project management provided to customers with installed systems.

 
10

 

For ASP and other hosting arrangements, the Company evaluates whether the customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty and whether the customer can feasibly maintain the software on the customer’s hardware or enter into another arrangement with a third party to host the software. If we determine that the customer has the contractual right to take possession of our software at any time during the hosting period without significant penalty and can feasibly maintain the software on the customer’s hardware or enter into another arrangement with a third party to host the software, we recognize the license, professional services and hosting services revenues. For ASP and other hosting arrangements that do not meet the criteria for recognition, the Company accounts for the elements considering the multiple element arrangements using all applicable facts and circumstances, including whether (i) the element has stand-alone value, (ii) there is a general right of return and (iii) the revenue is contingent on delivery of other elements. The Company allocates revenue to each element of the arrangement that qualifies for treatment as a separate element based on vendor-specific objective evidence (“VSOE”), and if VSOE is not available, third party evidence, and if third party evidence is unavailable, estimated selling price. For professional services associated with ASP and hosting arrangements the Company determines do not have stand-alone value to the customer or are contingent on delivery of other elements, the Company recognizes the services revenue ratably over the term of the applicable agreement.

The Company bills service fees either on a time and materials basis or on a fixed-price schedule. In general, the Company’s consulting services are not essential to the functionality of the software. The Company’s software products are fully functional upon delivery and implementation and generally do not require any significant modification or alteration for customer use. Customers purchase the Company’s consulting services to facilitate the adoption of the Company’s technology and may dedicate personnel to participate in the services being performed, but may also decide to use their own resources or appoint other professional service organizations to provide these services. Software products are billed separately from professional services. The Company recognizes revenue from consulting services as services are performed.

Licensed Software Model

In the Licensed Software Model, clients utilize GCMS, Authoring Coach, X-Content, or a combination thereof, to self-perform their translation services.  This technology-only solution provides the Company’s clients with the ability to independently operate translation services without assistance from the Company’s professionals.  The Licensed Software Model has two elements: (1) license fees, and (2) post-contract customer support (maintenance).

The Company recognizes revenue from license fees, based on VSOE when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collectability is probable at the time the software application is shipped to the client.

The Company’s customers typically purchase maintenance annually.  Maintenance prices are based on a percentage of the product license fee. Customers purchasing maintenance receive product upgrades, Web-based technical support and telephone hot-line support. Unspecified product upgrades are not provided without the purchase of maintenance. The Company typically has not granted specific upgrade rights in its license agreements. Specified undelivered elements are allocated a relative fair value amount within a license agreement and the revenue allocated for these elements is deferred until delivery occurs.

Other

Sajan’s agreements with its customers may informally provide the customer with a limited time period following delivery during which the Company will attempt to address any non-conformity to previously agreed upon objective specifications relating to the work. Revenue is recognized as services are delivered in accordance with the terms of the agreement with the customer, are not contingent, and are earned.

Revenues recognized in excess of billings are recorded as unbilled services. Billings in excess of revenues recognized are recorded as deferred revenues until revenue recognition criteria are met.

Cost of Revenues

Cost of revenues consists primarily of expenses incurred for translation services provided by third parties as well as salaries and associated employee benefits for personnel related to client projects. Cost of revenues excludes depreciation and amortization which is presented separately as a component of operating expenses.  Depreciation and amortization expense for the three and nine months ended September 30, 2010 was $217,009 and $682,748, respectively, and for the three and nine months ended September 30, 2009 was $252,145 and $675,978, respectively.

 
11

 

Foreign Currency Translation

The functional currency for payment of accounts receivable for certain of the Company’s foreign customers is the local currency of the country in which the customer’s operations are based. Realized foreign currency translations gains or losses arising from exchange rate fluctuations on balances denominated in foreign currencies and unrealized foreign currency transaction gains or losses relating to accounts receivable balances were not material for the three and nine months ended September 30, 2010 and 2009.  Foreign assets and liabilities are translated using the year end exchange rates. Results of operations are translated using average rates throughout the year. Translation gains and losses are accumulated as a separate component of equity.

Income Tax

Current income taxes are recorded based on statutory obligations for the current operating period for the various countries in which the Company has operations.

Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences, and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

River Valley is a limited liability company, and, in lieu of corporate income taxes, the members will separately account for their pro rata shares of River Valley’s income, losses, deductions and credits. Accordingly, no provision for River Valley for federal or Wisconsin income taxes was recorded for the three months ended September 30, 2010 and 2009.  As of the date of the Merger, River Valley was deconsolidated.
 
Use of Estimates

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 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. Actual results could differ from those estimates.

Recent Accounting Pronouncements

In February 2010, we adopted changes issued by the FASB to consolidation accounting and reporting. These changes establish accounting and reporting for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This guidance defines a noncontrolling interest, previously called a minority interest, as the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. These changes require, among other items, that a noncontrolling interest be included in the consolidated statement of financial position within equity separate from the parent’s equity; that consolidated net income be reported at amounts inclusive of both the parent’s and noncontrolling interest’s shares and, separately, that the amounts of consolidated net income attributable to the parent and noncontrolling interest be included on the consolidated statement of operations; and if a subsidiary is deconsolidated, that any retained noncontrolling equity investment in the former subsidiary be measured at fair value and a gain or loss be recognized in net income based on such fair value. Other than the change in presentation of noncontrolling interests, the adoption of these changes had no impact on the consolidated financial statements. The presentation and disclosure requirements of these changes were applied retrospectively.

 
12

 

In January 2010, the FASB issued amendments to guidance on fair value measurements and disclosures that will require inclusion of the amount of significant transfers in and out of levels 1 and 2 fair value measurements and the reasons for the transfers. In addition, the reconciliation for level 3 activity will be required on a gross rather than net basis. An amendment related to the level of disaggregation in determining classes of assets and liabilities and disclosures about inputs and valuation techniques was also issued. The amendments are effective for annual or interim reporting periods beginning after December 15, 2009, except for the requirement to provide the reconciliation for level 3 activity on a gross basis, which will be effective for fiscal years beginning after December 15, 2010. The Company is currently assessing the impact of the amendments and does not expect the adoption of this amendment guidance to have a material impact on its consolidated financial statements.

In October 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-13, Revenue Recognition (605), Multiple Deliverable Arrangements, a consensus of the FASB Emerging Issues Task Force, which addresses the accounting for products or services (deliverables) separately rather than as a combined unit.  ASU 2009-13 also changes the definitions of VSOE.  The effective date for ASU 2009-13 is September 30, 2010, although early adoption is permitted.  The Company adopted ASU 2009-13 on January 1, 2010.  There was not a material impact on the Company’s consolidated financial statements.

2.
Reverse Merger Transaction –

Pursuant to an Agreement and Plan of Merger (the “Merger Agreement”) dated January 8, 2010, by and among MathStar, Inc., a Delaware corporation, and Sajan, Inc. a privately held Minnesota corporation whose business is providing language translation technology and service; Garuda Acquisition, LLC, a wholly-owned subsidiary of MathStar, now known as Sajan, LLC; and Thomas Magne, solely in his capacity as agent for the holders of common stock of Sajan, Inc.  Sajan, Inc. was merged with and into Garuda Acquisition, LLC, (the “Merger”).   Garuda Acquisition, LLC (“Garuda”) was the surviving entity in the Merger and subsequently changed its name to Sajan, LLC. As a result of the Merger, Sajan became a wholly-owned subsidiary of MathStar. MathStar will continue the business of Sajan and operate as a provider of language translation technology and service under the Sajan name. The Merger was closed and effective on February 23, 2010.

At closing, MathStar paid $6,100,000 in cash, of which $5,100,000 was paid to existing stockholders of Sajan.   The Merger Agreement provided for the remaining $1 million to be placed in an escrow account with an escrow agent, which funds would be utilized to fulfill the indemnification obligations of the pre-Merger Sajan stockholders through February 23, 2011.  This amount is presented as restricted cash and a note payable – indemnification escrow of $1 million on the consolidated balance sheets.  The Company may request claims against the escrow as defined in the escrow agreement.  The remaining balance of the $1 million escrow at February 23, 2011 will be distributed to the pre-Merger Sajan stockholders as defined in the escrow agreement and the Merger Agreement.

As a result of the Merger, Sajan’s 5,573,742 shares of common stock were exchanged for 6,827,734 shares of MathStar common stock, or an exchange of 1 Sajan common share for 1.225 MathStar common shares. Options to purchase Sajan common stock issued under Sajan’s 2001 Stock Option Plan and certain non-plan options and warrants were converted into options and warrants to purchase MathStar common stock and will remain outstanding as options and warrants to purchase shares of MathStar common stock.  Immediately after the closing of the Merger, the former stockholders of Sajan, Inc. owned approximately 43% of the outstanding shares of MathStar common stock. At the time of Merger, 112,500 shares, valued at $364,000 per management’s determination of fair value at the time of the Merger, were recorded for dissenter shares.  (See Note 11)

Pursuant to the Merger, Sajan merged with and into Garuda, with Garuda as the surviving entity. For accounting purposes, Sajan is treated as the continuing reporting entity that acquired MathStar because Sajan obtained effective control of MathStar as a result of the Merger. This determination was based on the following facts: Sajan stockholders will have a large minority interest in the combined entity, the governing board will consist of a majority of Sajan board members, and the composition of the senior management will be Sajan’s management team. Under this method of accounting, the recognition and measurement provisions of the accounting guidance for business combinations do not apply and, therefore, there is no recognition of goodwill or other intangible assets. Instead, the acquisition has been treated as the equivalent of Sajan issuing stock for the net monetary assets of MathStar, primarily cash, which are stated at their carrying value. Because of the Merger, the historical results in this and future Quarterly Reports on Form 10-Q and future Annual Reports on Form 10-K will represent those of Sajan.

 
13

 

At the time of the Merger, the following amounts are being allocated from MathStar’s net monetary assets and liabilities to Sajan:

Cash and cash equivalents
 
$
5,472,000
 
Restricted cash
   
1,000,000
 
Prepaid expenses and other assets
   
22,000
 
Accounts payable and accrued liabilities
   
(652,000
)
Notes payable – related party
   
(1,000,000
)
Net monetary assets
 
$
4,842,000
 

Cash and cash equivalents, restricted cash, prepaid expenses and other assets, accounts payable: The tangible assets and liabilities were valued at their respective carrying amounts by MathStar, except for adjustments to accrued lease obligations, necessary to state such amounts at their estimated fair values at the effective date of the Merger.

Accrued liabilities:  Sajan retains the accrued lease obligations under MathStar’s non-cancellable operating leases, pursuant to which total rent payments are projected to be $358,000 and $257,000 for the years ending December 31, 2010 and 2011, respectively.   In addition, Sajan retains MathStar’s non-cancellable long-term commitment with Synopsys, Inc. for the purchase of design tools. Payments under this agreement will be $151,000 during the year ending December 31, 2010.

Merger transaction costs: In connection with the Merger, MathStar incurred transaction costs of $543,000, including financial advisory, legal, accounting and due diligence costs, which were recorded as Merger transaction expenses on the consolidated statement of operations for the year ended December 31, 2009.  Sajan allocated approximately $540,000 of Merger-related costs which were allocated to additional paid-in capital for the three months ended March 31, 2010.

Change in Control

Upon consummation of the Merger, MathStar experienced a change in control, with the former stockholders of Sajan, Inc. acquiring approximately 43% ownership of the outstanding shares of MathStar common stock.  MathStar was incorporated under Minnesota law in April 1997, and was reincorporated under Delaware law on June 14, 2005. During the three months ended June 30, 2008, MathStar curtailed its operations as its Board of Directors evaluated strategic alternatives. Immediately before the effective date of the Merger, MathStar was a “shell company,” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended, having no or nominal operations, and assets consisting solely of cash and cash equivalents.  The Merger had the effect of causing MathStar to cease being a shell company as of the effective date of the Merger.

Pro Forma Financial Statements

Since the Merger was effective February 23, 2010, there is not a change in the March 31, 2010 balance sheet and not a material change in the income statement for the three and nine months ended September 30, 2010.  The unaudited pro forma information for the year ended December 31, 2009 does not purport to represent what the Company’s results of operations would actually have been if such transactions in fact had occurred at such date or to project the Company’s results of future operations.

The accompanying unaudited pro forma consolidated combined financial statements are presented as if Sajan and MathStar had been operating as a combined entity. The unaudited pro forma combined consolidated balance sheet as of December 31, 2009 presents the financial position assuming the Merger had occurred on December 31, 2009. The unaudited pro forma combined consolidated statement of operations for the year ended December 31, 2009 presents the results of operations assuming the acquisition had occurred on January 1, 2009. All material adjustments to reflect the acquisition are set forth in the column “Pro Forma Adjustments”. The pro forma data is for informational purposes only and may not necessarily reflect future results of operations and financial position or what the results of operations or financial position would have been had Sajan and MathStar been operating as a combined entity for the specific periods.

 
14

 

(RIVER VALLEY BUSINESS CENTER, LLC)
UNAUDITED PRO FORMA COMBINED BALANCE SHEETS
(in thousands, except per share data)
December 31, 2009
 


  
  
Sajan, Inc.,
Subsidiaries,
and
Affiliate
  
  
Deconsolidation of
River Valley
Business Center,
LLC
  
  
Sajan, Inc.
and
Subsidiaries
  
  
MathStar,
Inc.
  
Cash  Pay
Out
Adjustments
  
  
Pro Forma
Adjustments
  
  
Record
MathStar
Net
Assets
Adjustments
  
  
Unaudited
Pro
Forma
Total
  
                                               
Assets
                                             
                                               
Current assets:
                                             
Cash and cash equivalents
 
$
120
   
$
91
   
$
29
   
$
13,050
 
$
(5,100
)
A
$
61
 
B,C
$
5,472
 
F,J
$
5,562
 
Restricted cash
   
-
     
-
     
-
     
-
   
-
     
-
     
1,000
 
E
 
1,000
 
Accounts receivable, net of allowance of $10,000
   
2,871
     
30
     
2,841
     
-
   
-
     
-
     
-
     
2,841
 
Deferred tax asset
   
660
     
-
     
660
     
-
   
-
     
-
     
-
     
660
 
Unbilled services
   
257
     
-
     
257
     
-
   
-
     
-
     
-
     
257
 
Other current assets
   
39
     
110
     
(71
)
   
54
   
-
     
-
     
7
 
F
 
(64
)
Total current assets
   
3,947
     
231
     
3,716
     
13,104
   
(5,100
)
   
61
     
6,479
     
10,256
 
                                                               
Property and equipment, net
   
3,350
     
2,571
     
779
     
-
   
-
     
-
     
-
     
779
 
                                                               
Other assets:
                                                             
Intangible assets, net
   
337
     
-
     
337
     
-
   
-
     
-
     
-
     
337
 
Capitalized software development costs, net
   
877
     
-
     
877
     
-
   
-
     
-
     
-
     
877
 
Other assets, net
   
24
     
24
     
-
     
16
   
-
     
-
     
15
 
F
 
15
 
Total other assets
   
1,238
     
24
     
1,214
     
16
   
-
     
-
     
15
     
1,229
 
                                                               
Total assets
 
$
8,535
   
$
2,826
   
$
5,709
   
$
13,120
 
$
(5,100
)
 
$
61
   
$
6,494
   
$
12,264
 
                                                               
Liabilities and Stockholders' Equity
                                                             
                                                               
Current liabilities:
                                                             
Checks issued in excess of bank balance
 
$
113
   
$
-
   
$
113
   
$
-
 
$
-
   
$
-
   
$
-
   
$
113
 
Current portion of capital lease obligations
   
11
     
-
     
11
     
-
   
-
     
-
     
-
     
11
 
Current portion of long-term debt
   
105
     
105
     
-
     
-
   
-
     
-
     
-
     
-
 
Cash paid out at closing
   
-
     
-
     
-
     
-
   
(5,100
)
A
 
-
     
-
     
-
 
Note payable - related party
   
293
     
31
     
262
     
-
   
-
     
(262
)
C
 
1,000
 
E
 
1,000
 
Note payable - indemnification
   
-
     
-
     
-
     
-
   
-
     
-
     
1,000
 
E
 
1,000
 
Line of credit
   
1,000
     
-
     
1,000
     
-
   
-
     
-
     
(1,000
)
J
 
-
 
Accounts payable
   
901
     
51
     
850
     
37
   
-
     
-
     
28
 
F
 
878
 
Accrued interest - related party
   
23
     
-
     
23
     
-
   
-
     
(23
)
C
 
-
     
-
 
Accrued compensation and benefits
   
505
     
-
     
505
     
-
   
-
     
-
     
-
     
505
 
Other accrued liabilities
   
748
     
-
     
748
     
702
   
-
     
(461
)
D
 
775
 
F,K
 
1,062
 
Deferred revenue
   
337
     
6
     
331
     
-
   
-
     
-
     
-
     
331
 
Total current liabilities
   
4,036
     
193
     
3,843
     
739
   
(5,100
)
   
(746
)
   
1,803
     
4,900
 
                                                               
Long-term liabilities:
                                                             
Long-term debt, net of current portion
   
2,412
     
2,412
     
-
     
-
   
-
     
-
     
-
     
-
 
Other long-term liability
   
20
     
-
     
20
     
213
   
-
     
-
     
213
 
F
 
233
 
Deferred tax liabilities
   
605
     
-
     
605
     
-
   
-
     
-
     
-
     
605
 
Total long-term liabilities
   
3,037
     
2,412
     
625
     
213
   
-
     
-
     
213
     
838
 
                                                               
Total liabilities
   
7,073
     
2,605
     
4,468
     
952
   
(5,100
)
   
(746
)
   
2,016
     
5,738
 
                                                               
Stockholders' equity:
                                                             
Common stock
   
57
     
-
     
57
     
92
   
-
     
-
     
103
 
F,K
 
160
 
Additional paid-in capital
   
1,919
     
-
     
1,919
     
155,940
   
-
     
263
 
H,I
 
4,375
 
F,K
 
6,557
 
Accumulated deficit
   
(709
)
   
-
     
(709
)
   
(143,864
)
 
-
     
544
 
B,D,H,I
 
-
     
(165